Confidence is more important than interest rates when it comes to business investment in growth
Story by Rick Berg
News Item: On Dec. 15, 2015, the Federal Reserve Board’s Open Market Committee decided to raise the target range for the federal funds rate to 1/4 to 1/2 percent – the first such increase since June 2006. In its report, the Committee indicated it expected “only gradual increases in the federal funds rate” and that “the federal funds rate is likely to remain, for some time, below levels that are expected to prevail in the longer run.”
The prospect that interest rates will continue to increase in the coming year might be incentive enough for some businesses to pull the trigger on expansion plans, hoping to acquire the needed capital before rates go much higher. Maybe. But commercial bankers and commercial builders alike say interest rates – high or low – are the least likely motivator for businesses to commit to or refrain from expansion.
Rather, they say, business owners are going to be motivated to invest in expansion only if they believe their prospects for sustained growth are strong enough to promise a solid return on investment.
Among the factors most likely to impact those investment decisions:
• Growth in demand: Will market demand for the company’s goods and services be strong enough to return profits on the expanded facilities?
• The labor market: Will there be sufficient skilled talent available to produce those increased goods and services?
• The global and national economy: How confident are business owners that the general economy will sustain demand for goods and services?
Peter Prickett, president of Neenah-based First National Bank-Fox Valley, said interest rates are “one small component of the decision-making process,” but “rates are still historically low and even if the Fed would do a couple more quarter-point increases, rates are still going to be very low. That’s not likely to impact a company’s decision.”
Prickett said that Congress’ extension last year of the accelerated depreciation tax breaks would likely have more impact on capital expenditures, but even that is limited.
“If expansion has already been in the back of someone’s mind as a good move for their business, then by taking the tax consequence off the table because of accelerated depreciation, they ought to do it, absolutely,” Prickett said. “But interest rates and taxes aren’t reasons enough.”
“You have to make those decisions for the right business reasons, based on your expected return on investment,” Prickett added. “Tax and interest rates consequences should really be secondary and tertiary considerations. If you buy something to get a tax write-off, it’s like throwing two-thirds of the money out the window if you didn’t need that asset to begin with.”
Mike Dempsey, president of Manitowoc-based Bank First National, noted there has been “a little flurry of activity since the accelerated depreciation tax advantage was extended. Someone can maybe rationalize their return on investment differently if they can write off the cost of equipment faster. It’s not sustainable, but it does get people thinking about pulling the trigger. If you’re on the fence about when to make that investment, you might move it ahead a few quarters. It becomes a timing play more than a long-term capital equipment strategy.”
Mark Nysted, regional manager for Kaukauna-based builder Keller Inc., agrees the Fed interest rate decision would have little direct impact on business owners’ decision to expand their facilities.
“Interest rates are still at or near historic lows,” Nysted said. “The current prime rate is 3.5 percent, which is only a quarter percent higher than in 2009 when it hit the low of 3 ¼ percent. For financially strong business owners this means a small increase to the interest rate in which they can borrow money. Most borrowers will still be getting a rate between 4 ¼ and 5 percent from their financial institutions, which is still a very favorable rate.”
On the other hand, Nysted said, the Fed decision could have a psychological impact.
“Some business owners might look at the rise in the interest rate as a sign of the U.S. economy getting stronger, which in turn gives them a sense of stability and increases their comfort level to make capital investments,” Nysted said.
Dempsey had a similar observation, calling interest rate hikes a potential “canary in the coal mine.”
“If interest rates rise, that might be a canary in the coal mine telling us about other costs going up – the cost of equipment, the cost of real estate, maybe even wage inflation,” Dempsey said. “In that case, a business might decide to accelerate capital investment to try to get ahead of the cost curves. There might be something to that.”
Steve Schmudlach, president and CEO of Fond du Lac-based Fox Valley Savings Bank, echoes the thoughts of several others.
“The first 25 basis-point increase didn’t produce a ripple in the water,” Schmudlach said. “There’s still an abundance of available cash for businesses to borrow at very low rates and yet a very tepid demand for it. It’s been a non-event so far.”
