How Rising Interest Rates Can Present Opportunities for ESOP Companies

To combat inflation, the Federal Reserve continues to raise interest rates. While rate increases present challenges for all borrowers, it provides mature ESOP companies with an exceptional opportunity. Rising interest rates allow them to get higher yields from safer assets. In other words, less risk for the same reward. 

When interest rates were at 0%, companies with liquidity to spare could only get yields at 3-4% by investing in riskier assets, such as equities and lower-quality bonds. With rising interest rates, however, they can find the same yields through investing in safer assets: Treasury bills, high-quality corporate bonds, or bank money market and CD rates.

Mature ESOP companies are well-placed to take advantage of this opportunity because they’re more likely to have built up a substantial liquidity reserve. Companies with more than $500,000 in excess liquidity—or, more generally, enough to set aside six to twelve months to see returns—are best positioned to take in high yields from rising interest rates. 

There are several key opportunities for ESOP companies to explore to maximize the situation in this environment of rising interest rates.

Laddering Various U.S. Treasury Maturities

U.S. Treasury bonds are among the safest and most liquid investments available, and under current conditions, yields are notably high, even close to 4%. Laddering multiple maturities together—for instance, buying a 30, 60, and 90-day bond simultaneously—can lead to constantly maturing investments every month. ESOP companies can use these yields to help fund repurchase obligations or reinvest in potentially higher-yielding bonds as rates rise.  It’s also important to note that income from US Treasuries are not subject to state income taxes, further pushing up the yield in high tax states.

Laddering High-Quality Corporate Bonds

Just as you can get reliable yields from Treasury bonds, blue chip corporate bonds offer the potential for high returns over a long period. Compared to Treasury bonds, corporate bonds will offer higher yields, though without the backing of the U.S. dollar. Fundamentally, the strategy remains the same: ladder together multiple maturities, and get constantly maturing investments over several years, which you can use for repurchase obligations or reinvest in potentially higher-yielding bonds.

High Dividend Stocks Mixed with Bonds

This option presents the best of both worlds: a potentially high-yielding stock and a steady source of reliable returns through bond funds. Combining high dividend stocks from large, stable companies with a fixed income portfolio can offer high returns, especially while interest rates are high. Keep in mind that this option must receive clearance from your ESOP Trustee, and consult your investment policy if you have one.

Regular Bank Deposits, CDs and Overnight Money Market Sweep

This option requires opening an account with an FDIC-insured institution. For a sweep, when the funds in the account are in excess of its threshold, the money that goes over transfers into another account with a higher interest rate. This option has begun to show a sharp improvement in yields—in some cases, more than 2% for a sweep or a CD with a set term. It's a simple, straightforward approach, and you can put it into action almost immediately.

First American Bank can help

At First American Bank, we have extensive experience in working with ESOPs to develop their portfolios to maximize returns while also balancing risk to protect hard-earned assets. We understand how ESOPs can navigate the demands of liquidity and growth, and we bring that understanding to bear in helping you achieve your goals. Our full-service Wealth Management Group can provide investment options—from Treasury bonds to equities—to get you into a strong position to reach short- and long-term aims.