No matter where you look, interest rates are higher than just a few years ago.
The federal funds rate set by the Federal Reserve has increased from zero in early 2022 to 5.25%. Prime rates at banks have followed suit, jumping from around 3% to now more than 8%, adding to the cost of borrowing for businesses. The average 30-year fixed rate mortgage in the U.S. was less than 3% in 2021. It is above 7.6% now.
Of course, interest rates are higher for a reason. The Federal Reserve began hiking its rate in early 2022 in an attempt to combat inflation. Despite repeated increases over the past year, inflation is yet to return to the Fed’s 2% target.
With inflation remaining stubborn and a relatively strong job and labor market, many signs point to interest rates remaining higher for longer. The median projection as of September from members of the Federal Reserve’s Open Market Committee puts the appropriate federal funds rate at 5.1% in 2024. At least one member thought the rate should be more than 6.1%.
Perhaps at some point the Federal Reserve’s interest rate hikes will fully bite, slowing the economy and bringing inflation under control, but for now, businesses are faced with higher borrowing costs and the uncertainty of exactly when and by how much the economy could slow.
To get an idea of what higher rates will mean for the region’s economy and how businesses can navigate higher borrowing costs and uncertainty, BizTimes spoke with 10 bankers and economists from banks active in the southeastern Wisconsin market.
Economic impact
While the Federal Reserve may have been increasing interest rates since early 2022, it takes time for those increases to be felt throughout the economy.
Residential real estate has been hit as home buyers opt to keep the 3% rate they locked in a few years ago and limited inventory pushes prices higher. In southeastern Wisconsin, home sales are down 30% from 2021 through the first three quarters, according to data from the Greater Milwaukee Association of Realtors.
Elsewhere in the economy, Ivan Gamboa, senior vice president and chief commercial lending officer at Tri City National Bank, said the bank is starting to see a drop in spending from its own customers with debit card swipes down year over year.
Kevin Anderson, Milwaukee market president and president of business banking for Old National Bank, noted that across banks there has been some uptick in credit card and auto loan delinquency, especially for less-than-prime borrowers, as the support and liquidity created by stimulus programs wears off.
Higher rates will also continue to ripple through the commercial real estate landscape. Anderson noted there’s been some softening for investor-owned projects, which tend to be more price sensitive than other parts of the market and Jay Mack, president and CEO of Town Bank and Wisconsin market head for Wintrust, pointed out there’s an impact on development projects, too, with higher interest expenses making the numbers harder.
While there may be some signs of weakening in parts of the economy and obvious potential impacts, David Anderson, head of commercial banking for southern Wisconsin at BMO, emphasized the lag between the start of rate hikes and the full impact on businesses and consumers. For now, unemployment remains low, and people are able to continue consuming goods and services.
“By definition, you can’t have a recession when you have consumption,” he said.
One risk to the expectation that rates will remain “higher for longer” is that the economy could weaken faster than anyone expects. Gus Faucher, chief economist at PNC, said if a recession does hit, it is possible the Fed will start cutting rates aggressively. If growth slows but the economy doesn’t tip into recession, rates would likely stay higher.
As for where that leaves businesses, Faucher, who recently completed client presentations in Milwaukee and Chicago, said many have expressed optimism about their own company, especially having navigated a myriad of disruptions over the past three years.
“I think they’re cautious,” he said. “Demand is still strong.”
But Faucher also noted there is more uncertainty than even a month or two ago. War in the Middle East and a looming presidential election were two sources of uncertainty mentioned by bankers.
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Rising rates
Interest rates, including the federal funds rate, bank prime rates, 10-year treasuries and 30-year mortgages, have risen sharply over the two years, a departure from the low-interest environment of the past decade but not out of line with rates from the 1990s and 2000s.[/caption]
Business advice
For businesses, navigating higher interest rates and the higher operating and capital investment costs that come with them starts with an appreciation of how the past decade of low rates was a departure.
From the start of 2008 through the end of 2021, the average effective federal funds rate was 0.62% and the average bank prime rate was 3.74%. From 1990 to 2007, those rates averaged 4.4% and 7.3%, respectively.
“The low interest period that has ended, was a bit of an anomaly,” said Kevin Anderson.
Brian Andrew, chief financial officer at Johnson Financial Group, said the economy has shifted from a period where interest rates have lower highs and lower lows to now having higher highs and higher lows.
“We are in a fundamentally different environment than we have been in,” Andrew said.
