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Maneuvering in a High Interest Environment

COMMERCIAL BANKING: San Diego Bankers Share Insights on Strategies to Succeed

At last month’s meeting of central bankers held annually in Jackson Hole, Wyoming, Federal Reserve Chairman Jerome Powell indicated the Fed would likely raise interest rates again in September, citing a still growing economy and the central bank’s determination to return inflation to its 2% target.

For companies looking to manage the current high interest environment, managing risk, lowering debt and adding efficiency are crucial to success – and make companies stronger in the long-term.

Steve Espino
SVP & San Diego Commercial Banking Division Manager
Banner Bank

“These are the highest rates we’ve seen in a while, but we’ve operated in higher rate environments in the past. With all the economic headwinds – rising costs, rising interest rates and general uncertainty – it’s easy to overlook the opportunities,” said Steve Espino, senior vice president and San Diego commercial banking division manager at Banner Bank. “Look for ways to be one of the companies that embraces the disruption and uses it to make their move within their industry or make their companies stronger.”

Add Efficiency

In high interest rate environments, Espino said operating efficiency becomes more important. He advises businesses to make internal adjustments with a focus on managing costs and pricing goods and services.

“Take another look at tools that can help you manage your cash flow. Ask your banker to bring you cash management solutions; it’s fair to expect them to provide solutions to make the money you have work harder, not just renew your loan or line,” he said.

Steven Stuckey
EVP & San Diego Market President
California Bank & Trust

Steven Stuckey, executive vice president and San Diego market president at California Bank & Trust, said automation – whether through directly investing in in-house automation technologies, or through outsourcing processes to third parties – is a good way for businesses to achieve the same or higher levels of production at a lower cost.

“It also often allows a business to scale more quickly than traditional manual processes would allow for,” he said, adding that business owners should work closely with their vendors, suppliers, service providers and their customers, to identify areas where either automation or outsourcing could yield benefits.

The emergence of new tools such as artificial intelligence is also already playing a role in how businesses are creating efficiencies in areas such as operations and communications, “particularly in a tech-forward state like California,” said Aaron Ryan, San Diego region manager for middle market banking and specialized industries at JPMorgan Chase.

Aaron Ryan
San Diego Region Manager, Middle Market Banking & Specialized Industries
JPMorgan Chase

Ryan pointed to JPMorgan’s Midyear Business Leaders Outlook survey that showed 53% of business leaders in the state are already using AI tools or are considering them – which is 15% higher than the national average.

“We’re also seeing a lot more interest from our clients in advancing the way they interact with their banks,” he said. “Our bankers are interacting much more with chief technology officers at companies to help integrate banking into their entire digital platform. This really helps organizations run more efficiently and frees up personnel to focus on other aspects of their business.”

Jennifer Gallagher
Commercial Business Banking Executive, Southern California
Bank of America

Investing in automation, even through financing in this high interest environment, can still be beneficial for certain industries, according to Jennifer Gallagher, Bank of America commercial business banking executive for Southern California.

“Our manufacturing clients in particular are expanding and adding equipment to automate processes,” she said. “Bank of America offers comprehensive equipment financing solutions to help clients raise capital, manage equipment risk, consider tax advantages and strengthen their balance sheet.”

Wells Fargo San Diego Commercial Banking Market Executive Chris Amble said that companies automating their operations should work with their bankers on details such as analyzing foreign-exchange market risks, because “a lot of needed equipment and technology is manufactured outside of the U.S.”

Chris Amble
San Diego Commercial Banking Market Executive
Wells Fargo

“Companies with the ability to apply automation may also see benefit in this environment,” Amble said. “Businesses that can improve efficiency may be in the position to earn additional revenue at better margins.”

Alan Prohaska
Regional President, Greater San Diego
PNC Bank

Automation that improves efficiency for additional revenue and better margins is not just found through expensive manufacturing equipment. Automating receivables and payables processes for more efficiency “can be a significant benefit to companies in a tighter expense environment,” said PNC Bank Regional President, Greater San Diego Alan Prohaska.

“As macroeconomic factors continue to apply external pressures, many businesses face additional internal headwinds due to inefficient treasury operations, especially those with small treasury teams,” he said. “Investing in streamlined, automated solutions provides companies with the ability to replace labor-intensive, time-consuming and error-prone processes, which provides employees with more time to focus on strategic tasks.”

Manage Interest Rate Risk

Businesses investing in automated solutions – or borrowing for any other reason – need to manage interest rate risk because the impacts of rising rates “can be detrimental to profitability,” Amble said, adding that this is another area automation can help.

“Examples include automating processes to pay down higher priced line of credit debt through use of credit sweeps,” he said.

Companies can reduce risk of interest rate swings by maintaining debt at more moderate levels, Stuckey said, adding that a company can take additional steps to reduce interest rate risk by entering fixed-rate borrowing agreements, or by entering interest-rate swap contracts, which effectively fix the interest costs of a borrower.

“Most importantly, note that not taking any hedging actions is effectively a bet on interest rates, as the company is fully exposed to variability in short-term rates,” he said. “While both fixed-rate debt and swaps can decrease financial flexibility, taking interest-rate risk off the table makes a company more robust to other sources of risk.”

To manage risk, companies also need to be “adjusting and pivoting” levels of liquidity, Espino said.

“Ensure that your liquidity is earning an appropriate return. As the Fed raises rates, the focus has been on borrowing, but remember deposit rates are also increasing. Take a look at what you’re earning on your cash,” he said. “Or it may be prudent to use excess liquidity to pay off higher interest loans.”

To make decisions around how to manage liquidity and debt levels, Ryan recommends business owners undergo the same kinds of stress testing that banks do to make sure they are resilient to market pressures.

