Economic Trends Manufacturers Need to Know

TE:
One of the things that both accountants and bankers do with clients is have a number of discussions on various issues. How would you suggest that your conversations and clients and prospects have changed since the end of last year and where are they now?
GM:Yeah, that's an interesting question, and there definitely has been some change. So, you alluded at the beginning there to the rate environment and that's going to obviously play into each and every one of our clients in differing ways. But I would tell you that we've probably lived through two years, even with COVID, of much of the client base. And there are some specific industry segments that would probably be exempt from this comment, but much of the client base, doing fairly well. There were obviously the PPP and government incentive programs that came out shortly after the outbreak of COVID. And since that time, throughout 2020 and 2021, most clients, most industries, it was arguably steady as she goes. I think there was some real fear early on, but rather quickly, we stabilized. And most of the client base that I've dealt with have been in a fairly good position.

Over the course of this calendar year 2022, you can feel that a bit of a shift is underway. I think companies are a little bit concerned about demand, companies are definitely concerned about the federal government, and the changes that they're making, and shift to different programs, et cetera. And really, is there a looming recession? Have we already entered into a recession at this point, arguably? And I think through that, the conversations have moved from maybe a check-in phone call and all is well, how things going on your end, to maybe liquidity discussions, what happens if as the year goes on, and maybe certain challenges are faced, and what can we do to handle that? But the king now is arguably just having transparency.

In my role, making sure I'm reaching out and staying in contact. And arguably the same, it's a two-way street. On the client end, you want them to be reaching out and being transparent with you and letting you know what they're seeing so you can react early. And you have all your tools, if you will, in your tool shed, to be able to access in order to help those clients and to be more prepared, if and when change may come.
TE:George, I'd like to pick up on a couple of comments you made there, one in hindsight, and then one on a perspective basis. You made reference to the Paycheck Protection Program. Now that we're past it, and hopefully if we're not needing another one as we go into what looks like another recession, what would be your summary of the Paycheck Protection Program and how it actually worked out?
GM:Yeah, it's a great question. It's something we really wrestled with at the beginning of the pandemic, because I don't really think inside of the banking world, many bankers, risk officers really knew how to digest the program. You really didn't know how to look at a company. So, you take the average where a company fell on some pretty tough times, they were absolutely in need of a program such as PPP, and they received those funds. And you wanted to continue to be able to look at the business the right way. And there was a lot of conversation that first summer in 2020 as the program was coming out in full force, and funds were being deposited into different companies' accounts from the federal government and qualifying for the program and saying, "Well, this is a one time thing, how should we handle it?"

Should we look at the company through two lenses? What if they didn't receive these funds, what would the financial profile look like? And the reality of they did receive those funds, and what do we think now? And I would tell you through 2020, we're figuring that out a little bit as we went. And I think we probably took both of those scenarios into account. I do think since many companies did end up doing okay or better throughout the past two years plus of the pandemic, it was making them a bit stronger than they otherwise would've been. And arguably, their need for borrowings dropped off in many cases, which is one of the big services that we provide, obviously as a bank.

So, I would tell you, looking at PPP historically, I think there was a bit of a high, and there were definitely a number of companies at least that I covered and that I see on a day to day basis, that were obviously far better off than they would've been had they not received the funds. Looking forward, now, I think a lot of that has worn off and things are beginning to stabilize. You're starting to see such businesses come back and start accessing their lines of credit, and the borrowings are getting back to where they were. Now, we just got to hope we don't go too far in the other direction and things go awry again here after we made it through, obviously a very difficult period.
TE:We've also addressed the supply chain quite often in the previous podcast. There are still a number of challenges. One thing that I am hearing more and more about is labor shortages for M&D companies, whether it's in the plant or facilities or in the head office. I think labor shortage is now a key issue in addition to the inflation challenges. That's what I'm seeing from a number of my clients. Again, there's other issues, any thoughts that you have, what you're seeing from clients now related to supply chain?
GM:Yeah, it's definitely been a hot topic and it's probably right there as the PPP storyline starts to wear off. Supply chain has most definitely come front and center. And in many of the companies we have headquartered here in New Jersey, have been dealing with supply chain now throughout the pandemic, so for the past two plus years, and it still doesn't show any signs of easing in any way. In preparing for this call, I'd had some discussions internally with some of our economists here at the bank, not to mention some of our leaders here at the bank, and I will tell you that we do not foresee the supply chain issues being resolved at least well into 2023. So, this is something we're going to continue to live with for the next 12 to 18 months at a minimum.

