Advising Your Borrowers on CRE Loans with Sim Cheema

INTRO: Helping community bankers grow themselves, their team and their profits. This is the Community Bank Podcast.

CALEB: Well, hello, and welcome back to the Community Bank Podcast. Thanks for joining the conversation today. I’m Caleb Stevens with SouthState Bank’s Capital Markets and Correspondent banking division. Wherever you are, welcome. We’re glad you’re here for today’s show. Specifically, if you’re a commercial lender, or if you’re in the credit world, or if you’re an executive–listen up, because we are talking about the state of commercial lending, and specifically, the state of CRE lending. Today, I’ll be talking with Sim Cheema. She works with our ARC loan hedging program. She serves community banks just like yours around the country, helping them win more loans and increase their fee income through the ARC program. She also works with our own internal lenders here at SouthState as well, so every week Sim is on the phone with banks all over the country, with lenders looking at all different types of credits and different kinds of borrowers. And she is helping them close more deals. So, she’s going to talk about the trends she’s seeing in the commercial lending world, and we hope it will be helpful to you as you make decisions and grow loans and hopefully deposits–right?–at your bank. And so, great conversation.

CALEB, continued: Real quick, before we get there, you’re invited to attend our 2024 Elevate Banking Forum. We’re bringing the best community bankers together for a two-day event in Birmingham, Alabama. And we’re going to be talking about the strategies your bank must implement if your bank’s going to remain relevant over the long haul. It’s in Birmingham, Alabama. It’s October 10th and 11th, and we would love for you to join. To check it out, view the agenda, and to register, click the link in the show notes of this episode. We’d love to have you join the 2024 Elevate Banking Forum. We want to elevate your bank’s performance and ensure that you’ve got the strategies and resources that you need to maintain relevance in the future. And now, here’s my conversation with Sim Cheema.
 
CALEB: Well, hey, Sim, welcome back to the podcast. How are things up your way in New York?

SIM: Pretty good. Enjoying the summer heat waves.

CALEB: Yeah, you’re not—you’re not kidding, it’s several weeks of 100 plus degree days down here in Georgia. So, you know New York—they say it’s cooler up there, but actually, I lived there one summer, and I would say it’s just as hot and you’re, you know, outside walking all the time. So, I’m sure it’s hot your way, too.

SIM: I think it’s extra miserable just because you have to walk everywhere, but very much looking forward to the fall.

CALEB: Yeah, no doubt. Well, you and I, speaking of weather, we spoke back in December when it was cold, and it was a good show talking about the state of commercial lending in general. You work with our ARC loan hedging team here at SouthState. You serve community banks. You also serve our own lenders here at SouthState and so we want to take a few minutes just to sort of give our listeners an update. You know, a six-month update on where we have come since December. But, for folks that missed that first episode, tell us about yourself and your role at SouthState and what you do to serve lenders.

SIM: Absolutely. So, I have the pleasure of working with the majority of our commercial lenders here at South State. So, basically Atlanta all the way up to Richmond. So good to see a lot of different markets, different types of borrowers, different lending environments, and then I also get to work with a lot of our correspondent banks in the Midwest and up here in the Northeast, which again is unique to be able to see what’s going on in different states, different regions, how different banks are handling the rate environment. And basically, my role involves working directly with lenders and then also having conversations with their borrowers and helping them make decisions regarding financing of their projects, rate outlooks, and all that kind of stuff.

CALEB: Yeah, you definitely have a broad role, and you get to see a lot of different markets, talk to a lot of different types of companies. All kinds of different lenders and markets and so I’d love to start there as you sort of look at the landscape. You’re on these calls with lenders and borrowers every week. What are some of the general trends that you’re seeing as pertains particularly to the commercial real estate world?

SIM: Absolutely. So, it’s definitely a unique year. A lot of deals that are refinancing this year are refinancing from rates that were probably in 3s and 4s to now in the 7s and 8s, so it’s thicker shock for everyone. Borrowers are trying to figure out the best strategy in terms of how long they’re going to finance or refinance for. And we’re just trying to guide them the best that we can and offer the insights that we can.

SIM, continued: We have noticed that borrowers that were sitting on the sidelines for the past year or two waiting for rates to come back down have now accepted that you might be waiting a really long time and if you need to get projects done and deals done, you just have to do it and make sure that the rate that you’re getting works for your project and do it and move on. So, we’ve seen a lot of people come off the sidelines and then there’s a lot of new players that are coming in now and starting to wait on the sidelines and they’ll probably find themselves in a similar spot come next year.

CALEB: Those refis going from 3 and 4 to 7 and 8. What are you seeing? How is that impacting like debt service coverage and just overall credit quality for those borrowers? Are they still kind of hanging steady and staying okay, or are they, you know, is it like, man, we’re getting kind of thin here? What are you seeing there?

