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May 23, 2022

Commercial lenders aren’t sweating rate hikes – at least not yet

HBJ PHOTO | STEVE LASCHEVER George Hermann, president and CEO of Windsor Federal Savings, will step down in July.

Community bank leaders say commercial loan demand remains strong despite recent hikes in the Federal Reserve’s benchmark interest rate.

The blitz on home loans and refinancings, however, is coming to a close.

Ion Bank President and CEO David J. Rotatori said interest rates remain historically low and that builders and other commercial borrowers have “plenty of room to maintain profitability.”

“A lot of them have refinanced already, so they are all in a relatively strong condition, and the amount of liquidity in the market right now is very high,” Rotatori said.

Residential home loans are another story. Housing prices have jumped 20% to 45% in the past year. Interest rates have jumped from the low-3% to mid-5% range, making monthly payments more expensive and less affordable, Rotatori said. There are still purchases being made, but it is slowing. Mortgage refinancing dried up two months ago, he said.

Rotatori said he advised his own daughter, who recently graduated from the University of Connecticut’s pharmacy school, against buying a house right now. It’s better to wait six months and see what the landscape looks like, he said.

Rototari still predicts a record year at his $1.7 billion-asset bank for commercial lending, prompted by construction of apartments, warehouses, healthcare facilities and manufacturing capacity. Economic activity doesn’t seem to be clustered in any sector, he said.

George Hermann, president and CEO of $739.6 million-asset Windsor Federal Savings, acknowledged the economy is being buffeted from several angles. There are supply chain shortages, the war in Ukraine and associated inflation. But Hermann predicts the robust economy can weather these shocks without recession, provided current supply chain woes don’t drag on too long.

Hermann said it will take time for the impact of the recent rate hikes to manifest. But they have been well telegraphed by federal officials, allowing businesses and investors to prepare, he said. Many took the plunge on borrowing ahead of rising interest rates.

“If they were trying to decide if they were going to do something or not, they pulled the trigger and did it,” Hermann said.

Banks have also cultivated high levels of available cash as a hedge. That was helped by the pandemic, which caused bank deposits to soar as individuals and businesses were reluctant to spend and borrow money amid uncertainty from the health crisis.

Connecticut’s 32 federally-insured banks held $116.3 billion in deposits at the end of December, up 7.5% from a year earlier, according to Federal Deposit Insurance Corp. data.

“It’s like buying inventory in advance,” Hermann said. “So, the impact of the rate increase really hasn’t hit yet and realistically it probably won’t show up much before the summer.”

The interest rate hikes have slowed home loans, but it hasn’t killed activity entirely as might be expected, Hermann said. He attributes this to an ongoing shortage of available housing.

Hermann said it is hard to predict if there will be an economic slowdown. Commercial lending activity remains robust, he said.

At the end of December, Connecticut federally-insured banks held $83.8 billion in total loans and leases, down 6.3% from a year ago, FDIC data shows.

“We still see, based on our pipeline, there is pretty good demand out there right now,” Hermann said. “There is a big need for warehouse and distribution. There is still demand on the housing side. Our main defense manufacturers between Pratt [& Whitney], Sikorsky and Electric Boat have some pretty good contracts. A lot of subcontractors are humming along and have needs.”

Mixed forecasts

Economic forecasts are murky and mixed.

John Carusone, president of the Hartford-based Bank Analysis Center, said the mounting list of economic challenges creates strong potential for a downturn and slowing commercial loan demand.

Overgenerous federal spending coupled with a late response to obvious inflationary risks has resulted in a 40-year inflationary high, Carusone said. It will take tough measures to curb it.

“The likelihood is the recent 50-basis-point step-up in the rates is just the first in many such step-ups, because inflation won’t really come into control until the Federal Reserve target rate is at or above the rate of inflation,” Carusone said.

In a statement May 4, Fed Chairman Jerome Powell said that additional half-percentage point rate hikes are possible.

Today’s extraordinary inflationary pressures resemble those of the early 1980s, when the Fed brought the reserve rate up to 18% to curb double-digit inflation, Carusone said. That caused home mortgage rates to hit almost 20%.

“The issue is how can the Fed kill inflation without throwing the economy into a recession, a major economic slowdown or, more onerous, into a period of stagflation where you have high levels of inflation and a stagnant economy, as we had in the Carter years 50 years ago,” Carusone said.

Carusone agreed home loans are drying up and commercial lending hasn’t been much impacted — at least not immediately.

“Not yet, but the probability is pretty high there are going to be increasing pressures on credit quality and loan demand and changes in pricing as the Fed continues to run up interest rate increases to deal with this inflation,” Carusone said.

Photo | Nathan Oldham, UConn School of Business
UConn economist Fred Carstensen said Connecticut’s economy has lagged for a decade and the coronavirus pandemic will only exacerbate the state’s challenges.

Fred Carstensen, director of the Connecticut Center for Economic Analysis at the University of Connecticut, predicts no short-term impacts from the rate hike. Builders and businesses are already committed to high-demand projects, like multifamily housing and warehousing.

“It looks like the economy is doing really well so it can bear the costs of moderate increases in the interest rates,” Carstensen said. “We used to celebrate when we could get rates down to 6%.”

Carstensen sees fundamental economic weaknesses in Connecticut and beyond. Income inequality, lack of affordable housing and growing monopolization of various industries are bigger challenges than inflation, which could be short-lived if the war in Ukraine and COVID-19-induced supply chain issues moderate, Carstensen said.

Carstensen pointed to the most recent robust jobs report, which saw Connecticut’s unemployment rate continue to drop, reaching 4.6% at the end of March.

He also noted that interest rates remain historically low. Rates haven’t climbed high enough to dissuade economic investment, and the hype around economic challenges, including the rate hike, is louder than the actual threat to economic activity, he said.

“At the margins it will delay some major purchases, but for the most part, things look like people are being reasonably patient,” Carstensen said.

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