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Katelyn Egger | SBJ

Foggy Conditions: Uncertain economic factors keep banking industry cautious

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While banking officials say the industry has largely been on stable ground since last year’s high-profile bank failures in California and New York, the uncertainty of factors such as higher interest rates and the presidential election will continue to keep banks on a conservative path.

After Santa Clara, California-based SVB Financial Group (Nasdaq: SIVB), dba Silicon Valley Bank, and New York-based Signature Bank collapsed and subsequently were taken over by the federal government last March, the industry was a bit on edge, said Jackson Hataway, Missouri Bankers Association president and CEO.

“A lot of them were looking at things really conservatively after those bank failures with interest rates going up and all the commotion out there. Are we going to recession? Is it going to be a hard landing, a soft landing?” he said of the Federal Reserve’s attempts to curb inflation. “Everybody just kind of buckled down. Deposits got pricier, so you had to kind of control your lending carefully to make sure you weren’t lending above and beyond what your deposits could support.”

According to the Federal Deposit Insurance Corp.’s. most recent quarterly report, banks and savings institutions insured by the agency had net income of $68.4 billion in third-quarter 2023, down $2.4 billion, or 3.4%, from the prior quarter. Lower noninterest income and higher realized losses on securities drove down the net income, according to the report.

While the FDIC hadn’t released its fourth-quarter report as of press time, several area banks with Springfield branches did so in late January, showing mixed results. Jefferson City-based Hawthorn Bancshares Inc. (Nasdaq: HWBK), Pine Bluff, Arkansas-based Simmons First National Corp. (Nasdaq: SFNC), Kansas City-based UMB Financial Corp. (Nasdaq: UMBF) and Springfield-based Great Southern Bancorp Inc. (Nasdaq: GSBC) all reported a quarterly drop in profits, ranging 29%-388%. However, Moline, Illinois-based QCR Holdings Inc. (Nasdaq: QCRH), the publicly traded parent company of Springfield-based Guaranty Bank, reported fourth-quarter and full-year profits that officials say were the best in company history. Net income rose 14.6% to $113.6 million during 2023, compared with profits of $99.1 million in 2022.

Challenging environment
Despite a strong 2023 at Guaranty Bank, CEO Monte McNew said all banks continue to be challenged by the current interest rate environment. At its most recent meeting in February, the Fed kept interest rates unchanged amid improving consumer confidence and a declining inflation rate. The federal funds target rate has remained at 5.25% to 5.5% since last summer, following 11 rate increases that began in March 2022.

“With those rates going up, it makes deposits far more competitive than they’ve been in many years,” McNew said. “That competition is coupled with a lot of the cash from post-COVID that has kind of dried up or been used. That means you have less cash out there and rates in a raising environment where it’s really difficult and competitive to get those deposits. The loans are a little slower to move because oftentimes those rates are fixed for a long period of time.”

Jeff Jones, the finance, economics and risk management department head at Missouri State University, said the higher interest rates mean a dampening of lending activity at financial institutions.

“Banks are not making as many loans, and so there’s less profit to be had. The other piece of that is not only is there less loan activity, but now in competing for available deposits, banks are having to pay higher rates,” he said. “Even though they may be able to charge higher rates on loans, they’re also having to pay more for deposits to fund those loans.”

Reflecting on the Fed’s rate increases, Jones said while the number of them in such a short period might have been historic, it was the appropriate policy action.

“They had to move that quickly because, quite frankly, I think they waited too long to move at all,” Jones said, noting the current interest rates are at a normal level from a historical perspective. “The kind of normal range for a mortgage is probably between 6% and 7%. It’s normal to get 4% and 5% on your certificates of deposit. It just hasn’t been normal to do that in the last 15, 20 years.”

Hataway said he’s heard from a lot of banks in the state that said overall numbers, such as deposits, didn’t suffer in the aftermath of the bank failures.

“We saw almost no deposit runoff here in Missouri from our banks, community banks, regional banks,” he said. “What happened was you had this vision that things were going to go south, and then it’s like everybody’s confusion in the national media about why are we still headed toward a soft landing. Somehow, we just seem to be managing through less liquidity in the market or just good business practices from people out there.”

Still, he said there were banks who had net interest margin compression that impacted profitability, as they had to pay more for deposits, CD specials and time deposits, which is an interest-bearing account with a specific maturity date.

“They were working to keep their business and consumer deposits, so they were kind of squeezing their net interest margin a little bit,” he said.

McNew said customers seem to be more accepting of the current rate environment, adding he believes commercial activity in the Midwest is on the rise in recent months. Locally, he pointed to the development plan to bring a second Target store to west Springfield as a significant project. City officials estimated the project cost at roughly $60 million, according to past Springfield Business Journal reporting. City Council is currently considering a community improvement district proposal for Sunshine Towne Center, the future home of the retailer.

As mergers and acquisitions have contributed to a drop in the number of banks nationally, activity in that area was muted in 2023. The 98 bank mergers were down from 161 deals a year prior, a nearly 40% drop, according to S&P Global Market Intelligence. Regulatory scrutiny, interest rates and recession fears were contributing factors and that environment should mean another slow year in that area, Hataway said.

“Once you get into 2025 and you do hopefully have a little bit of rate improvement, you’ll see some institutions that are able to go through M&A activity a little more,” he said. “It all comes down to how the market looks for that kind of activity. What are capital ratios and equity ratios going to do?”

Rate wait
The Fed’s decision on interest rates is one the banking industry will be watching closely this year, McNew said.

“When you talk about we may be seeing lower rates, a lot of banks have to make that decision about the highest and best use of capital and deposits to make good prudent decisions,” he said. “You don’t want to build your business around guessing and hoping. You’re not going to see a lot of people, even if it’s educated, making guesses on what’s happening because you can really have some challenges from that.”

While prior predictions from some economists estimated the Fed would make multiple interest rate cuts in 2024, Jones is skeptical. Part of that is connected to the national unemployment rate, which the U.S. Bureau of Labor Statistics reported at 3.7% in January, as well as the current 3.1% inflation rate.

“If employment numbers continue to be strong, and inflation is just kind of sitting where it’s at, I don’t see them cutting,” he said. “Why would they cut? You tend to want to cut when you want to stimulate the economy, but if the economy doesn’t need stimulating and you cut, what you do is create inflation. We could perhaps maybe even be towards the end of the year before we see a cut, if at all.”

McNew agrees there’s an uncertainty with what is going to happen, which has the industry in a wait-and-see mode.

“Then also the political landscape dictates being conservative to see what’s going to be going on over the next coming months,” he said. “You’re going to see banks be very conservative in how they deploy their capital, how they deploy their deposits.”

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