Balancing higher interest rates, impacts on capital costs and liquidity returns for Tribes

The change in interest rates intensifies existing challenges Native American communities have historically faced in accessing capital. Increased interest rates have made it crucial that Tribes work with a trusted banking advisor to evaluate the environment and pinpoint the right strategy.

Mike Fesl and Ben Rechkemmer, KeyBanc Capital Markets experts in financial solutions for Native American Tribes, suggest points to consider in an elevated interest rate environment for capital raise and investment return issues.
 

Capital raise and liquidity return considerations

The high interest rate environment is affecting borrowers and depositors. Fesl, Director of Key’s Native American Financial Services, says that the rate environment is part of every conversation he is having with clients.

Borrowers want to understand how the rate environment is impacting capital costs and their borrowing capacity, while depositors are looking at the increased rate of return and exploring ways to use liquidity to their benefit. Key is working with both to either mitigate the impact of rates on capital raises or maximize the benefits of higher returns on liquidity. Returns on deposits and short-term liquidity have increased significantly and therefore those balances, and the types of financial instruments Tribes are using to manage cash, should be reviewed strategically. 

“We have taken a proactive approach by increasing the deposit rates for existing clients as the Fed increases their target rate, and we are actively pursuing new clients with meaningful deposit rates as well,” says Fesl. “We are very competitive, and we are hearing positive feedback from existing clients and prospects that we are winning price comparisons.”
 

Capital raise alternatives

Borrowers are beginning to see the negative impact of higher interest rates and how the cost of capital can reduce borrowing capacity to the point of impacting project scope or viability.

For example, several major casino resort projects are on hold due to the higher cost of development, including the cost of capital as well as supply chain issues. Such delays have prompted Tribes to evaluate alternative options.

One potential way to work around these obstacles is for borrowers to take a phased financing approach to new development, which means funding one portion of the project at a time.

“We are seeing borrowers taking a phased approach instead of pursuing an expansion project all at once,” says Fesl. “That allows them to be more strategic about the level of debt to incur and add flexibility to the borrowing costs and repayment method.”

Fesl says the strategy is effective for the right projects because borrowers can take advantage of available financing options to jump-start a project, and then leverage the completed portions of the project to secure capital for the next phase. Ultimately, this is an opportunity to push projects through that would otherwise be stalled because of higher costs or limited access to capital.  

Yet the phased approach can have total cost and full project development implications to consider, according to Rechkemmer, Managing Director at KeyBanc Capital Markets. “It is a balancing act of deciding if phasing a project is a good alternative,” he says.

The best way to secure capital for a project is to work with an experienced banking advisor to execute the optimal phased strategy and determine how best to break up the project. “Borrowers should understand that the wrong strategy could lead to high project costs and higher long-term borrowing costs.”
 

Tapping the benefits of an inverted yield curve

Borrowers have another option in the current market. The yield curve is currently inverted, meaning that short-term borrowing rates are higher than long-term borrowing rates.

This is an unusual phenomenon that won’t last forever, but it allows borrowers to lock in long-term financing at a lower rate than short-term financing — particularly borrowers who can take advantage of tax-exempt financing and place long-term bond instruments.

“It is a benefit that some of our clients are seeing today, and we are encouraging them to take advantage where they can,” says Fesl.

Leveraging an inverted yield curve by looking to the bond market for financing solutions can be an excellent alternative in a banking market with extremely volatile rates.

With an inverted yield curve, borrowers have an opportunity to look to the bond or institutional markets to access capital at favorable rates and tenors, where there might be more demand. “That is an important underlying theme now,” says Rechkemmer.
 

Could 105(l) Leases provide a new source of capital?

The 105(l) Lease program is an agreement between the Bureau of Indian Affairs, the Bureau of Indian Education or Indian Health Services, and a Tribe to reimburse facility costs when the facility is used for programs, activities, or services included in the Indian Self-Determination and Education Assistance Act. This includes the financing costs of the building, depreciation costs, utilities, and capital expenditures for upkeep. This is a major advantage for Tribes, who would otherwise carry most of these costs on their own.

Currently, Congress has appropriated “such sums as necessary to fully fund all leases.” While funding for the program is discretionary, the conversation about whether this will become a mandatory federal obligation is currently happening in Congress.

Should that happen, Tribes would have even greater leveraging power to secure debt for multiple projects and not be concerned about appropriation risk.

“There would be little to no restrictions of what the Tribe could do with the debt and repayment is secured by revenues coming from the federal government,” explains Fesl.

Key is actively encouraging clients to enter into105(l) leases to receive facility cost compensation that they are owed and develop the ability to capitalize on those funds.  
 

Selecting the right alternatives in a high interest rate environment

The current high interest rate environment has created challenges for many borrowers. Tribes are particularly exposed — but there are solutions. By understanding the market dynamics, Tribes can secure the capital they need to pursue expansion projects and governmental infrastructure for their communities. 

Key is one of the nation’s leading capital originators with proven experience working with Tribes.
 

For help getting your deals to the finish line

Contact Ben Rechkemmer, Managing Director, Head of Native American Financial Services, at 425-709-4509 or ben.rechkemmer@key.com.

Visit: key.com/nativeamerican.