Jump-Starting Revenue Growth

Jump-Starting Revenue Growth

Bankers expect Minnesota businesses to pick up the pace of borrowing to finance expansions, new products and equipment.

Businesses are focusing their attention on economic growth and higher interest rates, now that the outcome of the 2016 presidential election has been resolved.

Small to middle-market companies across a wide range of industries appear ready to expand, according to bankers working with businesses throughout the state and region. But challenges remain for these businesses, as well as for individual sectors—specifically agriculture.

“This recovery has been slower than many in the past, and the optimism of business has matched this slow growth. But now their revenue has returned. They are seeing top-line growth and bottom-line growth. And they have really become efficient,” says Phil Trier, Twin Cities market president for U.S. Bank, Minneapolis. “Businesses in Minnesota are healthy. They are strong. They are vibrant. They are optimistic about the future, and that makes us optimistic.”

Statistics from the National Center for the Middle Market, defined as companies with annual revenue between $10 million and $1 billion, show some encouraging signs. In the fourth quarter of 2016, 70 percent of U.S. middle-market companies surveyed reported revenue growth, and 33 percent planned to add jobs. However, one-third of companies were reluctant to make capital investments and instead were holding cash.

For several years, businesses have enjoyed historically low interest rates. However, the Federal Reserve raised its benchmark rate in late 2015 and late 2016. Showing confidence in the strength of the economy, the Fed announced on March 15 that it would increase short-term interest rates by 0.25 percent. It indicated that it is likely other rate hikes will come later in 2017.

Low delinquencies

“Businesses are looking at their options to refinance. They are locking in rates for a longer period of time. They are taking advantage of today’s rate environment and fixing costs,” says Dave Rymanowski, chief business banking officer for KleinBank, Chaska. He expects 2017 rate hikes to occur in 25-point increments.

Rick Wall, CEO of Highland Bank, Minnetonka, says the sluggish global economy is not robust enough to put pressure on the U.S. to raise rates substantially. Switzerland and Sweden have had negative interest rates, and many central banks around the world have continued to lower rates. Notable exceptions include the U.S., Brazil, Mexico, Chile and South Africa, according to global-rates.com.

Despite uncertainty, banks are healthy and ready to lend to companies with strong balance sheets. “Our credit quality—low delinquencies—is a reflection of our customers’ finances, and our delinquencies are the lowest they have been in 20 years,” Wall says.

And that’s true for most small banks in Minnesota. According to Federal Deposit Insurance Corp. data for third-quarter 2016, most small Minnesota banks were at or near zero on net charge-offs to loans, and many had less than 3.5 percent non-performing loans. Historically, Wall says those numbers are closer to 0.5 percent for charge-offs and less than 2 percent for non-performing loans, excluding recessions.

“It remains a very competitive environment,” says Trier. “The industry is very focused on loan growth. Loan margins have tightened and loan structures have loosened a bit. We continue to focus on the quality of our loan portfolio.” While U.S. Bank’s loan growth increased 6.9 percent in 2016 over 2015, many businesses have not made a final decision on expansion.

“There’s a lot of liquidity. Most banks are interested in growing their portfolios,” Rymanowski says. “For a qualified business with a solid business plan and a good story, it’s a good time to borrow money. There are a lot of options.”

Many businesses have started to take advantage of those options. After years of focusing on bottom-line efficiency and right-sizing, companies have started to look at the top-line revenue and are realizing that to grow margins they need to improve revenue through new investments—expanding their customer base, their offerings or their presence through new markets.

Upswing in borrowing

Wells Fargo is No. 1 in total middle-market banking share in the U.S. and has the most primary banking relationships with middle-market companies, with $25 million to $500 million in annual sales, according to Barlow Research middle-market rolling data for the eight quarters ending third-quarter 2016. Tim Jordahl, regional vice president for Wells Fargo middle-market banking in Minneapolis, notes that Wells Fargo’s middle-market customers are borrowing more.

“They are making investments in facilities, equipment, capacity, and sometimes going into new markets,” Jordahl says. “Our customers are successful and want to grow. The topline has been a challenge, and now they are ready to make acquisitions or expand their facilities and or markets.” Jordahl adds that he’s seeing more businesses than usual take their first step into the global market.

U.S. Bank also serves a broad and diverse portfolio of middle-market clients, and says that while business optimism increased in early 2017, as of the start of the second quarter, optimism had not yet translated into accelerated loan activity.

“I have not seen an increase in investment and capital expenditures,” Trier says. “The change in optimism is refreshing. I do believe at some point that will translate into new investment, but I don’t know when. While they are making investments in their businesses, we are not seeing an acceleration in these investments, and utilization on lines of credit has been flat over the past several years.”

Others reflect that sentiment, but say the pipeline of businesses considering new investments with borrowed money is strong. “Loan activity is consistent. Our pipeline is strong,” says Wall. “But there’s still a greater sense of conservatism among our clients who went through the downturn. They are not as conservative as they were in 2010, but their willingness to take on high leverage in total has declined.”

Highland Bank serves start-up businesses up to companies with $100 million in revenue, but its most common business client has annual revenue in the $500,000 to $20 million range, with borrowing needs of $250,000 to $5 million. One change Wall has noticed is that more fund-owned companies are inquiring about loans compared with privately owned firms, although these businesses account for probably less than 5 percent of the bank’s business customers.

Sara Ausman, regional president for Alerus in the Twin Cities, has noticed a pickup in loan requests from a certain segment of business—acquisitions and ownership transitions. “We are seeing more transition credit requests from companies undergoing a change of ownership,” Ausman says. “Either the company is selling, there’s a shareholder buyout or it is part of succession planning. In the last six months, I’ve seen more than I have since 2008.”

