Next rate increase could come down to a coin flip; commercial bank retrench continues

Ag borrowers experience tough sledding in the commercial bank market

A perfect storm of regulatory and economic factors—including higher cost of capital due to rising interest rates, a potential increase in capital ratio requirements and insurance premiums, all compounded by concerns about credit quality tied to commercial real estate—is causing commercial banks to pull back on their lending activity.

“We just closed a large deal for a new ag customer that had been a four-year prospect,” said John Harkins, managing director, CoBank Capital Markets. “They became much more interested in what CoBank and the Farm Credit System could do for them when they tried to exercise an accordion option—which is a fairly simple increase in their line of credit—with their current bank and they couldn’t get it done.”

Another factor playing into the commercial bank dynamic is ancillary business.

“In many instances, commercial bank credit committees just aren’t approving transactions if there isn’t an opportunity for ancillary business that’s going to enhance their return,” Harkins said. “Returns and risk-adjusted returns on capital (RAROC) models have become their driving force for capital deployment.”

That’s where CoBank’s mission-focused lending focus comes in.

“CoBank certainly isn’t immune to some of the funding cost factors that affect the overall loan markets,” Harkins concluded. “Returns are important. But it's also our mission to lend funds to rural America that weighs into our decision-making about deploying capital. That allows us to be more of a stable source of capital going through cycles like the one we’re experiencing now.”

Nationwide labor shortage takes out the tortoise and the hare

The race to build new broadband networks across rural America has been slowed to a tortoise’s pace by a very serious nationwide labor shortage, according to Jeff Johnston, lead economist, Communications, with CoBank.

“Race is the right word,” said Johnston. “Everyone is racing into markets where there isn't any broadband, and everyone—from investors to executives—is anxious to plant their fiber flag first because the first mover advantage is so beneficial to them in terms of gaining market share.”

But Johnston says the labor issue, which was years in the making, is pushing out the deployment of many communications infrastructure projects.

“Looking at the macro-economic environment from a labor standpoint, the picture isn’t pretty,” Johnston continued. “Birth rates have been in decline since 1960. And even though it’s picking up now, U.S. immigration has been down significantly the past few years, and there’s no prospect of immigration reform on the horizon. Also, an estimated 2 million people ended up leaving the workforce earlier than they would normally have because of COVID.”

Johnston added that the labor-intensive nature of communications network construction, as well as government incentives in other industries, makes the problem especially intractable.

“It’s not just the availability of government funds for new broadband networks where boots on the ground are a necessity,” Johnston concluded. “Other government programs, like the CHIPS Act to bring more semiconductor manufacturing into the U.S., and the Inflation Reduction Act, which incentivizes battery and EV manufacturing, are putting even more pressure on the labor market.”

Johnston believes the issue is likely to worsen before it improves and that communications companies will have to look to creative solutions—including local partnerships—to move their projects forward.

Commercial banks continue to cloud lending environment

Similar to Ag borrowers, Power & Energy providers are experiencing more difficulty in executing their capital plans because of continued weakness in the commercial lending sector, according to Bill Fox, managing director of Capital Markets with CoBank.

“Many commercial banks have shifted from being picky and conservative in their lending activity to now simply refusing to lend to new or even existing customers that don’t have robust ancillary business and/or higher spreads and pricing than they paid in the past. This applies even at the investment-grade level, which represents the majority of energy borrowers we finance,” said Fox. “This is a different market than a year ago. And borrowers that are reliant on commercial banks in their deals are becoming aware of it and realizing that they may need to make changes to deal pricing and/or structure as appropriate, to achieve successful syndication.”

Fox added that he doesn’t see the market changing anytime soon, certainly not in the next six to 18 months.

“From the customer perspective, you have to give yourself time,” said Fox. “Have a trusted, consistent capital provider, such as CoBank, lead your deal, and then give us appropriate time to screen the existing and potential new lenders. 

“Whether borrowers are looking for incremental capital or a refinancing of existing debt, we need to screen all of the proposed lenders and get that feedback to the customer,” he continued. “The customer should then use its relationship power to weigh in on those conversations and influence their lending relationships as appropriate. Borrowers with ancillary business levers to pull will likely need to do so. Armed with borrower pressure, our solid prescreening data and market expertise, we can then come up with collective pricing and structure decisions that balance the needs of all parties involved, to achieve success.”