North Bay bankers explore what’s ahead in lending and finance for local businesses

A new year and a new set of challenges for North Bay businesses. Here’s what some local financial institution leaders had to say about what’s ahead.

With inflation expected to persist in 2023, to what degree do you see that continuing to impact lending?

Jeff Clark: It will continue to negatively impact lending for the foreseeable future. On March 31st Wall Street Journal Prime was 3.25%. It was expected to finish the year at 7.5%. Your cost of borrowing has more than doubled in nine months.

That does not include rising labor costs and other increased costs of doing business. The adult beverage industry has struggled to pass on increased cost of goods to consumers. It places producers in a tough spot.

Banks and borrowers are looking at increased refinance risk as well. Increased interest expense can render some loans unable to be refinanced at current loan balance levels when they mature. You must pay down the loan to a level that you can service the debt or you risk default. Many businesses do not have the liquidity for that. The ability to raise outside equity seems to have diminished of late.

Brian Kilkenny: Inflation is just one of the many factors affecting our local, regional, national, and global economy. Quality labor shortage, the lingering effects of the pandemic, geopolitical issues, and supply chain challenges are additional things that can affect local businesses.

The reality is that there are always a multitude of factors affecting the economy for both businesses and individuals.

While the last three-plus years have been especially difficult, our local businesses have, for the most part, done whatever they can to survive and even thrive in the face of adversity.

We’re all focused right now on where inflation is going, but wherever it goes, we need to account for it and recognize the world won’t stop turning.

Alison Martin: Businesses continue to face headwinds, including lingering effects from the pandemic like supply chain disruptions and rising costs.

We’re focused on helping our commercial clients navigate this environment with a broad range of solutions in addition to traditional lending. For example, we’re seeing increased demand for foreign exchange hedging strategies as volatile currencies impact companies that sell their products abroad and/or import materials. Companies are also accelerating their payment transformations, turning to us to help them digitize and automate more of their back-office work.

Sunil Pandya: Between supply chain stagnation, rapid inflation, rising interest rates, and one of the tightest labor markets to date, North Bay business leaders continue to operate in an environment that many haven’t seen in their professional lifetimes.

While escalating interest rates are no longer a surprise, with each Fed announcement, I’m having more conversations with North Bay business leaders to help them develop creative financing solutions to meet their short and long-term goals.

It’s a great time to conduct a thorough financial review, including cash flow projections, and have frank conversations (with financial institutions) to make any necessary adjustments to loan structures and working capital lines of credit.

Cody Radelfinger: The pace of inflation is slowing as the Federal Reserve has hiked interest rates at the most aggressive pace in decades.

However, the Federal Reserve remains committed to get inflation closer to their stated 2% goal. We have started to see longer-term rates easy slightly. This is largely because the risk premium being applied to long-term loans is declining as the Fed become less aggressive.

Brandy Lee Seppi: Inflation will impact lending in a number of ways in 2023. It will prohibit borrowers with less than perfect credit from executing on purchases/expansion projects due to increased material and borrowing costs, and encourage strong buyers to closely review the cost/benefit of any new investment.

Due to the uncertainty of inflation and economic challenges, lenders may pull out of lending for a period of time – further impacting the health of our business economy. At Summit, we will continue lending – similar to how we remained open during COVID, when many other lenders pulled back, or halted completely, their lending programs.

Nikki Sloan: The Federal Reserve’s ongoing efforts to raise interest rates to combat inflation has made borrowing more expensive and, as a result, loan demand did ease some in late 2022. This is likely to continue early this year, though economic activity throughout our Northern California footprint remains relatively healthy, and our bankers are actively engaged with commercial clients across all of our markets.

The rate environment continues to impact commercial real estate transaction activity as investors are taking a pause as borrowing costs increase. We are seeing that in fixed rate, commercial real estate lending, even though rates remain relatively low from an historical perspective.

However, we believe activity will continue; it's just hard to predict how long investors will sit on the sidelines, waiting to see what the new landscape will look like.