Alerus offices in North Dakota and Arizona also are seeing similar requests. While Ausman is not sure why the number of these credit requests is increasing, she thinks it could be due to baby boomer retirements, general succession planning and uncertainty over tax changes. Alerus also serves middle-market businesses, and Ausman notes that the bank’s pipeline of potential borrowers was stronger at the start of the second quarter than it was a year ago.

KleinBank is seeing new loan activity based on business expansion and capital expenditures occurring across sectors. “Residential construction has been particularly strong,” Rymanowski says. “It was a healthy year last year, and there was healthy momentum through the winter. The builders we are working with feel really good right now. There is a lot of demand from entry-level, first-time homebuyers.” The recent increase in mortgage interest rates likely has contributed to the healthy demand for new homes in the outer suburbs, he says. While rates continue to be relatively low, some buyers have accelerated their buying decisions in anticipation of continued rate increases.

Today’s full employment market, however, is creating issues for businesses. “There’s increased wage pressure, and trying to find qualified employees is a challenge,” Rymanowski says. “Some businesses have opportunities to expand or grow, but they are having a hard time finding help.”

Struggling ag economy

Not every industry is doing well, though; the state’s agricultural economy is struggling due to depressed commodity prices. For instance, corn prices peaked in July 2012, before dropping about 25 percent from about $8 per bushel to $6 per bushel by August 2013. Current corn prices are near $3.80 a bushel, about half of what they were at the peak.

Lynn Paulson, director of agribusiness development for Bell Bank, in Fargo, N.D., says that while good farm managers continue to do well, for banks, the risk is with those farmers who are not making money. “Last year, was probably better than anticipated because production yields were higher than projected, offsetting some of the price declines,” Paulson says. “But a lot of producers are defining 2016 success as simply being able to farm in 2017.”  

Paulson notes that the farm sector doesn’t have a solvency crisis because balance sheets are strong. It has a liquidity crisis. “If producers are close to the end of their financial rope, we’re telling them not to look to 2017 to be a year of salvation,” he says. “We are not expecting a huge rebound in commodity prices. For those people who need to borrow money, breaking even will be a challenge.”

The majority of farm equity is tied up in real estate. To reduce debt, a farmer needs to make money or liquidate assets. While Paulson says he’s seeing some land sales, more farmers who need to liquidate assets are looking for investors to buy land and then rent it back to them.

“Bank regulators’ response to the stress in the ag sector appears to be measured and tempered,” Paulson says. “Ag banks—as compared to previous down cycles like the 1980s—have, as a whole, done a better job of identifying and mitigating risks in their loan portfolios. The vast majority of ag producers and ag banks have a strong capital base that helps buffer the consequences of economic down cycles.”    

After sustaining back-to-back losses, some farmers have completely burned through the cash reserves they built during the boom, and now that working capital has declined, they are looking at leveraging discounted assets that they’ve already paid for once, according to Michael Bahl, business banking manager for Wells Fargo, Owatonna.

For instance, Bahl says that southern Minnesota farmland values peaked in 2015 between about $10,000 and $11,000 per acre; today that same land is probably worth $6,000 to $7,000 per acre. Anyone who bought land at the peak had to finance it with at least 50 percent cash.

Bankers say about half of the state’s corn farmers have been relying on financing for working capital, but that portion is growing. In 2015, according to University of Minnesota FINBIN data, 70 percent of Minnesota corn farmers and 50 percent of soybean farmers lost money. Bahl expects the portion of farms that lost money in 2016 to be similar to 2015, with the percentage expected to increase across all sectors except dairy in 2017. However, dairy farmers are operating with low margins.

“Access to excess capital is not there like it was in the good times,” Bahl says. “There’s more scrutiny today. I haven’t seen any that have been shut off from credit yet. But there will be some farms that won’t be farming the entire year.”

U.S. trade clashes

Recent political rhetoric over trade issues also is worrisome. Brad Costello, agricultural relationship manager for Alerus, says there is lots of concern over potential trade conflicts, particularly with China and Mexico. According to the USDA, China and Mexico were two of the top three markets for U.S. agricultural products in 2015, with China receiving $20.5 billion in U.S. exports and Mexico $17.7 billion.


“When times are tough, farmers are not buying. Unit sales of large pieces of equipment are down 40 percent to 50 percent from the peak,” Bahl says. “Certain agribusiness dealerships are shrinking the number of stores they have and expanding their repair business to increase margins. We are going to see some failures with production agriculture in 2017, and we’ll probably see some failures in farm dealerships throughout the region.”

The good news for the sector is that many equipment dealers shored up their balance sheets in 2015 and 2016 by adjusting their business models and cost structures, and used farm equipment values are starting to rebound.

“Those who have been aggressive on working down the value of used equipment are doing well. Some have been aggressive at getting this inventory off the lot, even at a loss,” Paulson says. “Equipment dealers are borrowing less, simply because well-run dealerships have cut used inventory and used that money to pay down their line of credit.”

Other uncertainties continue to cloud the banking industry as well, including whether Dodd-Frank will be repealed, replaced or revamped, and bankers are mixed on what might happen to the federal banking regulations.

“We believe in regulation. Regulations are important,” Trier says. “Our position is that we are going to be a leader in having the resources, expertise and people needed. We have built the infrastructure and added needed staff. The new administration has run on a deregulation theme, but it’s too early to tell. For us, it’s status quo for now.”

Some of the smaller banks were hopeful that regulatory changes would be for the better. “The new administration is saying it will cut back regulation across industries, and the banking industry is hopeful there will be regulatory relief for the industry,” Rymanowski says. “But there’s also an ‘If not this, then what?’ feeling.”

Fran Howard is a St. Paul-based freelance writer and editor.