SIM: Yeah, even the strongest borrowers when you shock a rate by more than double what it was shocked at four or five years ago, you’re going to have some issues with coverage ratios, and we’re seeing that across the board. And what that’s requiring is some uncomfortable conversations from lenders to their borrowers generally asking borrowers to pump some extra cash into the loan to make the deal be able to paper and that’s happening across the board. Our bank, other banks. And that’s gonna be the story for the next year or two.

SIM, continued: And that also plays into why borrowers are so rate sensitive right now and trying to find the best rates that they can.

CALEB: Well, you mentioned borrowers coming off the sidelines. It’s funny when you and I were talking back in December. I think the forward curve priced in multiple rate cuts. I mean, 4 or 5, maybe 6 or 7 at one point. I can’t exactly remember, but the forecast for 2024 was many rate cuts in the, you know, coming down the line, and here we are in July, and we have yet to have even a single rate cut. And I’m not tooting my own horn here.

CALEB, continued: I’m not some economist or any, you know I don’t, I don’t follow rates, you know, like the economists do. But I remember in January, walking around the office, doing a little poll of some of my coworkers saying, “Okay, so the market saying this for rates, what do you think?” and I heard, “Yeah, maybe 3, maybe 4.” And I said I just don’t know, I said, “I think 2. It just does not feel like we’re going to get a whole lot of help this year because inflation still too high.” And here we are. We still have yet to even have one, so even my conservative prediction of two is like, “Will that come true? Will it not come true?”

CALEB, continued: And so, I just think it’s funny to see that, you know, man, we all were thinking rates are going down back in December and here we are and they haven’t. Therefore, a lot of borrowers, it seems like, are saying, “Okay, maybe we are going to hang study here for a while. Even if we get a rate cut or two, you know, that’s a little bit of a dip, but not a whole lot compared to where we were back during COVID.” So, is that kind of what you’re seeing? Are borrowers saying, “Yeah, maybe we are going to kind of hang around here for longer. At least for the time being.”

SIM: Yeah, definitely. And I think borrowers have kind of gone through that roller coaster this whole year because everyone was really excited in December. Like you said, the markets predicting 6 cuts. And because every month this year’s gone on and there’s been no cut. Everyone’s expectations have been reset, so I think everyone’s learned that every month, it’s a reactionary situation. Whatever the economic data comes out as that has a direct impact on what the rates do. So, we can take where it’s July right now.

SIM, continued: This month’s inflationary data came in below expectations, which in today’s world is good news and the next day rates were down 20 plus basis points and that was because due to the inflationary data coming in cooler than expected. The market was not pricing in a 90% chance of a rate cut in September. So, we also saw swap rates come down immediately, and a lot of borrowers took advantage if they’re in the process of being near closing. Of locking in right after that did happen because everyone knows it could be short lived. If next month’s inflationary data comes in higher than expected, none of us would be surprised to see the 20-30 base points that we saw come down go right back up and that’s just been the story of 2024 and it’s probably going to continue to be the story of 2024 until we start seeing consecutive months of polling data.

CALEB: Yeah. For borrowers that are taking on new debt, they’re not refinancing, but they’re just they’ve got a project or something that they need to fund and they’re taking on new debt, it seems like a lot of borrowers are trying to go with a shorter-term rate just again because there is uncertainty around rate volatility over the next few years. Do you see this as a good thing for banks, as a bad thing for banks? And maybe it depends. What are your thoughts on that?

SIM: Sure. I think it’s good and bad, but there’s more risk to it than there is benefit. We’ve seen certain banks doing deals where you’re offering the borrower a 7-year term but you’re only hedging the first three years of it. So, the borrower’s rate is known for the first three years, after those first three years are done, the borrower reverts to a floating rate, so you don’t know what that service is going to be. You don’t know if they’re going to be able to make those payments, but you still are committed for an extra four years. And the same thing for borrowers, it’s, I know it’s comforting to think “Oh, rates are definitely going to be down in three years. We’ll figure it out then.” But if you take a look at the actual market predictions, in three years.

SIM, continued: We might only have a maximum of, say, 2% worth of cuts. Is that really worth the risk of the flexibility you think you’re getting because if, when you’re closing and you have a choice of getting, just hypothetically speaking, a 6.5 percent swap rate or ARC rate, or 7.5 or 7.75 bank rate, you got to make your decisions based on what you think rates are going to do. But if rates never come down, then you signed up to pay an extra 1.25% for the term of your loan when you could have been saving that on your rate. So, there’s a lot of pros and cons to it. And at the end of the day, it’s all speculation. So, you should be doing upfront what makes sense for your business and a rate that you can withstand.

CALEB: Yeah. If you’re a business owner and now is the time to make a move because your business is growing, there’s a risk in waiting and not expanding or not doing what you need to do now to accomplish the goals that you have for your business. I think that’s great advice. Let’s talk real quick about, this idea of, well, “I’m going to wait for rates to come down. So, I’m going to stay on the sidelines.” Maybe with those borrowers that are still they’re still on the sidelines waiting. But the implication there is “I’m away for ages to come down,” but why, why are rates coming down?

