Hearing from corporate America’s ‘middle’ child

By Evan Sparks

The middle market doesn’t get the press that the Fortune 500 gets, and it doesn’t get the love from Capitol Hill that small businesses receive. But the middle market is a critical element of the American economy.

“The middle market is a very important, if not understated, part of the economy,” says Richard Cabrera, EVP and head of commercial and corporate banking at Portland, Oregon-based Umpqua Bank. “There are 45 million jobs that are connected with midsize companies, and it represents one third of the gross domestic product.”

Its significance can make middle market firms—those with roughly $10 million to $500 million in annual revenue—bellwethers for the economic outlook, Cabrera adds. “It matters to these companies that we get a pulse on what they’re seeing and what they’re doing. Often, economic change occurs at this level of the economy.”

The bottom line

“While economic concerns still linger, there’s tremendous optimism,” says Cabrera. “To be honest with you, it was a little bit surprising. Given the economic headwinds that you see in the media—and everybody’s talking about a rising rate environment and the concern of getting into recession—these companies are very resilient. [They] see opportunity, notwithstanding the headwinds.”

Cabrera adds that some of this energy and optimism comes out of the COVID-19 pandemic. “Having survived that and making some pretty key changes to their business strategy and their operating model, it’s shown them that they can survive the toughest of the tough situations.”

Deal opportunity remains alive, too, notes Bill Fink, EVP and head of commercial bank strategic partnerships at TD Bank. “There’s no question” that by raising the price of deal financing, interest rates have constrained the M&A market, Fink says. However, add-on deals remain alive and well. Through the end of September, Fink says there were 2,824 add-on deals done by private equity firms in the middle market space that came to about $295 billion, with the average deal valued at $105 million. “For bankers and their clients who are looking for market opportunities, how to improve revenue, how to potentially grow the business faster, the add-on market is one opportunity to do that.”

Where the investment is

“Capital investment has surprised a great bit of our economy and the business community,” says Fink. “As rates go up, how could we be having stronger capital investment?” While interest rates continue to be a drag on investment, Fink says that the fiscal stimulus of the CHIPS and Science Act and the Inflation Reduction Act—as well as state economic development packages for incentivized facilities in the high-tech, semiconductor and green tech sectors—are offsetting the increase in rates.

“The CHIPS and Science Act provides $52.7 billion for semiconductor incentives over five years,” Fink adds. “One of the key components that is spurring investment is a 25 percent investment tax credit for domestic semiconductor manufacturing—and that includes facilities.” He notes that historically, the largest tax credits for investment have been limited to 10 percent, giving these a substantial stimulative effect.

Additionally, “many of these projects have three, five, seven-year horizons till they come on line, and when you look at the factories themselves, they have to be outfitted with equipment [and]some of that equipment is very specialized,” Fink adds. “In addition to the building of these new fixed-asset facilities, there will need to be equipment. . . . So as you look over 2024 into 2025, possibly into 2026, you’re going to continue to see investment. It will move from big physical structures like plants and equipment to more specifically focused on equipment to make these factories operate.”

Facilities in demand

Despite the doom and gloom narrative for commercial real estate, many CRE subsectors—such as multifamily, industrial, storage and data centers—remain resilient and even booming. Fink points to warehouses and manufacturing facilities, “particularly in areas that support industries that are enjoying the benefits of technology investment.” He cites electric vehicle and battery manufacturing plants.

A lot of the robustness of industrial real estate has to do with onshoring and “near-shoring,” Cabrera adds. (The latter refers to replacing distant suppliers and logistics chains in places like Asia with partners in closer areas like Latin America.) After the supply chain disruptions of the pandemic, “from a logistics standpoint, companies now want to have raw materials and inventory closer to them, and they really they need places to store it. This onshoring phenomenon has been taking place for the last couple of years, and it has a lot of momentum you don’t hear as much about.”

Despite the resilience of CRE, other commercial and industrial lending is under pressure, says Stephen Philipson, head of global markets and specialized finance at U.S. Bank. C&I loan grown has “been pretty consistently flat to down across the industry. There’s some aspect of it that given the Basel III endgame, banks are working on building more capital and so there’s a little bit more focus on return on lending. But there’s a demand component to it too—we’re not seeing the same demand from corporate and commercial customers to borrow to do things like capex and other investments.”


CFOs remain focused on efficiency

In the middle market, CFOs remain focused on controlling costs and maximizing efficiency. U.S. Bank noted that this was a marked turn from the year before, when CFOs were focused on supporting growth. It’s “very much a shift to a defensive mode,” says Philipson, who notes that CFOs tend to be “one of the best leading indicators.”

For Fink, that focus means “artificial intelligence investments in factory and equipment. CFOs are really focusing on looking at that investment across the board to drive greater efficiency control costs as they look to the future.”

Banks also have a high level of expertise on cybersecurity—few industries prioritize it more—and they can help middle market protect themselves from social engineering scams like business email compromise and identify and root out fraud before it happens, Cabrera says.

How banks can help reduce friction

“It’s really less about topline revenue growth,” Cabrera adds. “It’s really about becoming efficient.” He says banks have a unique opportunity to help middle market firms optimize cash flow, improve collections management and provide more efficient payment solutions.

For Philipson, this is precisely “one of the ways that that we’re focused at U.S. Bank: helping in the payment space and bringing more instant payments to businesses to help them reduce those timeframes and create savings by having a more efficient working capital framework.”

For example, “we were part of the first payment on the RTP network, and we continue to see growth there. The RTP network has seen 11 percent volume growth and 18 percent value growth just in the third quarter of 2023. That growth is really being driven by finance professionals like the ones in this survey who are just trying to improve efficiencies in the business. And it’s a great way to be able to take to take cost out.”

Share.

About Author