“Many businesses are operating with a capital cost of around 7-8%, and we’re seeing some companies struggle with financing,” he said. “Stress testing should be incorporated into business planning going forward, as high interest rates will continue for the foreseeable future.”

For companies that find themselves over-inventoried as the global supply chain stabilizes, Amble suggests they leverage supply chain finance programs “to offset longer inventory hold times with preferred supplier terms by improving working capital and offsetting some of the carry costs associated with increased interest rates.”

For all types of businesses, Prohaska said banks should help clients identify a risk management strategy that best meets their needs.

“The current level of and outlook for interest rates are a key part of that strategy, but it’s important to also consider factors such as projected debt balances and future cash flows to help the client understand their risk tolerance level,” he said.  “Understanding each client’s unique needs enables us to suggest products and strategies that we believe will best meet those needs.”

Meeting Stricter Lending Requirements

High interest rate environments are designed to cool borrowing. Businesses that need access to capital are faced with tightening lending standards at banks.

To meet these tougher standards, Ryan said that businesses should maintain “a fortress balance sheet that can withstand shocks.”

“Businesses can work on building this balance sheet by focusing on maintaining adequate liquidity to sustain them through a downturn,” he added.

Stuckey said a first step for businesses looking to qualify for a loan is to meet with a bank and be as transparent as possible so that the lender can clearly understand the objectives and motivations for the proposed financing. Borrowers should be prepared for “candid feedback,” he added.

“Our goal is always to help you achieve your ultimate objectives, however, the path to this may be different than you initially think,” Stuckey said. “We often receive requests that may not be immediately feasible, but by working closely with the client, they end up achieving their goals in a different way or in a stepwise fashion over time.”

Despite the Fed making banks more cautious, banks still understand their role as the primary source of capital for businesses across the United States, Espino said.

“At Banner, we take our role in the economic ecosystem very seriously. That’s why we take a bit more of a conservative approach to running  our  business – so during times like this, our financial health is as strong as ever and we remain actively lending in every market we serve,” he said. “Our clients and the community are counting on us to be here for them during all economic cycles.”

Amble said that in cycles of economic uncertainty, lenders sometimes find businesses are either too eager or too hesitant to act on opportunities. Businesses that can identify their “horizon” allow them to know the difference between good and bad opportunities and are better prepared at explaining their goals to lenders.

“Knowing your horizon means aligning your priorities and practices to grow your business in the best way possible,” he said. “Companies that understand their horizon are better positioned to act when they see an opportunity that could enhance their business because they are more aware of the potential value offered.”

To become a “best client” to banks, Prohaska stressed the importance of talking with bankers and listening to their ideas.

“Our goal as bankers is to provide ideas and financial solutions that help businesses operate more efficiently,” he said, and pointed to an example of a banker suggesting improving financial reporting with a CPA Reviewed Statement or a CPA Audited Statement.

“While upgrading financial statements does cost more money, it also greatly improves a bank’s comfort with a borrower’s financial controls, accounting practices and quality of financials. This can be the very thing that a loan approval hinges on,” he said. “Lastly, always communicate good news and bad news early and often with your banker.  Clear and consistent communication is key to a healthy, trusting relationship.”

That trusting relationship is also the responsibility of banks.

“It’s incumbent upon a  banking  partner to be a thoughtful source of ideas to help the business operate more successfully and efficiently,” Stuckey said. “By learning as much as possible about our clients, the operations of their businesses, and their overall personal and business objectives, we are able to more effectively champion their interests and provide valuable advice on ways to achieve those objectives.”

Interest Rate Outlook

Looking ahead, commercial bankers are predicting an easing of rate hikes but with the possibility of recession.

Gallagher said economists at Bank of America Global Research expect the Federal Reserve to hold interest rates steady at their September meeting and issue “one final rate hike of 25 basis points at their November meeting, which will put the terminal Fed Funds rate at 5.50-5.75%.”

She added that BofA expects the Fed to begin rate cuts in June of next year, ending with a total of 75 basis points cut in 2024 and an additional 100 basis points in cuts in 2025.

Ryan said JPMorgan also sees the rate hiking cycle “nearing the end” and expects the Fed to hold through the middle of next year, “as long as inflation continues on its downward path.”

If the Fed is successful in bringing inflation back to its 2% target, it won’t be without some consequence, Prohaska said, because it will be “in part the result of economic declines that finally manifest as a result of the past 12-18 months of Fed monetary policy tightening. PNC projects the most likely outcome for the U.S. economy is a mild recession running from early 2024 through midyear.”

Prohaska warned, however, that optimistic economic forecasts in the post-COVID inflationary period could mean that the Fed’s tools for “manipulating consumer price pressures may have dulled versus economic cycles past.”

“Such an outcome would yield both policy missteps and inaccurate market expectations,” he said. “These influences risk combining to create volatility and, in the current environment, to undercut economic growth potential.”

Stuckey also noted that that even the Fed was “wildly inaccurate” late last year in its predictions of where those rates would be in 2023 and advised businesses to always be prepared for interest rate hikes.

“It’s better to position your business to be robust in the face of unknown future interest rate environments than to speculate on future interest rates,” he said. “The company’s  banking  partner can work with them to identify appropriate risk mitigation strategies.”

Amble looked to the bright side of the current and recent past economic challenges, saying they have given businesses the opportunity to “rethink their strategy.”

“Since the beginning of 2020, San Diego companies have undergone a series of stress tests. Global pandemic, geopolitical uncertainty and supply chain constraints have overhauled modern-day business planning,” he said. “Looking forward, there are certain to be challenges. However, San Diego companies that remain vigilant about liquidity, recognize the correlation between efficiency and interest rates, and understand their business horizon will find opportunities to thrive.”

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