Rising interest rates complicate commercial lending

Persistently rising interest rates are making commercial lending more challenging, but strong relationships between area banks and their clients are moderating the local impact.

“The Federal Reserve is raising interest rates with the purpose of slowing the economy to tamp down inflation. One byproduct of that is less loan demand due to the cost of borrowing across the industry, across the state of Colorado, really across the country,” said Mark White, executive vice president and president of regional banking for Independent Financial, which has 32 locations across Colorado.  “Business is still happening, but everybody is adjusting and shifting based on the current environment.”

“We’ve seen a slowdown, certainly on new housing construction and some on the commercial side, although there are a number of projects continuing to go forward,” said Shawn Osthoff, president of Bank of Colorado, which has 46 locations across the state. “Obviously, the rising (interest) rates do cause additional cost, and combined with inflated prices for material goods and supplies for construction, those two things together are causing folks to re-evaluate some of the projects.”

Prospective borrowers are tracking the changing interest rates as closely as the bankers do.

“Interest rates are absolutely a part of our cost analysis as we’re reviewing opportunities,” said Adam Bliven, chief financial officer for Journey Homes, a Greeley-based land developer and homebuilder.  “Ultimately, it adds a cost to the bottom line, so we have to make sure our opportunity cost is appropriate. If we’re going to pursue a project, is that the most profitable opportunity for us at that time?”

Local bankers say they are still busy making commercial loans, and when a developer stops loan negotiations, it usually means they are postponing a project, not canceling it. 

“We’ve seen some projects in commercial real estate delayed. They’re still in the works, but developers have pushed them out because of the uncertainty,” White said.

“I would say clients are being more diligent with consideration of what’s going to happen not only in the current rate environment, but also a year or two from now,” said Susan Moratelli, vice president of commercial lending at MidFirst Bank, a privately owned bank with four locations in Colorado. “Business has slowed somewhat, but we’re still busy with new opportunities.”

Journey Homes has not postponed any projects, Bliven said, although he has heard of other companies delaying or canceling projects.

“I would say we have adjusted our pace to meet what the market is expecting,” he said. “If we see home sales slowing, then maybe we’re not developing as many lots, etc.”

Journey “can control the flow better” since the company is both the land developer and homebuilder, he said.

Working as partners

Commercial lending at local banks is built on creating and maintaining strong and productive relationships with clients, bankers said.

“We want clients to know us, and we like to know them and help provide value through our expertise,” White said. 

Negotiations for a substantial loan can take several weeks to complete.

“We ask them questions and tell them what we think, and we have a dialogue back and forth that can be helpful to our clients,” White said. “We have the benefit of seeing many many clients and have a perspective of the data that maybe an individual client doesn’t have.” 

“Borrowers love to look at the best-case scenario, but they appreciate the (bank’s) perspective of being prepared to address problems,” Moratelli said. “It’s truly a partnership. I would not want to let them down by not helping to address objectively something I identify that I think they should be giving thought to. Trusted attorneys and CPAs would do the same thing.”

Journey Homes’ Bliven agreed that he views his company’s lenders as “partners.”

“I’m talking to my lenders at least monthly if not more frequently,” he said. “We’re staying in touch continuously, so as the markets are making adjustments, we’re having conversations.”

The rising interest rates color those conversations, Bliven said.

“I would say the scope and the topic of the conversations over the past 6-12 months has shifted. Both sides want to have a better understanding of the impact of the market on our business, how we’re navigating it, what we foresee, etc.,” he said.

The veteran leadership team at Journey Homes was not surprised by this evolution in focus, Bliven said. 

“Our principals have been in the industry a long time,” he said. “They understand as the market adjusts, the lender just wants to make sure we, as a borrower, have our hands around where we’re at, where we’re going and what the market means to us.” 

Bankers said they use a consistent approach in analyzing loan risk that has not been substantially altered by the rising interest rates.

“We really haven’t changed anything that we’re doing,” Osthoff said. “We always do an interest rate shock when we’re evaluating ability to repay. We’re allowing for that, which we always have done. We’ve stuck to our principles for years, and it’s worked great, even through the Great Recession. We came out of that very well, and we’ll continue doing what we’ve always done.”

While the overall process remains constant, the rising rates can impact the details of an agreement.

“If I was looking at a request to finance construction of an apartment building a year ago, I might be talking in terms of 75% loan to value, which means the borrower is putting in 25%, and the bank is lending up to 75%,” Moratelli said. “In this rate environment, maybe I want to be a little more conservative, and I’m going to ask my borrower to come in with 35% equity, and then the bank finances a lower level, 65% loan to value. That is a common tool bankers would use to mitigate the risk.”

Other issues complicating lending

Economic issues that started during the pandemic, such as supply chain breakdowns and workforce shortages, are still hindering the ability of some local businesses to expand operations, which limits their need for large loans.

“Employee staffing levels are challenging for all businesses right now,” Osthoff said. 

Global supply chain shortages continue to impact consumers and companies in Northern Colorado. Moratelli saw first-hand the impact on local auto dealerships of computer chip shortages and other manufacturing complications when she was shopping for a new car last May. 

“I had to put a deposit down sight unseen,” she recalled. “When the vehicle arrived five weeks later, luckily it was perfect for my husband and me, and we bought it, but that’s so different from how the car buying experience has been historically.”

The construction industry has been particularly hard hit by rising supply costs, Osthoff said.

“The costs of some of these material goods continue to creep up. That’s having a significant impact on your investment as you’re looking at projects,” he said.

“Several months ago, lumber costs jumped significantly, so those impacts on construction projects were pretty immediate,” Moratelli said. “Folks had to absorb that cost, increase their loan requests or modify their plans.”

New home sales have slowed, and many office buildings struggle with vacancies, diminishing interest in starting new construction. Such major problems in the real estate market can have an outsized impact on the overall economy, said Sanjai Bhagat, professor of finance at the Leeds School of Business at the University of Colorado Boulder.

“The housing and commercial real estate sectors are very large and have a huge ripple effect,” he said. “When the housing market is not strong, appliances are not getting sold, doors and windows aren’t getting sold. Workers who would normally be building houses are not employed.”

Luckily, pandemic-related problems are not impacting all sectors of the local economy.  The hospitality industry is poised for strong growth, Moratelli said.

“Hospitality was one sector of the local economy that got hammered during the pandemic. The impact on hotels and restaurants was well publicized,” she said. “Hospitality is roaring back because of pent-up demand.” 

Bank failures not a factor

Extensive media coverage of the failures of Silicon Valley Bank in California and Signature Bank in New York prompted fears that the overall banking industry was in trouble. Local banks moved quickly to reassure clients and minimize any impact.

“The national media really grabbed hold of those two stories, and obviously it’s on the top of a lot of people’s minds, so we’ve been proactive in reaching out to customers and explaining to them the differences between our bank and the two bank failures,” said Bank of Colorado’s Osthoff. “We’re on solid footing and that helps people understand the differences and why a community bank such as ours remains strong, as are most of the banks in the state of Colorado.” 

“We do business in the sectors our communities provide us. Certain spaces that are on everyone’s minds, the crypto space, the high-end technology space, we don’t really have a client in that,” White said. “Practically speaking, we have a business model that’s community driven. We know our customers very well, and they know us. In our case, it’s a very different scenario in terms of how we operate and the kind of business we’re involved in.”

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