I think may it be the actual raw materials potentially being sourced from overseas, the labor costs that you mentioned, and again, the list goes on from there. A lot of the companies that I work with have definitely seen it. I believe it has changed the way in which they look at their business. They've been forced to adapt. And it's definitely hit their bottom line, to put it plainly, because these costs are being pulled through. May it be the container costs that we've all heard a lot about, like you said, the labor costs that we're hearing more and more about. Actually I think a little more recently, the container costs have been there and continue to rise and been out there for a good number of months, but the labor costs are playing into it. And again, I don't think this is going away in the foreseeable future and arguably may be a bit of a new normal now for us to deal with.
TE:George, I'd just like to continue on your response with a couple follow up questions. What you're suggesting from the supply chain, if it does continue on through 2023, is that suggests to me more price increases, as we've seen over the last number of months. With that backdrop, what are your thoughts or Wells Fargo thoughts on both inflation, as well as interest rates as we look forward to the latter part of the year?
GM:Yeah. So, you hit the nail right on the head there. Because when you have your fed rate hikes, which we've touched on and you have your high inflation, both of those elements in a big way are going to act to govern the rate of consumer spending. So, what you and I can go out and spend on, it just continues to get thinner and thinner. I will tell you that with respect to inflation, specifically, we can start with the federal reserve and the fed funds rate. We do project three more, 50 basis point rate hikes over the course of this summer. The next three meetings, we're having this discussion in May, so over the course of the summer meetings, three more 50 basis point rate hikes. And we probably end the year somewhere in that three to three and a quarter range on the fed funds rate. And that's coming from 75 basis points to 1% right now. So, that's a healthy margin higher, and that's just our projection right now as a bank.

And that probably doesn't peak until also the midpoint in next year, late in the second quarter in 2023. And it'll be somewhere around 375 is the bank's expectation. With that being stated, they're clearly looking to battle inflation as much as they possibly can. And you walk a bit of a tightrope, because as you continue to raise this fed funds rate, and that's the main tool in their arsenal that they're looking to use right now, you're arguably going to go after inflation, but potentially at the cost of a more serious recession. And I think that's their job and something they're going to monitor pretty closely. But our ultimate projection is we don't fall into a deep recession, but we do fall into a general recession. So, it'll be a fine line.

And as each month goes by this year, I think we've got to take a pause and see how the overall economy is reacting. But inflation is clearly a major concern of the fed and is something for all of us to watch as the prices of almost every good we consume have gone up rather dramatically and probably will continue to do so for a bit longer.
TE:George, and the folks I've spoken with as well, we definitely would agree that it appears that we're headed towards a recession. In regards to your commercial clients who may be impacted by a recession and falling sales and a lower net income, what advice do you give those clients that would put them in the best position in their relationship with you?
GM:I think I mentioned earlier that transparency is always going to be king. And I think having regular discussion, and again, that's a two-way street, from my seat, as well as from a CFO's seat, a controller or a VP of finance, even a CEO, to make sure that the transparency is there. But I think beyond transparency, and these conversations have been happening to your point, especially over the course of the past few months about planning. You want to make sure, obviously whenever you go into a down cycle, you're as prepared as you possibly can be. We say, oftentimes inside the bank, cash is king. You want to have that liquidity on hand, so that when times get tough, you can weather that's storm. And I think a good C-suite, one, is going to be transparent. They're going to share those regular conversations with the bank. Sharing it early and often makes a big difference in the long term and getting through a cycle.