Paul Yeomans: Inflation affects all loans tied to the prime lending rate. Due to the jump in 2022 from 3.25% to 7.50%, and with anticipated rate increases in 2023, we will likely see more of an impact. An additional consideration is the inverted yield curve, with short term rates higher than longer term rates. Higher interest rates affect the cash flow available to repay new debt, which could result in less borrowing power.

There are also higher material and labor costs for businesses depending on the industry, such as restaurants, construction, manufacturing, hospitality or retail. At the same time, there is a softening to home prices.

Hopefully, those costs will reduce as inflation is brought under control. All of these factors impact lending, given that borrowing is more expensive, combined with the increased cost of business.

Is there an industry you service where you're seeing more loan applications from entrepreneurs and small businesses?

Jeff Clark: I am seeing demand for working capital. Some of it is to finance growth while others need it to literally keep the lights on. Fortunately, we are seeing healthy loan demand across the various product categories, even in construction.

Brian Kilkenny: Through the pandemic, we saw a rise in people starting their own small businesses. Many of the new businesses were people privatizing what they were already doing as an employee.

Examples are individuals who had worked in the construction trade for a larger company striking out on their own, or someone from the professional services sector (lawyer, accountant, investment advisor, etc.) leaving a larger firm and hanging their own shingle.

If we see downward movement in the economy, I think we will see some decrease in that as people will be more apt to stick with the security of the job they have while the economy settles. That being said, the North Bay is largely comprised of small businesses, and it's part of our rich history. So, we anticipate and hope to see more and more businesses begin and thrive

Alison Martin: There is not one particular industry per se, but we are seeing a steady stream of loan applications despite the economic uncertainty.

Sunil Pandya: North Bay companies are increasingly looking for not only financing but financial expertise in specific industries, including agriculture, technology, healthcare, sustainability, and investor real estate.

Cody Radelfinger: The segment of our business that serves startups and entrepreneurs tends to see new growers producing eggs and/or vegetables and using farmers markets for direct-to-consumer sales.

Brandy Lee Seppi: We are seeing applications from all business sectors, as every company has their own circumstances and character traits. Bottom line: we are open for business to help all business sectors grow and succeed.

Nikki Sloan: There is potential for interest in long-term fixed-rate financing from commercial real estate and business owners in order to take advantage of lower interest rates and avoid further rate hikes expected in 2023. Overall, we remain focused on executing on our relationship banking model by providing exceptional service to our current and prospective customers across various industries.

Paul Yeomans: We’re seeing interest in SBA lending from across all industries. The organic food and craft beverage industry in Sonoma County is still active, along with construction and residential lending.

If digital banking is here to stay, will this lead to more branch closures?

Jeff Clark: Live Oak Bank has only one branch, our headquarters in Wilmington, North Carolina. We have been operating like this since 2008, and it works well. I believe branches do serve several purposes, but digital banking does render some branch services obsolete.

Brian Kilkenny: Digital banking is certainly a major focus of the current and future state of banking. We are, and have been, investing considerable resources to build, maintain, and optimize our numerous digital offerings for our members. That being said, there’s a significant and important segment of our communities who want and need a physical branch, and it’s important to us that they’re not forced into a banking experience they’re not comfortable with. So, we don’t anticipate closing branches in the near future and, in fact, see expanding our branch network as more likely.

Alison Martin: At U.S. Bank, we’ve taken a “digital + human approach,” which means we’ve invested in digital capabilities and paired that with access to our 2,000-plus branch network and the bankers who work out of them and continue to play a vital role in serving our customers.

Sunil Pandya: Customers are increasingly using digital channels and transacting less often in branch.

One short-term goal that many North Bay middle market companies are considering, or implementing, is business automation. Many companies are investing in technology to mitigate the impacts of labor shortages. Some factors to weigh when automating and streamlining operations include:

Consider upgrading ERP or inventory management systems to provide the automation you need today and in the future. As companies grow, often systems lag behind, which requires more human capital to get the job done.

Analysis of companies’ treasury management services can also help improve cash flow and save on labor costs by optimizing digital payments and streamlining account receivables.

