Rising interest rates won’t lead to change in how banks underwrite credit, although business borrowers need to monitor their effects if they opt for a variable-rate commercial loan.
That’s one of the perspectives from a group of four bankers in the West Michigan market who offered their thoughts on rising interest rates, the economy, federal regulatory changes, and the emergence of online lending competitors.
In separate interviews, MiBiz asked bankers to shed some light on the state of the commercial lending. They were:
- Scott DeMeester, senior vice president and market manager for commercial banking in West and Central Michigan for Bank of America
- Rick Dyer, president and CEO of Edgewater Bank in St. Joseph
- Kelly Potes, president and CEO of ChoiceOne Bank in Sparta
- Sean Welsh, regional president in Grand Rapids for PNC Bank Here’s what they had to say.
We’ve seen two interest rate increases this year and the Federal Reserve has indicated more are on the way. Has the current interest rate environment changed how you’re underwriting business loans?
POTES: It really has not changed anything, either in the commercial space or the retail space. Loan demand is strong. I believe we will have two more rate increases this next year and it appears as though the economy or the market is able to handle the rate increases. It hasn’t altered our underwriting or anything in that nature. We’re up front with our clients and they really haven’t changed more to fixed rate or variable rate. It really depends on what makes sense for their request as to whether we go fixed or variable.
DYER: We are not underwriting commercial loans any differently than prior to the interest rate increases, other than the fact that the interest rates we’re using in our analysis have obviously increased. From a client perspective, we still have a number of borrowers who have not accepted the fact that market interest rates have increased. Interest rate quotes, especially on loan renewals, have been eye-opening for some clients simply because it does not hit home until it is time for them to renew a loan or obtain a new loan. We talk about the merits of floating versus fixed interest rate options, the term of fixed-rate options and the timing of transactions. We’ve had some projects move forward from a timeline perspective as borrowers are electing to lock into a fixed rate prior to market rates increasing again.
WELSH: No. We underwrite credit the same way through either side of the cycle. We think that’s the right way to do it. You have to manage risk, so not only are we getting a good return for our shareholders, but also we’re being a good partner for our clients. So if we change our credit appetite in good times and take on more risk in good times, there’s a chance we can’t support our clients in tougher times when they really need us.
DEMEESTER: Our lending standards are based on our risk framework with the goal of sustainability and long-term responsible growth. Interest rates are part of the story and indeed important for all borrowers. The bank can help mitigate the cash-flow impact of rising rates by offering fixed rates or hedging products. However, the underlying risk is that rising rates can cause the economy to slow and business growth stabilizes or even declines. We work with our clients to help them do sensitivity analysis to project the impact of various scenarios on their business.
Have the rate hikes altered the advice you offer businesses that are considering seeking credit in the near future?
POTES: It’s still the same advice. It’s really more around the basics of what is going to make them successful and what the future outlook is. At this point, the Fed seems to be pretty diligent that it doesn’t want to slow the economy down or stop growth. They really want to make it more manageable so we don’t have inflation that bites up on us.
DYER: One conversation that has been different is about when the interest rate is locked. Over the past several years, the rate quoted at the time of the loan commitment tended to be the actual interest rate on the loan. Now we need to remind clients that — if the loan does not close within a reasonable time after the loan commitment — the actual loan interest rate may be higher due to changes in market interest rates. That forces a more focused project plan and greater attention to timing, which is good for our clients and the bank.
WELSH: We’re just advising our clients to manage their interest rate risk to ensure that when they borrow the money, they’re either fixing it or ensuring that they can withstand a rate in the variable interest rates. Our job is to lend money, but really our job is to advise our clients, who run companies.
Economic outlooks look good for Michigan and the U.S. for now, although the growth won’t last forever. What are you telling commercial clients about how they should plan for the next few years?
