Rising Rates 2016
Rising interest rates have already occurred, starting with the Federal Reserve’s 25 basis point increase in December. Conventional wisdom says that another increase will likely happen early this year. Certainly, this tightening by the Fed could put a dampening on the lending business, since, banks will pass along those higher rates to its borrowers. And yes, that sequence of events has already started, as banks increased their prime lending rate just after the Fed’s increase happened. But, the relatively slight movement in the lenders’ cost of funds, in my opinion, will serve as the proverbial “stick” to prod more lenders to aggressively seek new commercial loan business. As a result, I expect commercial lending activity to remain strong throughout the coming year.
Why do I believe that higher rates will lead to more lending in 2016?
The rising rate environment starts to put pressure on the banks’ Net Interest Margin(NIM) as their short-term borrowing costs from the Fed are now increasing. Coupled with the fact that the national (NIM) average has already decreased from 3.8% in 2010 to under 3% in 2014, banks will want to turn the tide, or at least preserve their current level of Net Interest Income(NII) as rates rise. As a result, I believe that lenders will be more aggressively looking for quality commercial loans. Commercial relationships are valuable to lenders as they understand that lending to businesses can lead to other relationships with the business customer. Further, commercial loans tend to re-price much more quickly than the typical consumer mortgage or car loan. In the anticipated rising rate environment, lenders will want to have the flexibility to re-price loans more regularly in an attempt to improve their NII and the corresponding NIM. Seeking out more commercial loans will provide them with this opportunity going forward.
But haven’t lenders already been pursing commercial relationships?
The answer is generally yes. But the rising rate environment will stimulate their appetite for these assets. In order to compete for quality relationships, bankers will become more aggressive in pursuing those relationships. Also, the banks are in a stronger capital position as we enter 2016 and are in a better position to take on additional quality loan risk.
What other factors support commercial loan growth in a rising rate environment?
The rising rate environment is predicated on the belief that the U.S. economy is growing and jobs are being added. If this is true, commercial borrowers should be seeking viable ways to expand. With aggressive lenders offering still historically low rates and potentially better terms, then the business owner may be willing to take on the additional leverage being offered. Further, it’s an election year. Do you really think the Fed would be increasing rates if it thought that their actions would lead to a decline economically during this year? A majority of the Fed governors must believe that an increase in rates will have a positive or neutral effect during the upcoming year while enabling them to address any perceived inflationary pressures. It also restores their greatest tool to combat an economy that will inevitably slow at some point in the future; the rate cut. Lastly, the recent stock market volatility can serve as an impetus to commercial real estate as investors rotate their capital into an asset class that they deem more predictable and stable.
So thanks to rising rates, I expect 2016 to be a good year for commercial real estate lenders, borrowers, and all of us associated with that important part of the economy.
I hope you are having a great start to this new year.
Jerry