Key strategies to optimize corporate finance in a changing interest rate environment

In their most recent policy meeting on 21 September 2023, the 19 members of the Federal Reserve's rate-setting committee maintained the interest rate, signaling their optimism about curbing inflation to reach the 2% target without triggering a deep recession. The Fed's decision retained its benchmark rate at approximately 5.4%, with expectations of the first rate cut in 2024.

Amid this dynamic economic backdrop, large and resilient corporations continue to adapt their financing strategies to maximize benefits and effectively navigate the challenges posed by rising interest rates. Recognizing that there's no one-size-fits-all solution due to the varying trajectories and characteristics of each situation, corporations are increasingly tailoring their financing approaches on a case-by-case basis.

In this short article, we explore key strategies in the energy industry that can be implemented in this evolving financial landscape, underscoring the importance of considering the broader business context, market dynamics, financial strategies, capital structure, working capital approaches, and risk appetites.

1.????? Prepay loan installments and accelerate loan repayments:

Identify loans with maturity dates falling due within the next two to three years and assess the penalties for acceleration of repayments. Prioritize prepayment to minimize interest costs, albeit impacting the leverage ratio, while concurrently reducing borrowing costs, enhancing profitability, and improving the earnings per share (EPS) ratio.

2.????? Negotiate partial deferral of interest payments:

Especially beneficial for distressed projects, initiate negotiations with lenders for interest payment deferrals. This strategic move significantly alleviates immediate cash outflows.

3.????? Optimize cash position and investment portfolio:

Strategically consolidate cash reserves, cash positions, and any trapped cash and allocate more investments to financial assets. This proactive approach aims to generate higher returns from investment income, improving profitability and cash inflows.

4.????? Leverage opportunities in renewable energy:

Recognize that small and medium-sized enterprises (SMEs) engaged in renewable energy may struggle with elevated borrowing costs. Seize the opportunity for larger corporations to explore takeovers, expand into new markets, and bolster growth prospects.

5.????? Capitalize on supply chain disruptions and enhance vertical integration:

The disruptions caused by factors such as the COVID-19 pandemic, the Russia-Ukraine conflict, and geopolitical tensions between China and the West, have led to more pressure on the cost of raw materials increasing the cost of supplies and creating more pressure on suppliers to shift such cost to the consumers in a slowing global economy which is affecting the bottom line of suppliers besides the high borrowing costs.

Corporations can navigate these challenges by offering accelerated payment terms to suppliers, thereby negotiating improved pricing and delivery conditions.

In addition, pursue a strategic acquisition approach targeting key Original Equipment Manufacturers (OEMs) and Engineering, Procurement, and Construction (EPC) contractors. This bolsters large corporations' ability to implement long-term strategic projects while maintaining reasonable control over EPCs and OEMs.

6.????? Identify arbitrage opportunities in borrowing rates:

Explore disparities in borrowing rates across different markets. Implement Special Purpose Vehicles (SPVs) to secure loans in markets with lower interest rates, channeling funds towards premium projects.

7.????? Adjust funding sources:

Consider increasing capital from shareholders while reducing reliance on financial institutions over the next two to three years. This approach preserves control of equity holders.

8.????? Explore supportive government policies:

Monitor government policies and incentives that may be introduced to support energy companies facing increased borrowing costs. Seize opportunities to allocate additional capital and investments in such markets.

9.????? Consider Sharia Financing for new and existing projects:

Over the last decade, many new innovative products and solutions compliant with Sharia financing have been introduced for funding large-scale infrastructure projects. Assess the feasibility of utilizing Sharia-compliant financing for new ventures or refinancing existing projects. Unlike conventional financing, Sharia-compliant financing remains immune to interest rate fluctuations, as costs are determined by the specific terms and structures of the Islamic financial product in use.

Although a lender’s return is usually tied to a benchmark figure plus a margin, this benchmark figure is pre-agreed and structured in reference to a base rate such as LIBOR, Term SOFR, or any other index. Once the benchmark figure is agreed, it remains unchanged despite fluctuations in interest rates.

In conclusion, the evolving interest rate landscape demands a dynamic and tailored approach to corporate finance. By considering and implementing these strategies within the context of their unique business scenarios, corporations can not only maximize benefits but also effectively overcome the challenges posed by rising interest rates. Adaptability and a thorough understanding of the financial ecosystem remain key to success in this complex environment.