🔒CT bankers: Additional rate cuts needed before substantial increase in lending, earnings

While a recent half-point cut in the federal funds rate generated days of headlines, local bankers say interest rates will have to fall further before borrowing or profits pick up substantially.

“It’s probably not going to move the needle too much,” said Luke D. Kettles, president and CEO of Windsor Federal Bank, with $796.3 million in assets. “It’s probably going to take a (1 percentage point) cut before you see some release of pent-up demand. Mortgage rates might need to get into the five (percent range) before you see some real increase in refinance activity.”

Kettles said there is still intense competition among banks for depositors, so he doesn’t expect Windsor Federal to lower deposit rates anytime soon.

Connecticut bankers say one of their biggest challenges over the past year has been the inverted yield curve, which has caused depositor interest rates to outpace rates charged for long-term loans. That, in turn, has squeezed banks’ profitability and ability to lend.

“It’s definitely reduced our earnings,” said Rebekah Stokes, executive vice president and chief financial officer for Thomaston Savings Bank. “We are going into the next year hoping for a positively sloped yield curve, which is really what is going to help us and all banks improve our bottom line, even if we just do the same activity but under a positively sloped yield curve.”

The Fed’s Sept. 18 rate cut, its first reduction since March 2020, will push the yield curve in the right direction and start to revive refinancing activity, which had almost entirely dried up, said Stokes, whose bank has $1.8 billion in assets.

“I think we need a little more movement in rates before seeing refinance activity come back to any level at all, especially for us,” she said. “Almost all of our volume has been in purchase activity, which is cutting out half the mortgage business we would typically do.”

A similar trend holds true at Windsor Federal. In 2019, the volume of home loans at the bank was evenly split between refinancing and purchases, Kettles said. As rates dropped precipitously amid the pandemic, refinancing peaked at 78% of volume in 2021. By 2023, that balance flipped, with home purchasing accounting for 76% of volume and refinancing only 24%.

Economic concerns that drove the Fed’s recent rate cut could cause customers to shift from long-term investments to liquid deposits, Stokes said. That will eventually increase banks’ lending power, but likely not until rates drop from the current 4.75% to 5% range to less than 3.5%, Stokes said.

John S. Carusone, president of the Bank Analysis Center in Hartford, predicted that most banks will quickly lower rates for CDs and other short-term deposits. Interest rates benchmarked to the prime rate — like credit cards, adjustable-rate mortgages and business loans — will drop swiftly, he said.

For example, in the wake of the Fed’s rate cut, Waterbury-based Webster Financial lowered its prime rate to 8% from 8.5%.

Carusone said he expects a series of Fed cuts that will eventually lower rates to the 3% range. Over time, that will increase the appetite for business and real estate development loans.

“I don’t think there will be an immediate impact from this first (rate cut),” Carusone said. “It really is a function of how many cuts people are expecting.”

A tough year

Carusone said the inverted yield curve increased the percentage of unprofitable Connecticut-based banks from 13% to 21% between June 2023 and June 2024. Six out of the 29 banks headquartered in the state lost money in the second quarter of this year, while the proportion of institutions that increased earnings dropped from 53% to 10% in the same period, according to data from the Banking Analysis Center.

Connecticut banks’ net interest margin, a key indicator of profitability, dropped from 3.47% to 3.18% in the same period, according to the BAC.

Carusone said the yield curve has recently swung in a positive direction, which would have been cemented by a quarter-point drop in the federal funds rate. He considers the half-point reduction overkill that could lead to an inflationary spiral, especially as Fed Chairman Jerome Powell continues to assert the economy is strong.

“So, why reduce 50 basis points?” Carusone said. “For a lot of economists like myself and finance professionals it was not logical. He was contradicting himself.”

Ion Bank President and CEO David Rotatori anticipates his bank will drop short-term deposit rates. By how much will depend on how many rate cuts are made by the Fed, he said.

“That’s the positive news, that hopefully the curve stops being inverted,” Rotatori said. “That should have a positive effect on the banks.”

Rotatori, whose bank has $2.1 billion in assets, said he believes many homeowners contemplating refinancing will hold off in anticipation of additional rate cuts.

James C. Smith, owner of Waterbury-based banking consultancy JCSmith Advisors, also predicts the recent rate cut won’t prompt a quick spike in lending activity. The cut, he said, reflects increasing economic anxiety, which will curb borrowing appetite, at least in the short term.

Smith said mortgage rates have already dropped a point in the past six months in anticipation of the Fed’s rate cut. It will take even more to entice borrowers, he said.

Smith said he expects another 1.5% drop in the federal funds rate into next year.

“What I say to my clients is this is about the best thing that could happen to banks,” Smith said. “Banks thrive when short-term rates are low, which means deposit costs are low.”