Brandy Lee Seppi: This answer will depend on the make-up of each bank’s client base and profit-to-service culture. At Summit, we have five branches, all in Sonoma County, and do not anticipate any branch closures. We find that many business owners, nonprofits, and people not comfortable doing banking online, typically want to know the people that guard their money. Even if they don’t need daily assistance – they find comfort in knowing a local person is available to help them, should they need it.

Nikki Sloan: Digital banking is here to stay. The speed and convenience that it affords is increasingly in demand among both consumers and business owners. That noted, many of our clients look to us for financial advice and guidance, and often this is most effective face-to-face. As a result, branches remain important meeting places for our bankers and customers, and we expect this to remain the case.

While we know that excellent in-person service and financial expertise of our bankers will always be vital, we also know that customers increasingly manage their finances online. As a result, we continuously evaluate enhanced digital offerings.

Paul Yeomans: Digital banking complements the products and services of the bank, both on the personal side and business. Customers have gotten much more comfortable using digital banking for making deposits, checking balances, paying bills, sending money to family and friends and much more.

Digital banking also makes borrowing easier, whether it’s auto, home and even business. Actually, digital banking could lead to even more opportunities for growth.

Do you expect more mergers in your industry in 2023? If so, why?

Jeff Clark: I do. Current economic conditions provide great opportunities to expand for well thought out business models with solid balance sheets, ample liquidity, and strong cash flow.

As mentioned earlier, the beverage industry has struggled to pass on cost increases. There is no lack of substitute product in the beverage space. Increasing prices risks someone buying your competitor’s lower priced offering. At some point the industry will have to pass on cost increases, but when is the question.

If you can’t increase prices to offset increased cost of goods, your only option to increase margins is to reduce the cost of doing business. Mergers can sometimes provide economies of scale and reduced overhead. Many beverage business models were already struggling before COVID. PPP, EIDL, ERC, and other government support helped but have for the most part gone away. Many businesses will need to merge to survive.

Brian Kilkenny: Mergers have been a hot topic for quite some time, so I anticipate that will continue. But after years of robust liquidity in the banking industry, we’re transitioning back to high demand for deposits to bolster capital available to lend and help ease cost of funds. That always raises the prospect of a merger, as institutions see that as an opportunity to “buy” deposits. The deposit aspect coupled with anticipated continuing economic challenges provides a landscape that will see both buyers and sellers entertaining the prospects

Cody Radelfinger: Mergers have been trending upward in the agriculture industry over the past several decades as agricultural production has sought to optimize efficiency through economies of scale. As a key business partner to farmers and ranchers, we’re always looking for opportunities to build on our strength and add value for our customers. In May 2022, Farm Credit of New Mexico and American AgCredit announced our intent to merge. The merger is subject to regulatory review and a stockholder vote in 2023. This will be a great opportunity to provide agricultural producers in New Mexico additional resources and capital, while continuing to diversify the American AgCredit portfolio.

Brandy Lee Seppi: Mergers tend to happen for a variety of different reasons. Typically, two top reasons are lack of performance and/or an aging management team/board of directors. That said, the uncertainty in the current market will need to stabilize for prices to be attractive and the volume of mergers to increase – should that stabilization happen, I would expect more bank mergers in 2023.

Nikki Sloan: Yes, we believe banks will continue to seek the economic gains and economies of scale afforded by mergers and acquisitions. The pursuit of scale is bound to drive further consolidation this year and in coming years. That said, the pace of M&A in 2022 did slow amid longer regulatory reviews and some concerns about a slowing economy. These factors could continue to keep deal activity relatively modest in the first half this year.

Paul Yeomans: Yes, the cost of running a bank is increasing, as it is for many other businesses. Some institutions will be looking at the increasing costs of doing business, compliance costs, and the ability to attract and hire qualified employees. Some banks will determine that their institution can’t grow enough to sustain these higher expenses. Our industry is always working to stay ahead of labor laws, states laws and federal regulations, which are constantly accelerating and need to be adopted and monitored