CALEB, continued: That might mean that there’s warning signs. The cracks in the economy that are starting to show, and that’s not good for a business, and that may not be a great time to take on to take on debt or to refinance because the ability may not be there. So, talk about that side of things. You know the idea, “I’m gonna wait, but that could mean that there’s a recession on the horizon.”

SIM: Absolutely. That’s a great point. So, if rates do come down drastically, that means something happened to cause them to come down drastically. So, when’s the last time we saw a crazy shock in rates that got everyone off out of their seats? It was COVID. What happened to businesses? Didn’t do that well. So, if it’s a shock like that that’s unexpected and we’ll almost definitely bring rates down really fast. Does that mean you’ll be able to get financing at that point or take advantage of those rates or even service the debt you already have?

SIM, continued: Not necessarily. Or the other situation I can think of is the SVB collapse. That scared banks. That made banks tighten up on their credit quality, desires, and the type of deals that they were doing. And honestly, we’re still seeing the effects of that right now. Banks got way more conservative after that happened. So exactly what you said, you needed to take it with a grain of salt. If rates come down, there’s going to be a reason for them to come down and think realistically. If it’s a negative reason, will your business still be as attractive for banks to finance?

CALEB: Yeah. You mentioned before we started recording, the nature of the Fed, and how they just control the short term, you know, interest rate. And of course, they did quantitative tightening and using that kind of stuff as well. But the Fed funds rate is the short-term rate and that does not always have a one-to-one impact across the curve as you go further out in duration. And so talk about where we are with just the overall yield curve right now. We’ve seen it flattened a little bit, but it’s still inverted, but just your thoughts on kind of the nature of what we’re seeing with the yield curve right now.

SIM: Definitely. So, one thing that we find ourselves talking about with borrowers and lenders, is the common thing we all keep hearing in the news is that rates are coming down, which we’ve been hearing that since December and have yet to see them come down significantly. But the rates that the news says are coming down, those are Fed-controlled rates. So, when the Fed cuts 25 base points, one month’s SOFR is going to come down by 25 basis points. So on and so forth. But that does not have an impact on the three-year rate or the four-year rate or the five-year rate and so on and so forth because those are controlled by the market.

SIM, continued: So, if the market thinks that rates five years from now are actually going to be a lot higher than they are right now, you’ll start to see the curve be upward sloping again. Which for the past few years we’ve had a very inverted yield curve. Now we’re starting to see it flatten, like you said. Now there’s only a few basis points of the difference between a five-year rate and a six-year rate, seven, ten, so on so forth. Like two years ago, that was more than 30 basis points between a 2 and a 10. So, keeping in mind that if rates do come down, it’s what the Fed controls, which is the short end that does not have a one for one correlation with what happens to the rates that actually matter to borrowers that are doing fixed rate financing, which is the longer-term rates.

CALEB: Yeah. Yeah, that’s helpful. Let’s talk real quick about, specifically, the advice that you’re giving to borrowers and to lenders right now. I know you work on the ARC loan hedging program. I’m sure some of our lenders know what that is, but some probably have no clue what that means or what that is. So, talk about the conversations that you’re having and how you’re trying to help borrowers and lenders be successful.

SIM: Absolutely. So, I think one of them is what we’ve touched on a few times already, which is just trying to separate what you hear in the news about rates going down and the rates that actually impact borrowers. Unless you’re floating, which most borrowers don’t want to do in today’s market, the Fed rate cuts don’t really impact you that much. And then the other advice is taking a look at your trade-offs. What are you being offered, perhaps, conventionally, at a bank versus what are you being offered with ARC product or swap product? There’s a reason why the ARC rates are significantly lower than what most banks are offering on balance sheet. And that’s because, like we talked about, swap rates or based on market expectation of rates.

SIM, continued: So, swap rates give you the advantage of having all the cuts baked into it already. So, when you can get a 6.25 with ARC versus a 7.5 as the alternative conventional, those are the trade-offs you need to compare. What’s the pros and cons of doing that? And that’s what we walk through with borrowers anytime we’re talking to them. And then my advice to lenders has always been the same. Try not to put yourself in a position of predicting rates. That’s a game no one wins, and you really don’t want to be doing that for your borrowers because sure, they’ll be happy if you happen to be right, but that’s just chance. Really, you should be helping them make the best decision for their business based on the information that we have right now and the best information we have right now is just the curve right now.

CALEB: Yeah. Well, if folks want to get in touch with you, if they want to learn more about what you do to serve banks and lenders of all different sizes, how can they find you and contact you?

SIM: Absolutely. So, you reach me on LinkedIn, or you can just shoot an e-mail to our desk, arc@southstatebank.com, and just address it to me, and I’d be happy to get in touch.

CALEB: Fantastic. Well, Sim, we appreciate the time. You’ve given us a lot to think about. And hey, we’ll have to have you back on the show in six months and reconvene and see where we are at that time.

SIM: Looking forward to it. Have a good one.