Will near-zero rates spur more borrowing?

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Federal Reserve policymakers took drastic action to counter fallout from the coronavirus pandemic, slashing interest rates to near zero over the weekend after an emergency 50 basis-point cut earlier this month.

The goal: Drop borrowing costs and keep credit available to reinforce the domestic economy against the novel virus as the tally of U.S. cases rises in excess of 3,500.

But will it spur continued borrowing and activity? At this early stage, there is an abundance of skepticism. In the meantime, bankers worry that near-zero rates could crush net interest margins.

Bankers said they understand that extraordinary government actions, including from the Fed, may be necessary. But they fear that the consequences for their own financial health could prove painful, particularly if the Fed takes another big step and pushes the U.S. into negative-rate territory.

Banks, already grappling with heavy margin pressure, could see their profitability squeezed. And if the Fed moves fail to offset economic impacts of the virus, banks could simultaneously struggle with deteriorating credit quality.

The exceptional market volatility in March reflects this unease. “This is a very challenging environment for banks,” Fred Cannon, an analyst at Keefe, Bruyette & Woods, said in a report Monday.

Bankers said unpredictability of the virus and the now very real potential of negative rates weighs heavily on their outlooks for 2020.

“We are in unprecedented times for rates,” said Robert Meyer, president and CEO of the $113 million-asset Wayland State Bank in Mount Pleasant, Iowa. “I’m worried we’re setting a standard that’s just dangerous.”

The March cuts followed Fed policymakers’ moves to lower their benchmark rate three times in 2019. Corresponding drops in borrowing costs could further juice demand for refinancing of mortgages and other loans, providing boosts to banks’ fee revenue. Many small businesses, hemorrhaging revenue amid virus-induced slowdowns, are likely to seek near-term loans to bridge their operations to a more temperate period.

Eight U.S.-based global systemically important banks, including JPMorgan Chase and Bank of America, said they would pause on share buybacks until the second half of 2019 to ensure they have the capital needed to support clients’ borrowing needs.

But, on the whole, Meyer and other bankers worry that blows to interest income will overshadow lending opportunities. Several European countries are already in negative-rate environments, and banks there have struggled with weak profits as a result.

Community bankers said that they will work to help small businesses. But, staring at the specter of negative rates, they are looking at new ways to generate more fee income. Ultimately, though, cost-cutting likely would prove the most effective lever for many of them. And that is hardly an attractive option, given that banks have operated leanly for years and, at the same time, need to make continued investments in digital banking services and cybersecurity.

Robert Carmack, chairman and CEO of the $464 million-asset Legacy Bank in Oklahoma City, Okla., said his and most banks are in the early stages of preparing for a drawn-out virus outbreak. He did not question the Fed’s aggressive posture on rates but hopes policymakers do not move into negative territory.

“This is not a time to panic,” Carmack said. “It is a time for calm, thoughtful response.”

That said, should the impact of coronavirus drag on for several months, bankers worry that monetary policy may not shield the U.S. economy from an inevitable plunge in activity. Already, major conferences, concerts and sports events have been canceled or postponed.

Read more: Complete coverage of the coronavirus impact

Observers said fiscal stimulus does not address the creditworthiness of borrowers, which in the case of many small business owners is already degrading. What banks need in order to lend to these companies are more government loan guarantees, including an expansion of the federal Small Business Administration lending program.

“The Fed has to make immediately clear what loans it will support and how; only then will money move fast to those who need it the most,” said Karen Petrou, managing partner of Federal Financial Analytics.

Stock markets have this month endured steep drops as investors worry that companies will experience significant revenue hits and, by extension, struggle to pay employees and service their debts.

Stocks traded down again Monday. The Fed’s actions, which also included plans for $700 billion in quantitative easing over coming months, “underscored the gravity of the situation and reaffirmed investor sentiment that monetary policy is simply not sufficient to combat this type of societal shock,” said analyst Isaac Boltansky of Compass Point Trading & Research.

Against that backdrop, low rates could do little to drive overall loan demand. Bank stocks have sustained big hits in recent trading, with deepening concerns about margins and, potentially, loan losses.

“Up through early March, things had been very good. But we know this could definitely affect loan volume, and we of course are staying on top of our book and monitoring for any credit issues,” said John Dill, head of business banking at the $939 million-asset Marquette Savings Bank in Erie, Pa. He commented last week, prior to the latest Fed cut, but he had anticipated the further action.

Consumers, too, are wary.

Consider the experience of Jorge Aguilar, a married father of two young children. He is eager to move his family out of a cramped apartment and into their first house. The assistant hotel manager in Orlando, Fla., has saved for a down payment and, following recent rate cuts, Aguilar said he could now afford to secure a mortgage and buy the home his family wants.

But he simultaneously worries that government action cannot counter virus-imposed uncertainty that is crippling travel and revenue at his hotel and, ultimately, could threaten his employment and ability to make loan payments.

For now, Aguilar is on the sidelines. “I don’t think anyone really has a good idea where this is all headed,” he said.

All of that noted, banks say the pandemic comes at a time when they are very well-capitalized and reporting historically low loan losses.

“Banks are in good shape; I’m confident about that,” said Steve Lane, chairman of the $133 million-asset Security Savings Bank in Gowrie, Iowa. “But it is a little scary right now. It’s something new every day.”

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