Perhaps you have heard or read about the "inverted yield curve". This situation has created significant opportunities to refinance debt at lower interest rates since mid to long term rates are lower than short term rates. Allow me to elaborate.
Let's start with a few facts:
First, the current prime rate is 8.25%.
Second, the five and ten year US Treasury rates (as of 2/28/07) are 4.46% and 4.50%, respectively.
Third, a significant number of businesses have some level of permanent working capital support in the form outstandings on their line of credit.
OK, now let's look at this a little closer. A number of companies have "permanent" or long term borrowings on their lines of credit. This is a dollar figure that they may clean down to during the year, but never seem to be able to pay off. These companies are usually paying a floating interest rate of Prime or Prime + something on the line of credit. Therefore the rate they are paying is probably 8.25% or higher. These companies may also own assets such as equipment or real estate that may not be fully leveraged.
Banks usually base interest rates for fixed term loans, such as commercial mortgages, as a certain percentage above the comparable US Treasury at the time of closing. The average mark up is around 2% (unrated - non investment grade). Given the facts listed above a 10 year fixed rate would equate to 6.50%.
Therefore, if a company has the ability to increase the debt level on their real estate they can lock in a long term rate lower than the rate on their line of credit. So why not try to term it out?
As an example, Company A has a $5 million line of credit with approximately $1 million in "permanent" borrowings on the line, and also owns a $2.66 million commercial building with a $1 million commercial mortgage. By increasing the commercial mortgage to $2 million and paying down the line of credit to zero, they can save at least 1.75% on the amount converted from line to mortgage. On top of that, if the company hasn't refinanced the commercial mortgage in the last five years they are probably paying a higher interest rate than the 6.50% in this illustration.
This is the beauty of the inverted yield curve. TAKE ADVANTAGE OF IT WHILE YOU CAN!
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