We have had an amazing run of stable interest rates. This has meant that I could create a business plan and have good confidence that the interest rate that I used would still be good a year or two later when it’s time to finance a project. That took one big worry off the plate because it hasn’t always been like this.
Historically interest rates have gone up and down and this period of steady rates is the exception in the way that interest rates have bounced during my career. Just within the last decade there were times where the bond markets were in such turmoil that it was nearly impossible to float new bonds. For the past few years we’ve seen nearly the opposite and the bond houses I know have instead been decrying the lack of bond deals wanting to get financed.
It’s not surprising to see interest rates starting to swing a bit again. We are going through a big stock market correction that has investors spooked. And the first thing that spooked investors affect is the bond market. The municipal bond market sells almost entirely to wealthy individuals looking for a safe haven for money. And corporate bonds are sold to both wealthy individuals and big pools of money like pension funds and insurance companies. As those buyers liquidate stock holdings there is a big increase in demand for bonds. Bank rates are the last to change, but they react over time to changes in the corporate bond rates.
Interest rates really matter to fiber projects. A project that might be feasible at a low interest rate might become risky at a higher one. I can remember times in the past when floating a municipal bond deal was dependent on the interest rate that was being offered on the day the bonds went to market. Bond sellers would hire experts who would try choose the right time to sell new bonds. And on the morning when a bond was to go for market I’d be sitting waiting to plug in the interest rate and bond term being offered that day to make sure it was a good deal.
I certainly don’t hope for a return to those kind of crazy times because high or fluctuating interest rates can put the kibosh on many good projects that would have easily been funded in better times. But since the payment term for bonds is so long the interest rate matters a lot – fiber bonds might last for 25 or even 30 years and might not be able to be called and refinanced for 10 or 12 years.
This blog was prompted by reading an article about the widening spread between corporate bonds and US Treasury bills. The spread for the whole corporate bond industry has opened up to 770 points, meaning that the interest rate being charged for issuing corporate bonds is a full 7.7% higher than the rate being paid on T-bills. That different climbed 1.1% just during the month of January. We haven’t seen a full 1% change in interest rates during a month for quite a while. More worry came when I just read that a Federal Reserve survey of banks shows that the majority of banks see a tightening of credit for 2016.
Why do interest rates matter to a fiber project? Consider a $50M fiber project. I just did a calculation of a project of this size for a client. In that project an increase of 1% in interest rate cut long-term cash flows by over $5 million if funded with bank debt. But if funded by municipal bonds the impact was $15 million due to the longer payment term plus the fact that muni bonds usually borrow money to make the first few years of interest payments up front. While a 1% change in interest rates might not kill a project, it’s easy to see that changes of more than 1% can be deadly.
Maybe worse of all is that we have been sitting with interest rates at historic lows for a long time. This means that the only place that rates can go is higher. At least, when rates finally go higher, there is always a chance that they might drop. So I will start keeping my eyes on news of interest rates again. It seems one of our old worries is back on the plate again after a nice hiatus.