High anxiety over narrowing margins

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After the Federal Reserve’s latest interest rate cut, net interest margins will be front and center when banks start reporting third-quarter results.

Questions about loan yields, deposit pricing and, to an extent, risk management will likely permeate next month’s conference calls.

Margins “are going to be a big area of focus” for small and midsize banks, said Stephen Scouten, an analyst at Sandler O'Neill. “It’s becoming a very difficult environment.”

Banks have struggled to lower deposit pricing fast enough to keep up with changes to adjustable-rate loans, industry experts said.

“So certainly the environment is set up for shrinking margins,” said Paul Holewinski, chairman and CEO of the $1.6 billion-asset Academy Bank in Kansas City, Mo.

Scouten said he expects many banks will report 4 to 6 basis points of linked-quarter margin compression. Margins will likely shrink even more in the fourth quarter given the Fed’s September easing, and analysts are eager to hear bankers discuss their outlooks heading into 2020.

“We will want to take what we see and try to extrapolate that for the rest of the year and beyond,” Scouten said.

Loan volumes will also bear watching as banks look to offset pressure from lower yields, said James Bradshaw, an analyst at Bridge City Capital. That being said, the Fed’s shift, a global economic slowdown and a handful of credit warnings will spur more questions about loan performance.

Hints of credit deterioration have peppered the banking landscape this year, spanning energy, agriculture, health care and retail. Bankers have stated that the issues are isolated problems and not symptoms of a bigger trend.

Stephens analysts have pointed to a spate of restaurant chain bankruptcies this year — and associated loan charge-offs — as a potential harbinger of credit concerns in the retail sector. Restaurants depend on strong consumer spending, which accounts for roughly 70% of U.S. economic activity. If that spending is slowing, it could portend larger challenges. In the first half of the year, several banks disclosed charge-offs on soured restaurant loans.

The Fed’s shift on rates — July’s cut was the first in years — does not suggest a recession is imminent, said Scott Brown, the chief economist at Raymond James.

“But it does represent new caution,” Brown said. “That, paired with some of these credit issues, also gives banks reason for caution as well.”

A flatter yield curve can tempt lenders to cut loan rates and loosen other terms to win business.

“My concern involves pricing for commercial transactions and whether those lenders are getting paid for the risk,” said Julieann Thurlow, CEO of Reading Co-operative Bank in Massachusetts. “Another concern involves banks extending durations.”

While credit quality remains strong overall, Ed Wehmer, chairman and CEO of Wintrust Financial in Rosemont, Ill., said in a recent interview that an economic slowdown could stymie a borrower’s ability to repay loans. Wintrust was among those dinged in the second quarter; its charge-offs quadrupled from the prior quarter to $22.3 million.

“The increase last quarter was due to one-off issues but, that said, we know this great credit we’ve seen for years has to shift at some point,” Wehmer said. “We’re watching this closely.”

A combination of rising credit costs and thinner margins would raise concerns among investors.

While margin pressure is already taking hold, Bradshaw said credit looks resilient — for now.

“I still think conditions overall still seem pretty strong,” Bradshaw said. “We’re in the late stages of a recovery and there’s got to be some weaknesses out there, but I don’t see anything serious taking hold yet — certainly nothing that looks like it is about to implode.”

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Community banking Yield curve Net interest margin Earnings Credit quality
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