Community bank executives and investors alike are growing increasingly frustrated at the prospect that the Fed may further delay short-term rate increases, prolonging the low interest rate environment that has persisted since 2008 and hampering any prospect of net interest margin growth.
The 25 basis point interest rate increase in December 2015, though modest, actually did not have a positive impact on the net interest margin and earnings of community banks and thrifts. The chart below shows that the median net interest margin for community banks and thrifts decreased from the third quarter of 2015 through the first quarter of 2016, while earnings displayed only a modest improvement during the first quarter of 2016. The reduction in the net interest margin, following what investors deemed to be a highly anticipated move by the Federal Reserve, points to the fact that more can be done to better prepare for rising rates.
As indicated in the June edition of the Wall Street Journal Economic Forecasting Survey, the Federal Funds rate is likely to rise again during the second half of the year, by as much as 35 basis points. While this may seem like reason to celebrate, an increase in short-term interest rates may not be beneficial to the net interest margin of many community banks and thrifts unless they take action now to "lock in" term funding or take other measures to adjust their interest rate risk exposure to better position their balance sheets for rising rates before rates actually rise.
In the battle against margin compression, loan portfolio growth remains important as institutions need higher yielding assets. Relatively higher yielding loans, such as construction/land development and to a lesser degree commercial real estate ("CRE"), commercial and industrial ("C&I") loans, were the fastest growing loan segments in the first quarter of 2016, while consumer and other loans shrank over the period. In recognition of these trends and heightened regulatory scrutiny of CRE and construction/land development loan concentrations, robust concentration and credit risk management will be key.
Loan growth in today's economic and competitive environment is primarily driven by an institution's ability to attract new or repeat customers with competitive rates. As interest rates rise, those institutions that have proactively "locked-in" funding costs, be it through CDs, FHLB Advances, derivative securities, or other balance sheet management tools, may be at a competitive advantage in competing for loans by being better positioned to offer relatively lower cost loans than their competitors.
If you would like to discuss potential balance sheet strategies, please contact us.
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