Doing Business in a Complicated Economy

Doing Business in a Complicated Economy

Bankers and business clients are being buffeted by a potent mix of financial challenges, but they’re finding ways to adapt to inflation, labor shortages, and supply chain issues.

“Twenty-four months ago, a lot of bankers thought the world was ending,” says Ken LaChance, Minneapolis-based senior vice president and market executive for Wells Fargo Commercial Banking. Many of his business clients had the same fears. 

The world didn’t end, of course. But it has become very complicated. By many measures, the economy is fundamentally strong: Unemployment remains low and consumer spending is generally healthy. But those positive data points have their darker flip sides—labor shortages, high inflation, and difficulties obtaining key components such as semiconductors. Add rising interest rates, the ongoing global impacts of the coronavirus, and the worldwide disruptions caused by the Russian attack on Ukraine, and it’s feeling as though booms and busts are being compressed within months or even weeks. 

“I’ve been in banking 28 years,” LaChance says, and the past two years “seem like a couple of dog years of an economy.” It appears that we’re facing another such year in 2022.  

Bankers note that business loan activity remains strong and competitive. Sara Ausman, Twin Cities regional president of Alerus, notes that her bank’s first quarter in the Twin Cities market was very good in terms of commercial loan activity, and “we’re feeling pretty good about Q2.” Alerus is a Grand Forks-based bank and financial services firm.

Bank leaders are cautiously optimistic about the future, she says. But with so many unknowns, “it’s quarter by quarter right now.” 

How can businesses navigate these roiling waters? Area bankers are offering their clients some advisory and financial rudders. 

Building resilient businesses

An economic report released April 28 provided a snapshot of how complicated the economy has become. The U.S. economy shrank in the first quarter of 2022, with GDP dropping 1.4 percent on an annualized basis.

But that decline was driven largely by a 20 percent increase in imports as well as larger inventories companies had built up toward the end of 2021. Overall, consumers are still spending, particularly with wages rising, thanks largely to the tight labor market. 

“Short to medium term, businesses are ordering more inventory, anticipating continued growing demand, and hoping the materials arrive on time,” says Jim Mulrooney, senior vice president and director of commercial banking at St. Paul-based Bremer Bank. Mulrooney adds that suppliers are prioritizing larger orders, which can complicate businesses’ procurement strategy.

Longer term, businesses are assessing their supply chains and considering ways to reduce their risk by diversifying supplier bases. Adding to the economic volatility in the first quarter: the Russian invasion of Ukraine. “Businesses are and should continue to consider this situation to ensure a resilient and sustainable business,” he advises.

So far, Minnesota companies have generally proved resilient despite all the complications and uncertainties. New construction and company expansions, for instance, remain vigorous. “There are lots of big projects still breaking ground,” notes Aleesha Webb, president and vice chair of Blaine-based Village Bank, whose client focus is metro-area entrepreneurs. “We’re not seeing a slowdown. There’s still a lot of liquidity in the market.”

Webb says that the bank’s customers have been developing ways to work around many of the current challenges. Several companies with cash on hand have secured the necessary components for their products, buying in bulk and paying premiums for hard-to-get materials. And metro-area banks like Webb’s have been willing to make loans and extend lines of credit. 

That doesn’t mean that they’re giving money away. As Webb puts it, “If you ask for $100,000, I’ll ask you, ‘What are you going to do with it?’ ” Responsible bankers are asking questions about numbers, cash flow, margins, and how well companies are maintaining equity in their businesses. Webb says that she’s encouraging her small-business clients to invest in technology to help meet the current labor challenges. Businesses need to identify technology that “can save the business money and also provide convenience for its customers,” she says. 

Bankers are advising clients on problems specific to their operations. For example, Alerus’ Ausman cites a precision manufacturer that uses specialty gases for testing parts. One problem: Those gases are produced primarily in Russia and Ukraine.

Alerus is assisting this client’s hunt for alternative testing approaches by offering potentially helpful contacts. Another client, a commercial contractor, has been dealing with a shortage of some crucial materials, and the resulting reduced revenue. Alerus has ensured an adequate line of credit to help support working capital while the client waits for supplies to be delivered. “We’re seeing a lot of that right now,” Ausman says. 

A shortage of talent is common for many industries, including banking. One way that banks are helping clients is by providing financial wellness education and retirement planning options. Through an acquisition made a little over a year ago, Alerus began offering cash balance plans, a retirement plan option that organizations such as specialty medical groups and law firms can use to lure and retain talent.

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Health care clients also can access an Alerus mortgage program for physicians that can provide up to 95 percent of a home’s purchase price. This can help health care organizations attract a new generation of doctors, many of whom are burdened with heavy school loan debt. 