And furthermore being prepared going into it. You take advantage of the up times when you have them and the highs, and you got to make sure you prepare for those downturns. And I think the best and brightest CFOs out there know that, and they've seen some cycles in the past. And they're probably getting that feeling to the point of this discussion, that something's looming and let's be prepared. And we're obviously there as a bank to support. We understand that there is cycles. We too have made it through those cycles. And there are certain accommodations that you're going to want to make with clients, where they spell out the whole picture and you get an idea of what their expectations are moving forward, and it passes a sniff test. Then you go ahead and you continue to obviously maintain that support as you always have and be there for them to get them through those tough times.
TE:George, one of the things that you alluded to is that lenders don't like surprises. And in the last couple of months, it seems that us, as consumers or just the general population have been surprised by certain events. First of all, the oil prices skyrocketing, seems to have surprised everybody. And when you look back at it, there's probably some warnings that was a reasonable expectation. Similarly, when you look at the recent shortage of baby formula, if you looked at the events leading up to it, we should have known about that. Do you have any thoughts on what the next surprises may be as far as supply chain issues?
GM:That's a good question. And I think you hit it on the head, that it oftentimes is a surprise and a pretty tough one to get out in front of. Because even if you may have some telltale signs, you're not necessarily always prepared for whatever that next surprise may be. And even with a little bit of lead time, if you are aware, establishing the infrastructure to avoid such a surprise is rather difficult to do. I probably wouldn't make a guess on what the next surprise would be, but I think one telling sign that we've really had over the past few years and baby formula is an example, oil and gasoline are other examples. I think bringing things back on shore here in the US and having that plan B, and having some infrastructure in place to support the many different industries that we all touch almost each and every day. I think that's a good lesson to have learned.

It's probably difficult to cover the entire board, but I think as a developing economy over many years now, the tendency has been to get it for cheaper offshore. And that might not always be the best answer. So, we've got to be prepared and do everything we can to make sure that infrastructure is here in house inside the US.
TE:George, I think you made a great comment on the lack of manufacturing in the US. When you read that there are only three main manufacturers of baby formula across the US, and that are shut down of one facility, can cause a shortage across the country. It is alarming and concerning. One of the things that I'm concerned about that we've seen in speaking with clients, is just the impact or potential impact of the Ukraine invasion by Russia and what impact that will have on the cereals. For those of you who don't know, some of the main exports out of Ukraine and Russia are cereals, which is the wheat, barley, and oats, as well as fertilizer.

So, when you look at the combination of a lack of a harvest or the impact of sanctions, I think that could really have an impact on the supply of certain, those cereals as we go forward to the summer. And I don't think consumers are prepared for that at this time. But as you said, we don't know, and we will see. George, in closing, are there any other comments that you might like to make about what Wells Fargo or you are seeing from your conversations with your clients?
GM:Yeah, absolutely. I think we talked a bit about rates and go one step further on the rate discussion, because this has been a big part of most employees' lives inside of all the major banks, arguably. And that is the transition of the LIBOR base rate, which most commercial loans throughout the country, if not the world are based off of, from LIBOR to SOFR, the secured overnight financing rate. And there's a regulation out there from the government to make sure that all the loans held domestically here in the United States are transitioned from LIBOR to SOFR. And I think a lot of the people that'll probably listen to this, and I know for sure clients of Wells Fargo have already begun this transition. We've at a minimum, had some high level discussions about the change, about the new rate, about the differences in LIBOR being a unsecured rate and SOFR being a secured rate.

Many of the shortcomings of LIBOR and some scandals that happened, dating back to 2009, and why this change is necessary to prohibit any manipulation of base rates for our loans. And many of our clients have already begun the transition and actually have loans in place. Now, may it be revolving lines of credit, may it be term loans, even real estate loans and mortgages that are now based off of SOFR. And our goal here at the bank, which is the directive from the government, is to have all that wrapped up by the end of June of next year. So, I would definitely make a point to anyone who listens to this, that they make it their purpose to learn a bit more and educate themselves around SOFR. Speak to their bank, have that discussion and get an understanding for this change. Because it can sound a little bit scary on the surface, but once you actually peel the layers of the onion back, you get a real understanding of why this is better moving forward, versus the world we're coming from.
TE:George, I want to thank you for your time today. And thank you all for listening to this episode of ManuFacts and Perspectives in EisnerAmper's Podcast Series. Visit eisneramper.com for more information on this and a host of other topics. And join us for our next EisnerAmper podcast.

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