Bankers, economists predict modest growth for Arkansas economy, some concerns noted

Arkansas bankers are forecasting modest growth in 2016 based on improvements noted in several recent financial reports.

John Silvia, chief economist with Wells Fargo Securities, said during the company’s 2016 Financial Outlook that the Arkansas’ economy is directly impacted by U.S. growth and productivity linked to the global marketplace. He also said it’s important to remember that no state operates in a vacuum.

Economic indicators for Arkansas as compiled by the Federal Deposit Insurance Corp. show that one of the brightest spots is the improving employment picture. Through the third quarter, total nonfarm employment growth rates rose 2.1% compared to a 1.2% increase in the year-ago period. However, economists warn that the tighter job market can be a threat to continued growth in 2016, particularly in the areas of construction and trades given that the overall workforce participation is not at the levels of prior years.

John Dominick, a banking and finance professor at the University of Arkansas, said most areas in the state are near full employment and that can be a problem for businesses wanting to expand.

“It’s not just highly skilled jobs that can’t be filled, there are plenty of service-oriented jobs that are also vacant. This is also apt to cause wage increase pressure in the coming year,” he said.

CONSTRUCTION GAINS
“Construction has heated up again,” said Bob Taylor, president of Parkway Bank in Rogers. “There are commercial and residential projects popping up across the region and state.”

One of the biggest improvements noted in the FDIC report was the number of single family and multifamily home permits issued this year compared to last. Through September, single family permits rose 11.6% across the state, compared to a 1.6% decline in the same period of 2014. Multifamily permits rose 496% through September, up compared to a 33.9% drop in permits reported a year ago. The home price index also rose 3%, nearly twice the rate of 1.9% increase reported in October 2014.

Silvia said on the national scene multifamily construction will continue to be strong into 2016 and there is room for more single family expansion.

“Household formations have picked back up to a pace that is a long run trend. This is helping to drive the housing market forward. There is very little inventory of new homes on the market, which means there will have to be more new home construction in the year ahead,” Silvia said. “A thriving real estate market is good news for community bankers, mortgage lenders and the overall economy.”

BANKING PROFITS
“Community banks are a reflection of the economies they serve,” said Gary Head, president of Signature Bank in Fayetteville.

While optimistic for better growth at the local and state level, Head said a 2.4% U.S. growth rate is nothing to rave about. It is below the 3.5% historical growth rate for the U.S., according to Silvia. Not only is the forecast low, Silvia said it looks like it could be 2017 or later before the U.S resumes a 3.5% growth rate.

Dominick said bankers across the state will likely see modest profits for 2015 and 2016. He said the economy is better but there is also uncertainty in other markets around the globe that can upset the financial markets at a moment’s notice. With near 0% interest costs, Dominick said money is cheap but factoring in a decent spread for real estate loans given the appropriate risk will be crucial for community banks this year and next.

“The low-hanging fruit of fewer loss reserves in the past few years helped bank profits rise, but now banks are faced with making loans at decent interest rate spreads if they want to continue that growth,” Dominick said. “That’s easier said than done in this highly competitive climate.”

Dominick said banks across the state have to control credit risks and that is done by thorough underwriting and marking up the cost of the loan. He said the underwriting is being done, but the markup has been largely absent given the stiff competition for banks bidding on the same loans.

“It’s a borrower’s market and there is considerable pricing pressure on loans today because more banks are able to lend again. Bank balance sheets are much stronger than in prior years, but there are not enough loans to go around so banks are having to compromise on rates and that’s a real risk at a time when interest rates are expected to rise,” Dominick said.

AVOIDING THE SLIPPERY SLOPE
Taylor agreed that one of the biggest threats to profits is the competition for loans which beats down the pricing spread for the lenders.

“We have had to pass on some loans because the competitor’s price did not properly reflect the risk involved, in our opinion. I am sure they were great loans but we just don’t want to tread that slippery slope again,” Taylor said.

Dominick agreed that bankers today are having to make some loans at rates that don’t make sense knowing interest rates are likely to move higher in the short term. He said it may be against bankers’ better judgment, but it’s happening even though there is definite risk to future profits. He said in prior years the biggest risk to profits was the credit risk of the borrowers. But now that borrowers are in much better financial shape given tighter credit standards, the biggest threat is the potential squeeze rising interest rates can have on a bank’s fixed loan portfolio.

The FDIC report found the median net interest margin among Arkansas banks this year to be 3.99%, down from 4.05% a year ago. This lower margin further reduced the median yield on earning assets with Arkansas banks from 4.61% last year to 4.45% in 2015. The cost of money, overhead expenditures and non-interest income were all flat against last year. Net loan losses among Arkansas banks also declined from a year ago. This could attributed to fewer past due accounts amid stronger consumer balance sheets.

Don Gibson, president of Legacy Bank in Springdale, agreed that consumers are in better fiscal shape than in the past. But he continues to have a conservative stance on the state and national economies.

“The economy is moving in the right direction. I am somewhat concerned that the U.S. is not growing any faster than the 2.4% projected rate; and the fragile outlook for 2016, an election year with global slowing as well. But we are enjoying more vibrant growth in pockets around the state,” Gibson said. “It remains to be seen how the competitive lending environment will react if there is a gradual increase in rates.”

Gibson said Legacy Bank has planned for a slightly better 2016 but did say tighter loan margins are a cause for caution. The FDIC report said bank earnings among community banks were up from a year ago, thanks to improved asset quality.

The FDIC report also made note of the growing interest-rate risk and credit risk to banks.

“While the banking industry had another positive quarter, there are signs of growing interest-rate risk and credit risk that are are important because – as history tells us – it is during this phase of the credit cycle when lending decisions are made that could lead to future losses. Timely attention by banks to address these growing risks will benefit banks and contribute to the sustainability of the current economic expansion. These risks will continue to be a focus of supervisory attention,” FDIC chairman Martin Gruenberg noted in his summary remarks.