Factory Recovery

Factory Recovery

Bankers are bullish on the manufacturing sector, but supply chain disruptions and labor shortages are restraining growth.

U.S. manufacturing is rebounding in the economy that took a nosedive early last year when the pandemic surfaced. Statistics from the U.S. Department of Commerce show that orders for U.S.-made goods were up 17.2 percent year-over-year in May 2021. For May alone, factory orders were up 1.7 percent after a slight dip of 0.1 percent in April.

According to the ISM Manufacturing Index, 17 of the 18 manufacturing industries reported growth in June. “All of the six biggest manufacturing industries—computer and electronic products; chemical products; fabricated metal products; transportation equipment; food, beverage, and tobacco products; and petroleum and coal products, in that order—registered moderate to strong growth in June,” says Timothy R. Fiore, chair of the Institute for Supply Management’s Manufacturing Business Survey Committee.

Bankers and lenders are on the front lines of commerce and often the first to see signs of economic shifts with their small business clients.

Troy Rosenbrook, president of Highland Bank, says that manufacturing companies represent a “meaningful portion” of its portfolio; he says most manufacturers have regained their footing as the pandemic has waned.

“I think generally the majority really seem to have had substantial recovery. For some organizations in the right niche, 2020 was a strong year for them,” Rosenbrook says. “If you make parts that go into the housing sector, or if you make parts that go into the recreational sector—whether that’s boats or four-wheelers or snowmobiles—those companies really did reasonably well during the pandemic.”

Strong business expectations

What’s ahead? The short version: Things are looking up.

“I think for most manufacturers, 2021 would appear to be a good, solid year for them,” Rosenbrook says.

But manufacturers of all stripes are dealing with two clear challenges.

“Their two biggest issues are supply chain and people: employees,” Rosenbrook says. “It’s the people side that is currently the limiting factor on growth.”

Companies won’t buy new equipment if they don’t have someone to run the machines. Other businesses can’t expand if they can’t find the necessary staffers.

At the same time, Rosenbrook says that he’s seeing an uptick in mergers and acquisitions (M&A) activity in many industries, including manufacturing.

“M&A activity … has rebounded fairly robustly,” he says. “Maybe not as many [deals] have closed, but there are lots of conversations occurring. That feels like that’s returned for the most part.”

Many companies, partly bolstered by federal Paycheck Protection Program (PPP) funds, are sitting on a lot of cash, Rosenbrook says. The PPP loans effectively became grants if the borrower complied with conditions outlined by the U.S. Small Business Administration.

“Every other bank I’ve talked to has the same issue—we all have a substantial amount of liquidity; part of that is from PPP proceeds,” Rosenbrook says. “[Credit] line usage is down substantially in the industry.”

In the first quarter of the year, exports of Minnesota-made goods outside the U.S. were down 4 percent, compared to an overall increase of 2 percent for the U.S. But several states saw double-digit declines in the first quarter. Arkansas, for example, saw a drop of 23 percent.

According to the Minnesota Department of Employment and Economic Development (DEED), the state has added nearly 7,500 manufacturing jobs from June 2020 to June 2021, a gain of 2.4 percent.

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Manufacturing ranked as the state’s second-largest sector in 2019, contributing 14 percent to Minnesota’s overall gross domestic product. DEED numbers show that more than 8,300 Minnesota manufacturing companies employ more than 332,000 workers.

Supply chain hurdles

The core of business for St. Louis Park-based Bridgewater Bank is commercial real estate lending, but it also lends to small business clients in other industries, including manufacturing.

Nick Place, chief lending officer with Bridgewater, says the biggest challenge for most manufacturers right now is supply chain issues—they can’t get the materials they need to make their products in a timely fashion.

“We’ve got a manufacturing client that has a backlog of orders but is really supply-constrained right now and is really trying to work as best they can to fill those orders,” Place says.

But manufacturers are still ready to make investments.

“I think we’ve seen our clients looking to invest in expanding some of their equipment to make them more efficient, to help them potentially work through the backlog that they have. We do have clients that are expanding—they lease space, they’re looking to expand their space,” Place says.

But finding warehouse space, in particular, is another challenge, because everyone’s looking for it.

“Some of those clients have distribution as a big component to their business. Warehouse spaces are at a premium today,” Place says. “Everyone we know that’s in that industry is looking to expand their space to be able to accommodate more of their orders and fulfillment.”

Place is seeing some interest in new loans but says that companies are balancing that with their own cash reserves.

Flush with cash

“Banks in general have a lot of cash on their balance sheet because their clients are holding a lot of cash. Where folks have hunkered down and preserved cash, cut some expenses, used PPP funds or other stimulus to help support their overall balance sheet, they’ve got cash to be able to spend on some of this stuff,” Place says. “I think in some cases, if they haven’t already, they’ll start using that cash to invest into their business in conjunction with some lending. The fortunate thing is a lot of our clients have come through this with a pretty decent cash position. Now they’re just trying to figure out how to best utilize that.”

Like other banks, Bridgewater has not seen customers tapping their credit lines much.

“We expected, as a lot of banks did, our credit line usage to really ramp up when the pandemic first hit,” Place says. “We didn’t see those balances materially change.”

The rising economic tide seems to be lifting most boats.

“Businesses that are our customers seem to be doing, by and large, really well,” says Jon Dolphin, president of Minneapolis-based 21st Century Bank.

That includes manufacturing. “We’ve seen some acquisition opportunities in terms of financing those out there. We’ve seen your standard equipment loans; we’ve seen acquisition of building expansions occurring,” Dolphin says.

But he has noticed that clients looking for smaller warehouses—30,000 square feet or less—are having a tough time finding properties. Competition has heated up and prices have soared.

“That particular type of building has gone up pretty dramatically in terms of price per square foot in the metro area,” Dolphin says. “That isn’t just attributed to manufacturing expansion, but also to expansion that’s occurring within construction companies, distribution centers, storage.”

Dolphin also notes that M&A activity has rebounded.

“We’ve financed a fair amount of business acquisition across the board utilizing the SBA 7(a) program; manufacturing companies obviously fall into that realm,” Dolphin says. “There are opportunities out there,” he says, adding that “activity level is solid and fairly similar to what it was” before the pandemic.

Companies with cash on hand are still seeking loans, but in many cases they aren’t looking to borrow as much.

“Some of your equipment loans can be a lot shorter term and a lot more down [payment] than what you would have seen two years ago,” Dolphin says.

He has heard the refrain that companies are having trouble finding enough workers, but he says that smart business owners are working their way through those challenges.

“If they have the demand from their client base to grow, then they’re going to figure that out,” he says. “It just may slow that process a little bit. Good business owners figure that problem out. It may not be easy.”

Tom Beck, president and CEO of Minneapolis-based Northeast Bank, says that he’s hearing consistent themes from manufacturing clients.

“Their orders are increasing, things are getting back to normal, but finding people is difficult and the cost of their goods is a challenge,” Beck says.

He echoes other bankers, noting that most companies have plenty of liquidity.

“The balance sheets look pretty good for a lot of these companies,” he notes.

Loan activity has been up a little, which Beck says has been driven in part by rock-bottom interest rates.

“It’s a great time to borrow,” Beck says. “We’re bullish. I’m optimistic about where things are heading.”

In the big picture, the uptick in manufacturing is reflective of a generally improving economy.

“I think it’s really positive how quickly a very important segment of the economy has snapped back,” Rosenbrook says of the manufacturing sector. “That’s really a positive thing for all of us in the economy.”