Especially heading into the uncertain environment of 2024, bankers repeatedly emphasized the importance of businesses communicating early and often with their banker. They also expressed confidence in the capabilities of southeastern Wisconsin businesses to navigate the challenges.
Gamboa said the advice from Tri-City is to plan early on note maturities, renew earlier rather than later or at least get an understanding of what the bank is willing to do.
“The best bet is just to be proactive,” he said.
John Hazod, regional chief financial officer at Wintrust Financial Corp., pointed to a potential situation where a business’s loan is set to reprice from a 4% interest rate to 8%. Working ahead with your bank can include stress testing to understand how payments may change and get out ahead of any potential cash flow problems.
Kevin Anderson at Old National encouraged business leaders to emphasize planning and to overcommunicate with their bank.
“When everything is rosy, you don’t have to plan as much, you don’t have to watch as closely your cash burn,” he said.
Anderson also encouraged leaders to not assume what their bank will or will not be able to do to support their plans.
“We’re looking for great management teams to bank,” he said. “Most great bankers, collateral is important, but cash flow pays us back.”
Bankers spend their days looking at balance sheets and cash flow statements and may see things a business leader may miss, Anderson said, adding that there are a lot of things a bank can work with when making lending decisions including the term of a loan, amortization, interest rate and debt service coverage. The bank can also structure the loan to meet a business’s needs, optimizing for capital outlay, cash flow or another variable.
Margaret Capper, senior vice president of commercial banking at North Shore Bank, said one area for businesses to pay close attention to is getting their financials done in a timely fashion.
“You don’t want to be reactive,” she said, noting that a given month might have felt strong, but looking at the numbers will prove it. “There’s no emotion in numbers, they are what they are.”
Staying on top of financials can also provide important insight for companies, especially as customers facing their own stress may take longer to pay. Close tracking of receivables can identify issues before they develop into full blown problems.
Capper also said it is important for businesses to feel comfortable being transparent about what they are seeing and dealing with. The banker’s role becomes much more advisory in the current environment.
In some cases, a business may want to prepare for a potential recession by eliminating all debt, but that may not be the right use of available cash at this time. In other cases, a business owner may think they need a higher line of credit when, in reality, using a tool like a sweep to pay down the line with existing cash could reduce interest costs and even lower the required line of credit.
“It’s very individualized to each customer,” Capper said. “Bankers need to allow customers to make choices they feel comfortable with.”
While borrowing may cost more, Anderson said banks are still able to support business investment through working capital or financing for an expansion or acquisition.
“There is still plenty of capital out there for those types of projects,” Anderson said.
“It just requires a closer analysis of the projects and growth that need to be financed,” said Greg Larson, CEO of Ixonia Bank.
The Wisconsin economy is one that relies on capital-intensive businesses, especially in manufacturing, and companies need to make choices carefully when it comes to making investments.
“That can use up their dry powder when they should have done something else,” Larson said.
He said the current environment is one in which above-average management teams will shine and having a sound strategic plan has never been more important.
Ixonia is expecting to see a slowdown or very modest recession next year followed by a robust economy in 2025 and 2026. That outlook requires a business to closely analyze capital financing for 2024, but also to be positioned for future growth.
While any good business will be watching costs and maximizing profitability, “it’s also important to make sure you don’t disable yourself with cost cutting,” Larson said.
He also suggested businesses go with a fixed rate when possible.
“Don’t take interest rate risk,” Larson said. “It becomes a predictable expense if you get a fixed rate. I don’t think that anybody should be gambling that rates are going to be falling significantly.”
One area for companies to invest would be in improving productivity, incorporating artificial intelligence or adding the next generation of automation for manufacturers, Andrew said.
As for how to finance those investments, Andrew said banks are well versed in helping customers think about whether a fixed or floating rate makes sense. If rates are going to trend higher over time, it may make sense to look for fixed rate options, and Andrew encouraged businesses to think about the next five to 10 years, not just the next 18 months.
“I want to take advantage every time rates come down to add leverage at those times,” he said.
BMO’s Anderson said even though many businesses are coming off a couple of strange years, many in Wisconsin are in good shape and have good capital positions. The region’s private companies also benefit from the ability to be patient and opportunistic.
“There are many companies that would love to use this time to purchase other companies, whether that’s strategic or geographic,” Anderson said.
But interest rates also shape those deals. Capper said one deal she was working on cooled off because the buyer wanted a lower purchase price to offset higher interest rates.
