How Trump's trade war with China could hurt commercial lenders

It’s too early in the trade wars for banks to be suffering, but the Trump administration’s tariffs on steel and other imports almost certainly will inflict pain on the middle-market and small businesses that make up most commercial borrowers.

Trump’s 25% tariffs on steel that took effect this spring, and his recent threats to impose additional tariffs on other goods from China, have led dozens of U.S. companies to issue warnings about how their operations will be affected. The heavy equipment manufacturer Caterpillar, for example, said on July 30 that its costs will rise by $200 million in the second half of the year.

Most regional and community banks do not provide financing to companies of that size, but they have vast exposure to their suppliers and vendors, several lenders and analysts said. Those banking clients include trucking and transportation companies, distributors and the manufacturers of parts used in larger products.

If the U.S. and China continue to engage in retaliatory tariffs, those smaller companies will get hit, said Bill Fink, head of commercial credit management at the $312 billion-asset TD Bank.

“The real question is, how long will this go on?” Fink said. “The longer the tariffs stay in place, that’s when you will see the impact.”

Fink and others declined to predict how long it would take the tariffs to hurt bank lending. But if they last long enough, the impact will eventually be felt by smaller suppliers, said Peter Winter, an analyst at Wedbush Securities.

“We were surprised that none of the banks reacted to it [during second-quarter earnings calls], with the exception of Comerica,” Winter said. “But there is a real risk that there’s a delayed impact from it.”

Curtis Farmer, president of the $72 billion-asset Comerica, said that middle-market customers of the Dallas bank “remain cautious.” About 53% of Comerica’s loan book is in commercial-and-industrial loans.

“Probably the greatest source of caution right now relates to … what may or may not happen on the tariff side of the house,” Farmer said during a July 17 call. “The markets we’re in — Michigan, California and Texas — all have some economic reliance on trade.”

Reduced trade could manifest itself through diminished loan demand if companies put off expansion plans, said Shawn Hopper, an attorney at Miller Canfield in Detroit who advises banks on commercial loans.

“We’ve had projects that we’re advising on that have been postponed, but not necessarily canceled,” Hopper said. “There’s a certain chilling effect on investments.”

It is also possible that credit quality for commercial loans could deteriorate as companies’ cash flow dwindles, Fink said.

The most vulnerable are suppliers or vendors to companies that import raw materials from China and derive most of their sales in the U.S., Winter said. That is because they would pay the tariff on Chinese imports, which could be 10% or 25%, depending on what the White House decides.

The fashion design company Steve Madden this week said it will be forced to raise prices on its shoes and bags in the U.S. due to the tariffs, Bloomberg News reported. Steve Madden imported 93% of its products from China in 2017 and about 90% of its revenue came from the U.S.

“We and others will certainly try to pass on a good chunk of this to the consumer,” Steve Madden CEO Edward Rosenfeld said during a July 31 conference call. “Virtually all of our competitors make most if not all of their product in that category in China.”

About 10% of apparel and textiles sold in the U.S. are imported from China, according to 2016 data compiled by the U.S. International Trade Commission. About 39% of electronic products are imported from the China, the largest of any category.

The automotive industry fiercely opposes the Trump administration’s tariff strategy because vehicles are manufactured using parts made all over the world, Hopper said.

“An automobile may be assembled in the U.S., but they are made from a lot of parts that come from overseas,” Hopper said.

General Motors lowered its earnings forecast for this year due to the steel and aluminum tariffs and warned it may cut jobs. And the auto parts maker Cummins lowered its forecast for cash flow by $100 million for the second half of this year.

“Tariffs on vehicles and a broad spectrum of Chinese products would be significant and could push suppliers in the vehicle industry to the brink,” said Diane Swonk, chief economist at Grant Thornton.

Construction projects may also slow, as costs for steel and other supplies rise, said Mike Maddox, CEO at the $3.5 billion-asset CrossFirst Bank in Leawood, Kan.

“With the potential increase in prices on raw materials, that could have an impact,” Maddox said. “You’re doing a big development project with a lot of structural steel involved; that could have a substantial change in costs.”

Meanwhile, most bank executives seem to share the opinion of Marianne Lake, chief financial officer of JPMorgan Chase, who said that tariffs are an unwelcome variable, but not an immediate concern.

“Trade is firmly part of the risk narrative … but it is not at this point causing [clients] to change strategic actions,” Lake said during a July 13 conference call. “But it is important that that uncertainty is taken off the table.”

But that view is almost certain to change over time, if Trump and China continue to engage in tit-for-tat policies on trade, Swonk said.

“Tariffs are corrosive, not cataclysmic, at the moment,” she said. “They are squeezing margins and forcing more large companies to pass along the increased taxes as price hikes. The economy is currently strong enough to do that.”