Hedging against price spikes 

Businesses of all sizes are nervously anticipating the rise of interest rates, something they haven’t experienced in years. In early May, the Federal Reserve announced it was raising interest rates by half a percent.

“At the end of the year, we could see a federal funds target rate of around 2.75 percent,” says Phil Trier, Twin Cities market president for Minneapolis-based U.S. Bank. It’s worth noting, he adds, that such a rate would not be considered high from a historical perspective, “but it’s certainly a departure from the past several years.” And those rate increases could force some companies to make adjustments to their financial plans in the near term. 

“We’re spending a lot of time with clients, talking about rates, reviewing their balance sheets, making sure that they’re adequately hedged” for rising interest rates and that they conduct capital planning, Trier says. For instance, when a business client is carrying a significant amount of floating-rate debt, “it might be a good time for locking in some of that debt on a fixed-rate basis,” he says. If a company is planning a large capital project, “it might make sense to accelerate that project and lock in a lower rate.” 

For clients that foresee growth in their business lines, bankers are advising them to anticipate supply and inventory needs. “We have customers that ordered equipment early or in the middle of last year, and it’s finally being delivered,” Trier notes. “Businesses need to be mindful of supply chains, of delivery timelines, and what’s available to them” so they can meet customer demand. 

As of mid-April, U.S. Bank had been experiencing an uptick in loan demand, Trier says. “That’s a very healthy indicator for mid-market companies. We’re seeing an increase in utilization on lines of credit. So they’re building working capital, inventory, accounts receivable. We’re also seeing an uptick in capital expenditures—some of that is deferred capex [capital expenditures] that companies couldn’t get last year. But that’s another indicator that companies are confident and making investments in the future.”

In addition, U.S. Bank is continuing to see merger and acquisition activity, “which is another positive indicator,” Trier says. “When you add up those elements, I’d tell you that the middle-market space continues to be resilient. Business owners are optimistic about 2022—perhaps cautiously so, given the geopolitical concerns.” What’s more, he says, the bank’s internal credit levels are strong. By and large, companies are good loan risks right now. 

Banks are offering numerous strategies to help those business clients remain creditworthy. Take inflation. Banks with trading desks (typically larger institutions) can offer these clients ways to hedge unpredictability in commodity prices. Hedging uses market instruments such as futures, options, and forwards to offset potential losses from an essential commodity’s price surge. For instance, clients can at least partially balance higher costs of materials such as steel by locking in a price in the futures market.

For many clients, hedging is a strategy they’ve never had to consider before. LaChance provides an example: a Wells Fargo client in the baking industry that “never really worried about their wheat prices. Well, the world learned that wheat can be pretty dynamic, especially when turmoil hits [Ukraine], one of the world’s largest wheat-growing regions.” Suddenly, this client is having a hard time passing on the cost of each loaf of bread or bakery good.

In addition to commodities such as wheat, companies also can hedge future projects, whether that’s a real estate development or a capex investment, by locking down their price of money now, LaChance emphasizes, even if the project won’t be in operation for another 12 to 18 months. 

Whatever tactics businesses end up choosing to address current and future uncertainties, Alerus’ Ausman recommends that they take charge, meet with their bankers, and “take a deep dive on cash flows, projections, and factors that might crimp their business.” These companies’ bankers might advise increasing a line of credit to help them through what might be happening from a supply bottleneck standpoint, she adds. 

But bumping up credit lines has to be done carefully. Village Bank’s Webb advises companies to “know your numbers” and note subtle changes in your balance sheet and your income statement.

“This is important because lines of credit are not fixed. If you take out more debt on that line of credit and rates go up, that’s going to hurt,” she says. “That’s when you’re going to see the equity in the company or that bottom line slide.” A banker or other financial adviser, she adds, is “really about having a partner who’s not afraid to talk about the what-ifs and point out what you should be watching.”  

“ ‘Move forward cautiously’ is the way we’re working with clients,” Ausman says. One strategy Ausman advises for companies is to conduct stress tests: What will cash flow look like six months from now if interest rates go up a certain amount? What effect might rate increases have on lines of credit? “Businesses really need to be proactive and visit with their banker or other adviser, because this is a whole new environment,” she says. 

That noted, bankers are generally upbeat about the new normal. “When volatility hits and people want to talk and learn things and be advised, that’s when our industry gets fun,” LaChance says. In the last couple of years, the tone has been deeply concerned, and there still are plenty of concerns. But even with all the current volatility, “the underlying elements of the economy are functioning, and companies are doing really well,” LaChance says. “We could talk six months from now and things could feel different. But right now, I’m still really bullish.”