Listen to this articleThe Federal Reserve’s recent 50-basis-point interest rate cut has sparked optimism in the business community, but local banking experts say the immediate impact on business borrowing may not be as straightforward. The change comes at a time when businesses are navigating a complex lending environment, particularly in sectors like commercial real estate.
“We really haven’t seen any increase or decrease in loan demand from our side,” says Horacio Chacon, a commercial and industrial lender at Capital Bank. “You would think that with a half a percent decrease in rates, we would see some kind of an uptake in borrowing activity, but so far we haven’t seen it.”
Matt Cohen, Maryland market president at Univest Bank & Trust explains that while the Fed’s actions affect short-term borrowing rates, the impact on business lending is more nuanced.
“A 25 or 50 basis point cut from the Fed naturally reduces what it costs in interest expense,” Cohen says, “but it might not necessarily change the way in which businesses operate because the next 25 basis points is not going to have a drastic impact on what they do.”
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Stability, rather than the specific rate level, is what’s most important for business planning.
“If you know that a rate is going to be somewhere between 6% and 6.5% over the next six months, you can build your models to see if your debt-to-equity ratios work at that debt,” Cohen explains. “That stability is really a lot more important than where that short-term rate goes.”
The distinction between short-term and long-term rates is crucial for business owners to understand. While the Fed’s actions directly influence short-term borrowing costs, such as lines of credit, longer-term commercial real estate rates remain relatively stable at higher levels.
However, as the gap between short-term and long-term rates normalizes, banks’ ability to lend increases. “It allows us to lend more because we can take advantage of what would be a normal curve,” Cohen says.
“When the economy appears to be pretty stable and moderately growing, there’s less fear of recession,” he adds. “Matched with rates coming down, that allows banks to feel more comfortable over a longer period of time.”
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Increased Optimism
The impact of rate cuts extends beyond the direct cost of borrowing. Lower rates tend to boost business optimism, which in turn can drive increased business activity. As more businesses feel confident about expanding, hiring, or making capital investments, this increased activity helps fulfill the promise of economic growth that the rate cut initially signaled.
“We’re starting to see projects loosen up,” Cohen said. “The narrative around stability and then the vision of having lower interest rates makes those business owners feel more comfortable taking risks. I’m starting to see people talking about building, or wanting to bring on more people, or acquiring a business. We’re having more of those dialogues.”
This means not only potentially lower borrowing costs but also potentially easier access to capital as banks’ lending appetite increases. However, Chacon emphasizes that fundamental factors like cash flow, collateral and business plan viability remain the primary considerations in lending decisions, regardless of the interest rate environment.
Banks look first and foremost at cash flow as the primary source of loan repayment, with collateral and owner guarantees serving as backup sources, Chacon explains. “If I can’t get comfortable with the cash flow, we won’t be able to do the loan.”
Chacon advises businesses to prepare for various scenarios through stress testing. “When interest rates were 4%, I told all my businesses, this is not natural. Take advantage of what you can, but this is not natural for interest rates,” he recalls, noting that his stress tests typically factor in rates two to three percent higher than current market rates.
Regardless of the interest rate environment, business owners should:
1. Focus on their business plan first, treating interest rates as just one factor in the decision-making process.
2. Understand their debt service capacity through stress testing at higher rates.
3. Maintain open dialogue with their bankers about growth plans and capital needs.
4. Consider the total cost of capital, not just interest rates.
5. Evaluate their collateral position and overall business strength beyond just cash flow.
As the market continues to evolve, the key for business owners is to maintain a long-term perspective while staying prepared for various rate scenarios. The recent rate cut may signal a positive trend, but successful borrowing still depends on solid business fundamentals and careful planning.
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