State of the State Mid-Year 2024: Banks enjoying stable interest rates, ready when changes come

Arkansas banks have been catching their breath as interest rates have remained stable for a year. Now, they are preparing for future rate changes that might occur. In fact, the Federal Reserve hinted July 31 at a slight rate decrease.

Brad Chambless, CEO of Farmers and Merchants Bank and chairman of the Arkansas Bankers Association, said banks couldn’t respond quickly enough to the Federal Open Market Committee increasing the federal funds rate by 5.25 percentage points over 18 months.

But, the Fed’s keeping the rate steady at about 5.4% since July 27, 2023, has given banks time to adjust their assets and liabilities.

“Banks don’t like very volatile changes in their balance sheets,” Chambless said. “They like steady, slow up and down, so this period of somewhat normalization we hope continues forward, and it’s going to help banks across the entire state.”

Rapidly increasing interest rates are challenging for banks. They earn more money on loans but also must pay depositors higher rates in order to generate capital. Deposit rates have increased so quickly that banks couldn’t keep up.

“This has at least given everybody a chance to kind of stabilize and respond and get prepared, quite frankly, for whatever the Fed decides to do next,” said Susannah Marshall, the state bank commissioner.

THE RATE ISSUE
The Federal Reserve has signaled that a rate decrease could be forthcoming if inflation falls to the Fed’s 2% target. However, it hasn’t always followed through on its forward guidance. Marshall said banks have been building a rate cut into their budgets and models while also being ready if it doesn’t happen.

“I think they’ve been very prepared to react whether there were no rate movements or whether there was a potential for declines,” she said.

Chambless expects a rate decrease will occur, but it will be later this year. His bank and others have structured their assets and liabilities for a small downward shift.

Sam Sicard, president and CEO of First National Bank of Fort Smith, said his bank has a lot of construction and development loans in its portfolio but is seeing a slowdown in the pipeline. The higher rates are making it harder for people to buy houses, for companies to expand, and for contractors to build.

Banks face competition for deposits from other banks, online banks, money market funds and treasuries. To grow deposits to fund additional loans, his bank has been working on expanding relationships and has run a certificate of deposit special, as most banks have been doing.

Chambless said there has been a “severe decline in home loans, I think, across the state.” Banks are having to respond to the psychology of the consumer market. Potential borrowers have come to believe that the artificially low interest rates of the past 10 years were normal. They are waiting for loan rates to return to 3%. In reality, current rates are in line with historical averages.

SEEKING A ‘SWEET SPOT’
He would like to see a stable environment over the next year. He said that “if everything just stopped and stayed static, I think we would be in a really good spot. It would be up to that consumer and that commercial borrower to get back in tune with what is a true normal again.”

Sicard doesn’t expect rates to drop beyond 1% or so. Some of that expected drop already is priced into the market. Fixed home loan rates have already come down a bit, so they won’t fall as much as the Fed cuts. He’d like to see a modest decrease of 1%-2%. A cut that size would make loan payments more affordable for borrowers without hurting depositors too much.

Interest rates of 3%-4% on savings vehicles, along with loan rates of 6%-7%, are the “sweet spot” for depositors and borrowers. Sicard said the Federal Reserve appears to have succeeded in achieving its “soft landing” of raising interest rates to slow economic growth and tame inflation without causing a recession.

“Our consumer loans, people are still paying on them,” he said. “Our past dues aren’t elevated, so asset quality of our loans appears to be pretty good. So I’m pretty optimistic, at least in our markets. I’m a community bank in primarily western Arkansas, and so we’re in a pretty good market, particularly Northwest, but even Fort Smith’s doing fine.”

IN A ‘GOOD POSITION’
Marshall said Arkansas banks’ financial metrics were outpacing the national average during the first quarter. State banks exceeded the 1% mark for return on average assets. They performed favorably on net interest margins and average aggregate margins and currently report strong capital levels.

“The asset quality picture is still extremely clean,” she said. “We are not seeing or hearing of wholesale concerns or deterioration within loan portfolios.”

She is optimistic heading into the second half of the year, but she was looking forward to seeing Arkansas’ latest numbers.

“The reason I’m anxious to see what the June data looks like is because there’s pressure out there. And I think everybody can feel it, whether it’s the consumer can feel it, businesses feel it, banks are seeing it,” she said. “But I’m very optimistic. We have some banks that have some challenges to work through, of course, but on the whole, we’re in a pretty good position.”

Lorrie Trogden, CEO of the Arkansas Bankers Association, said she is “getting all good reports” from the banks with which she has spoken.

Still, certain challenges are making the situation “complex and muddy,” Chambless said. Like other sectors of the economy, banks are struggling to find workers. Consumers have a lot of debt to service month to month. The election season creates an uncertain political environment.

The regulatory environment has been another challenge.

“I feel like once a week, we get hit with something new that one of the regulatory bodies has done, and they may have gone through the proper process. But there’s a good chance that they may not have,” Trogden said.

Another concern for banks is fraud and increasing cybersecurity vulnerability.

“We are seeing and hearing more reports of where those issues just are unrelenting,” Marshall said.

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 around mid-year to provide an update on the state’s economy. Link here for the State of the State page and previous stories.