Confidence in economic outlook is the key
“Some business owners have been reluctant to invest large dollars in the past few years only because they feel the economy is still volatile,” said Nysted. “Our experience at Keller is that many businesses are investing now because they have a pent-up demand and are investing large amounts to continue their growth plans and visions for their companies’ and employees’ futures.”
While most prognoses for the year ahead are positive, there are varying degrees of strength to those outlooks.
“Some business owners we talk to are concerned about the strength of the overall economy and what impact that will have on their own business outlook,” Prickett said. “The value of the dollar going up is putting some pressure on exporters. There seems to be some softness in manufacturing right now. They’re probably less optimistic this year than they were last year, but it’s not a terrible environment – just a touch tighter. In 2015 we saw quite a few capital projects being undertaken. We think it’s going to be a little softer in 2016.”
“We’re bullish in Northeast Wisconsin,” said Dempsey. “We’re seeing businesses with good business models investing and being confident in their business plan to grow their business. We’re seeing a measured approach. They’re positioning themselves for growth, but they’re doing it with a great deal of evaluation. They’re being careful about the opportunities they’re chasing.”
Dempsey said he doesn’t expect to see any rapid acceleration of capital expansion.
“It’ll be more of the same, we think, which isn’t all bad. It’s been OK.”
Election year reluctance
History suggests that many businesses will back off on potential expansion plans in an election year – especially as it gets closer to the November elections.
History also suggests that how the election turns out might have little to do with how businesses choose to proceed, said Dean Hunt, director of marketing and business development for Green Bay-based Bayland Buildings.
“But they still want to know what their strategy is going to be. I think the first half of the year will remain strong, but we’ll probably see a pull back in the second half of the year,” Hunt suggested. “Business people will be saying, ‘We just want to know what’s going on before we make a decision,’ and then once they know, they’ll make their decision and move on.”
The stock markets are not necessarily accurate barometers of business confidence and activity, but the relationship between markets and presidential election years has been widely studied.
Markets tend to respond far better to predictability, according to Mary Ann Bartels, head of Merrill Lynch Wealth Management Portfolio Strategy. “This time, we’ve got a lot of uncertainties, and if there’s one thing markets hate it’s uncertainty,” Bartels said late last year.
Regardless of a president-elect’s party or political leanings, departing two-term presidents create a void that financial markets typically find unnerving, Bartels noted.
“There is a lot of trepidation about a clear change in administration,” Schmudlach said. “I don’t know if we’ll go from a Democratic president to a Republican president or to another Democratic president, but regardless we’re going to a get a new president and with that comes a lot of uncertainty.”
Sectors primed for growth
Bayland is finding strength in several sectors, Hunt said.
“Manufacturing still seems strong. We’re seeing a lot of work in education. Assisted living is going to continue to grow. I see no end to that,” Hunt said. “Health care continues to expand and multi-tenant housing continues to grow – even high-end multi-tenant.”
But global economics could be a limiting factor.
“Wisconsin companies have increased their activity in the global markets by providing products and services to foreign countries,” Nysted said. “There is always the risk to these companies on how the foreign economies will affect their business. Companies that are sending the majority of their products or services overseas might be more inclined not to make the capital investments because of the impact those economies may have to their business.”
“More than anything we’re still seeing the confidence issue as a factor limiting business decisions,” Hunt said. “Business has been good; they’ve been able to meet demand. Could they add on to produce more? Yes, but are they confident those sales will continue? There are a number that want to expand, but they’re holding back for now.”
Schmudlach said he expects loan demand to remain somewhat flat.
“We’re still way off the peak of 2007-2008,” Schmudlach said. “We really have quite a ways to go before we have a steady stream of construction expansion. I think we’re still going to see a lot of standing on the sidelines until confidence grows. Where there’s a shortage there will be activity. I think with the election this year there will be a little extra speed bump.”
Even without a rush on borrowing, there’s plenty of room for optimism.
“The timing is right for capital projects not because of borrowing costs, but because of other factors,” Hunt said. “Right now we’re seeing in the industrial sector not much Class A space out there. The cost of land is pretty reasonable and the cost of construction has held steady. However, because of the shortage of labor, labor costs are going to go up. We’ve had three back-to-back record years and with our pipeline so far it could be even better this year than last. There’s definitely a lot more activity than in some time.” n
Rick Berg is a freelance editor and writer based in Green Bay.