Interest rates add to uncertainty for commercial and residential lenders.

When thinking about lending activity in the year ahead, interest rates are the biggest uncertainty that commercial and residential lenders face. We all know that inflation is rising – and typically when inflation rises, the economy starts to overheat and the Federal Reserve usually takes action by raising interest rates.   

At BayCoast Bank, 2021 saw us set records in both residential lending and commercial lending, surpassing our previously best commercial year (2018) by $100 million. But our primary concern for 2022 is whether rates are going to go up, and if so, by how much. 

We’ve experienced a long period of low interest rates – both on the commercial and residential sides. I think, as human beings, we have short memories and tend to forget things quickly. I’ve been in the business long enough to remember when the prime rate was set at 22 percent – some people just can’t fathom that!  

I’m not saying that’s going to happen, but even an increase that saw the prime rate double would have an extremely dramatic effect on companies and their ability and desire to borrow. It would certainly slow down the economy. I don’t think the prime rate will get that high, but given the length of time we’ve experienced low interest rates, any material increase in rates will send shock waves throughout the economy. 

Ongoing Uncertainty 

The rise in inflation and interest rates will certainly impede businesses’ ability to comfortably achieve the debt service requirements they need, especially those who have their business line of credit tied to some index, usually the Wall Street Journal prime rate, which today is 3.25 percent.  

Should that rate go up, many businesses may experience increased interest payments required on their loan. And if the cost of materials continues to rise and sales level off or go down, these businesses may quickly find themselves in a cash crunch, with a limited amount of net income to service their monthly debt.  

We’re already starting to see that a little bit as short-term rates have gone up. Year-over-year, residential loan rates are one-quarter to three-eighths higher, which, at first glance, doesn’t seem like it would be significant enough to impede lending activity but certainly creates an impact on homeowners who have already refinanced at lower rates.       

 Continued uncertainty in the supply chain and cost of materials will also affect the commercial side of lending. We had one customer planning to develop a 280-unit apartment complex, and he calculated that because of supply chain issues and the cost of materials going up, he would need to spend an additional $14 million, which he felt he just couldn’t absorb. As a result, the project is on hold until more certainty is available in the market. I think we’re going to see more pauses with big undertakings in the near future. 

Some Positive Trends 

On the residential side, we’ve also seen an uptick recently in capital market rates, which inevitably cause mortgage loan rates to go up. Given the fact that a great number of people have already refinanced their home loans, combined with a lack of housing inventory – the Massachusetts Association of Realtors announced the commonwealth currently has the lowest housing inventory on record since they began keeping track in 2004 – we’re anticipating a 20 percent reduction year-over-year in residential loan originations. That’s after experiencing $1 billion in loan originations back-to-back in 2020 and 2021. 

Carl Taber

That said, the severe lack of inventory and rising interest rates have led and will continue to lead to a nice increase in home equity lending. With home values continuing to go up, and many homeowners already enjoying very low interest rates on their mortgages, more and more are tapping into their equity through home equity loans or lines of credit.     

Because commercial lending rates have been so low, and it’s been so competitive to attract loan customers, some banks have been trying to buy the market by foregoing their typical required minimum interest rate spreads and offering rates which result in lower interest rate margins, adversely affecting their profitability. In the short term, those institutions might gain some additional business, but in the long term, that practice is not fiscally sustainable. 

When the pandemic first hit in early 2020, many of us in the banking industry, and beyond, prepared for the worst. While it turned out many did have a couple of lean months, 2020 ended up being a very good year financially for most institutions – with obvious exceptions for the hospitality industry, including hotels and restaurants, and office space. We knew those industries in particular would be challenged and are glad to now see there have been some slight improvements and positive trends for those hardest hit.  

We expect to see continued improvements across all these sectors, while we wait to see whether – and how – higher inflation and rising interest rates will impact commercial loan production. 

Carl Taber is executive vice president and chief lending officer at Swansea-based BayCoast Bank