State of the State 2024: Arkansas banks navigate uncertain interest rate landscape

Editor’s note: The State of the State series provides reports twice a year on Arkansas’ key economic sectors. The series publishes stories to begin a year and stories in July/August to provide a broad mid-year update on the state’s economy. Link here for the State of the State page and previous stories.

According to the state’s top banking official, the uncertain interest rate environment is the most significant conversation topic entering the year.

“The rate environment is posing headwinds for many institutions, but tailwinds for others,” said Susannah Marshall, Arkansas State Bank Department commissioner. “Especially those that have structured their balance sheets to be in an asset sensitive position and to take advantage of repricing assets at higher interest rates.”

Marshall said banks with strong mortgage divisions bore the brunt of the interest rate volatility in 2023 and will remain impacted until a downward movement emerges.

“I don’t want to attempt to predict what will happen with interest rates in 2024 or the timeframe of any potential rate decreases,” she said. “Regardless of whether we will see any additional increases or rates remain flat for the foreseeable future, I believe any potential declines could be further out in 2024.”

Marshall and other Arkansas banking leaders offered various thoughts on the industry entering 2024. According to the latest data from the Federal Deposit Insurance Corp. (FDIC), 82 federally insured lenders doing business in Arkansas had a cumulative net income of $1.49 billion through the third quarter of 2023, up 4.1% from the previous year. The banks grew their combined assets robustly to $165.6 billion, up 7.3% year-over-year. Loan growth was even stronger at 13.8%. Construction loans accounted for a third of that growth, reflecting the vibrant economy.

Tim Yeager expects banks to remain strong — Arkansas’ average return on assets (ROA) of 1.23% is well above the benchmark ratio of 1% — but they are unlikely to match their 2023 performance.

“The lagged effect from high interest rates will lead to slower loan growth, an increase in problem loans, and a shortage of core [stable] deposits,” said Yeager, a finance professor who holds the Arkansas Bankers Association Chair in Banking at the University of Arkansas. His responsibilities include teaching, research and outreach to Arkansas bankers. “Loan demand will slow as businesses and consumers adjust to higher interest rates. In addition, borrowers will struggle to repay the higher interest payments on their debts, leading to more problem loans.”

Like many analysts, Yeager said he expects the Federal Reserve to lower interest rates in the coming months, which will somewhat reduce the pressure on loan demand and funding costs. He said Arkansas bankers are most concerned about a longer-term issue: the ability to hire and maintain qualified workers. He noted that many top students in finance want careers in investment banking, primarily because they think they can make more money on Wall Street.

That might be true, but he tries to explain that there are other advantages of working for a bank.

“We need to get the message across that this is a soul-fulfilling career,” Yeager said. “You’re going to do well, but will you be a millionaire or a billionaire? It’s less likely. But you will have a much more balanced, satisfactory life by doing this.”

According to the American Bankers Association, Arkansas banks employ around 16,000 people at over 1,000 offices and branch locations and have around 5 million customers.

‘ARTIFICIAL’ ECONOMY
Simmons First National Corp. (Simmons Bank) of Pine Bluff is one of the state’s largest banks, with $27.5 billion in assets. It’s one of four Arkansas-based lenders with assets greater than $21 billion at the end of last year’s third quarter. Bank OZK of Little Rock ($32.7 billion), Arvest Bank of Fayetteville ($27.3 billion) and Centennial Bank of Conway ($21.8 billion) were the others.

George Makris Jr. is the bank’s president and CEO. He said that after a decade marked by growth through acquisition, Simmons Bank is focused on organic growth and efficiency in 2024.

“We acquired 13 banks [in five states] in the past 10 years, which has given us access to some of the best markets,” he said. “We are improving our delivery channels and standardizing many internal functions. That combination should produce favorable financial results leading to capital growth and additional capacity to offer to our customers.”

Makris said the uncertainty around interest rates coupled with government spending and its upward pressure on inflation makes for an “artificial” economy, and that environment will trickle down to consumers.

“Banks are in the risk management business and will shift as much of the risk to the borrower as possible under uncertain times, which will restrict credit access,” he said. “That is more severe for the least credit-worthy borrowers. Loan funding costs and the cost of capital are also negative drivers of access to credit. That said, access to credit is still there for solid projects. Speculative projects will sit on the sidelines.”

Makris joked that his crystal ball has a crack in it, but he predicted that if inflation remains steady for the first half of the year – the current U.S. inflation rate is 3.4% for the 12-month period leading up to December 2023, according to the Bureau of Labor Statistics – a modest rate reduction could come in late 2024.

“However, this is an election year, and whether we like it or not, politics plays a role in many governmental decisions,” he said.

Makris also offered an opinion on artificial intelligence (AI) in banking.

“Banks are certainly aware of the proliferation of AI discussion,” he said. “That has driven much of the buzz for tech stocks. However, I believe we need to be very cautious and deliberate in advancing AI. It will be used for nefarious purposes well before we have maturity and risk protocols to mitigate bad actors.

“The other element not discussed much is who is teaching AI to deploy its logic. Banks have been using variations of AI to determine probability, relationships and other integrated data sets.”

Marshall also alluded to the increasing threat landscape regarding cyber risks and their impact on the industry.

“This increasing risk also translates into increased costs and pressure on resources,” she said. “Unfortunately, many comments I have received lately center around bankers’ concerns about the increases in fraud attacks on their customers and the impact it is having on the industry.”