Persistent slow economic growth, coupled with continued pressure on net-interest margins, will again be the theme for 2016, and will challenge banks to improve earnings in any way.
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While a modest interest rate increase is now in the cards, I don’t think it will have much impact on the national or local banking industry. Persistent slow economic growth, coupled with continued pressure on net-interest margins, will again be the theme for 2016, and will challenge banks to improve earnings in any way.
I think the best performing banks will be those that can combine efficient management of their operations with a disciplined approach to pricing and loan underwriting. Maintaining this disciplined approach becomes more and more challenging when the economy is not growing, as loan demand decreases and rates remain at historic lows, creating an extremely difficult earnings environment.
I believe that history has shown that when banks deviate too much from tried-and-true underwriting standards and compromise too much on rates, bad things tend to happen. Although credit quality has been strong, the economy seems to still be somewhat fragile and it may not take a whole lot of negative news to negatively impact those metrics.
On the positive side, banks in Connecticut generally are well managed and well capitalized, and have successfully navigated this challenging environment for several years. I have no reason to think that will not continue even in the most difficult and uncertain times.
As bankers, we spend a lot of time thinking about what could go wrong, or said differently, we spend a great deal of time identifying, quantifying and managing various risks that can impact our businesses. Every day, we think about credit risk, cyber risk, operational risk, reputation risk, interest rate risk, etc. As a management team, we can control and mitigate some of these risks; others are beyond our control, which is why the question is so hard to answer.
With that in mind, if I had to identify one thing that is beyond all of our control and would impact us negatively it would be the potential for the yield curve to flatten or even invert. Most regional and community banks rely primarily on our net interest margin to generate our revenue.
In simple terms, the margin is the difference (expressed as a percentage) between what we earn in interest and what we pay in interest. A typical yield curve has a slope to it with rates on the short end of the curve lower than rates on the longer end of the curve. As bankers we manage our balance sheet to optimize the difference in the curve at the different points in time.
There are many variables that impact the Fed’s decisions on interest rates, but they continue to indicate a bias towards raising rates (possibly raising the short end of the curve) and yet our economy is experiencing low inflation and low growth (possibly keeping the long end of the curve down).
Should this scenario materialize (the Fed decided to raise short-term rates Dec. 16), further downward pressure on bank earnings will occur, making it more difficult for many banks to operate profitability.
While difficult to zero in on one event, a flatter or inverted yield curve for a sustained period of time would create a significantly more difficult operating environment for the majority of the banks in our state.
[See what others are saying on HBJ's Economic Forecast 2016 page]