POTES: The economy is strong now, but we do know from history that markets go up and down and it’s not a linear progression up. The economy waxes and wanes and they need to be ready for the inevitable slowdown that we would have. They should have money in reserves. They shouldn’t overextend and plan that they’re going to have the same rate of growth every year ad infinitum. They need to have a cushion to fall back on if the economy slows.
DYER: I run a business, a community bank, so I have a unique perspective that I am able to share with clients. I have to be prepared for a downturn, I have to deal with changing market conditions, and I have to address operating expenses such as payroll, employee health care, and regulation. I think in the same way as our clients do about the future. I talk to clients about how the bank plans for the future, how we protect our business from tough economic times, and how our plans may or may not change depending on what we see on the horizon. We talk to our clients about today and tomorrow.
WELSH: We give the same advice to our clients that we give to ourselves, and that’s build a business that is successful through the cycles, because the cycles will happen. In 2008, ’09 and ’10, PNC was a very active lender because we had built a balance sheet that worked through the cycles. We give that same advice to our clients because oftentimes that is the time you can be opportunistic.
DEMEESTER: We have a highly focused strategy around responsible growth and one of the key pillars of that strategy is ‘sustainable growth.’ This is something we share and discuss with clients frequently. Our job is to deliver insight and perspective to help businesses through all stages of their life cycle. We advise our clients to help mitigate risk, while growing responsibly, so they are prepared for whatever the future brings.
How has the emergence of online, alternative lenders affected your business and how is your bank responding to them?
POTES: It really hasn’t affected us, the online lenders. In fact, there’s plenty of opportunity for banks to partner with online lenders. We really haven’t seen in our traditional banking areas that the online lending platform is something that our customers are feeling comfortable with. They really want to talk face to face. We do offer in the mortgage area online applications for our clients. We have that, but as far as internet-based (lending), that really hasn’t taken any of our market share that we can perceive.
DYER: The area of our business that has been most impacted by online or alternative lenders is the smaller retail client. … If a borrower simply wants the cheapest funds available from a lending source that knows nothing of their company or themselves as a business owner other than what goes down on an application, then the alternative sources may work for them. We’re convinced that a good lender is also a good partner in business and not simply a source of funds. The clients we’ve had that looked into alternative or online lending options, for the most part, convinced themselves that the options did not provide what they were really looking for. In fact, some have come to us for advice on the lending options, which is fairly ironic since the access to such advice is what they get from a traditional lender versus an online lender.
WELSH: If you look at auto loans or mortgage lending, really a large percentage of mortgage lending, as an example, now comes through what we call alternative channels, meaning they’re coming through the internet. We have to be set up to respond and service those clients. The clients in this consumerism wave have raised people’s expectations about how quickly they can do things and how well they can be done. So we’re investing constantly in technology.
Recent changes to the Dodd-Frank Act eased the regulatory burden for some banks. What was the most significant change made to the law and how might it affect your commercial lending practices?
POTES: There probably wasn’t one big change we could hang our hat on. There were a lot of little changes. From a regulatory side, I would say they’ve made it easier to be in compliance with our capital and leverage requirements. From our client’s standpoint, the things that would help the most (are) rural appraisals. We have no problem in the Grand Rapids area and Kent County getting appraisers to do real estate, but that can be difficult more for our northerly branches. In some of those rural areas, if we can’t get an appraiser that’s available within the next five business days, then we would be exempt from the appraisal requirement. So it’s good for that client. … We can still service that client.
DYER: The passage … is a good thing for the industry, but does not have a significant impact on the day-to-day practices of a small community bank, especially as it relates to commercial lending. The more significant changes impacting small community banks are in the areas of residential mortgage lending and regulatory reporting. Any change that eases regulatory burden is beneficial, but there is limited direct benefit or change for our commercial lending clients.
WELSH: It won’t affect our practices. If you look at PNC, we’re a Main Street bank. If you look at how we do business, we take in deposits in the communities that we’re located, we lend out money in communities that we’re located. Good regulation is something that we welcome because it doesn’t have that much impact on us.