Lenders eager for higher rates — just not too high

Small and midsize banks emerged from earnings season upbeat about loan income rising based on higher interest rates anticipated in the year ahead — but they worry loan demand will suffer if rates rise too sharply.

Additionally, the pandemic lurks as a wild card, and competition remains fierce. Meanwhile, the specter of rising interest rates presents an opportunity to bolster profitability but creates some concern about the possibility of stunting economic momentum needed to drive loan growth.

“We’re very optimistic about ’22,” Mark Hardwick, CEO of First Merchants Corp. in Muncie, Indiana, said in an interview. “We’re seeing headwinds recede and more opportunities emerge, but there’s still reason for caution. Certainly, there’s some anxiety about what’s next, what’s unknown” about future coronavirus variants and their potential impact.

Still, loans at the $15.5 billion-asset First Merchants grew in the fourth quarter at an annualized rate of about 13%, with credit demand mounting across industries alongside steady economic growth. The U.S. economy grew at an estimated 6.9% annual rate in the fourth quarter of 2021, according to a federal estimate last week, culminating the most robust year of growth in nearly four decades.

The national economy rebounded from a pandemic-induced recession that began in 2020, and Mark Hardwick said growth across First Merchants’ Midwest footprint followed that recovery.

“In our markets," business owners recognize that the risks presented by the virus "are very real, but everyone is finding ways to just keep moving forward,” Hardwick said.

Business owners are making expansion plans and drawing on lines of credit or seeking new loans to finance their growth, he said. This, in turn, is fueling the bank's expectations for a solid year ahead.

Bank OZK in Little Rock, Arkansas, painted a similar picture. The bank’s bread-and-butter national real estate construction lending came in just shy of $8 billion for all of 2021, up 20% from the previous year, driven by company record growth in the fourth quarter that reflected robust demand in markets across the country.

“As we sit here today, we definitely expect a strong origination year for 2022,” Paschall Brannon Hamblen, the president of the $26.5 billion-asset Bank OZK, said on an earnings call in January.

Nonetheless, competition is intensifying as banks throughout the United States are flush with deposits — an effect of higher savings levels through the pandemic — and are eager to put that funding to work to generate interest revenue from loans. As such, commercial loan refinance activity is elevated, and both loan paydowns and payoffs are high and expected to remain so through 2022, Hamblen said.

Repayments in the bank’s national lending arm reached $6.22 billion last year, a record for Bank OZK and largely offsetting the new originations. The bank expects paydowns to increase further this year, making net loan growth a tall order. For 2021, its total loans were down nearly 5%, mostly because of payoffs in its national business and other lending lines.

For the year ahead, “it's going to be a horse race between the originations and the paydowns,” Chairman and CEO George Gleason said on Bank OZK's earnings call.

The likelihood that interest rates will rise is a catalyst for loan growth. When rates rise, banks earn more interest income on loans.

Federal Reserve Chairman Jerome Powell said last week the central bank was poised to boost rates at its March 15-16 meeting in an effort to tamp down inflation. “This is going to be a year in which we move steadily away from the very highly accommodative monetary policy that we put in place to deal with the economic effects of the pandemic,” he said in televised remarks.

Apollo Bancshares in Miami is a private company, so it doesn't report earnings. In an interview, Chairman and CEO Eddy Arriola said the $1 billion asset bank's lending grew in 2021 and expects to advance further this year given solid economic and population growth in southern Florida that has fueled credit demand. Higher rates would make that growth more profitable, he said.

But he also noted that Powell said the Fed could move more aggressively than it had in the past, presenting the possibility of rates escalating too fast and curbing loan demand and economic activity.

“It’s going like gangbusters right now,” Arriola said of both consumer and business momentum. “If you’re lending right now, you are very busy, and I can tell you we are optimistic that we and banks in general will benefit from higher rates. Variable loans reset faster than deposits, especially when banks have plenty of deposits and can let some of those run off.”

But, he added, “if you raise rates too fast, it can backfire.”