Strategies for community banks to grow, navigate the upcoming “hurricane”

The current economic headwinds might seem like a "hurricane" on the horizon to some, but advisers and bankers at S&P Global Market Intelligence annual community bankers' conference said institutions could navigate choppy waters.

In the latest Street Talk podcast, we share the advice that bankers, advisers and investors offered at the event, including how to prepare for unprecedented changes in rates and how to accelerate growth through recruitment, incentives and financial technology partnerships. Conference participants also offered their views of the potential market opportunity and risks from fintech partnerships as well as their views of current bank stock valuations and the economic environment.

The Federal Reserve's tightening of monetary policy, elevated inflation and a potential recession emerging all create an uncertain environment for community banks. The Fed faces the daunting task of trying to engineer a soft landing for the economy while raising rates quickly and shrinking its nearly $9 trillion balance sheet. The task ahead even prompted JPMorgan Chase & Co. Chairman and CEO Jamie Dimon at an investor conference on June 1 to compare the current environment to a hurricane lying on the horizon.

Sally Pope Davis, portfolio manager at Goldman Sachs Asset Management, used a similar analogy at our community bankers conference on May 18, noting that current market turmoil — which has left bank stocks down 15% since the beginning of 2022 — is akin to being on a beach during a hurricane.

"It's a little bit like being on the beach during your hurricane. But you're not in a hurricane. You've got a sunny sky and it's blue," the investor said. "But there is something coming, and it's starting to show up, and it may hit and it may be hard, it may not be hard. We don't know."

The investor noted that fundamental bank trends remain strong, with institutions reporting during first-quarter earnings season pristine asset quality, improving loan growth and better outlook for their net interest margins, but the market is worried about a potential recession. The investor believes bank stocks are currently priced for a slowdown, not a recession.

We recognized the challenge as the elephant in the room and kicked off the event on May 17, talking with Jason Elder, partner and managing director of corporate strategy at Performance Trust Capital Partners LLC, about how banks can prepare for the changing rate environment. Elder noted that forecasts are often wrong and suggested that banks spend more time thinking about who they are and how they would perform in different rate environments.

"You can't find any economists or people that forecast interest rates over time, that are consistently right," Elder said at the event. "We don't believe anyone knows where interest rates are going to go, so we act on that. How do we act on that? We pay attention with our clients to how a bank will perform in a variety of different interest rate scenarios."

Elder further noted that most banks are asset sensitive at this point in the rate cycle, meaning that their net interest income will increase as rates move higher. With that in mind, he said the risk facing most banks is that rates actually decline at some point.

"Low rates for a bank is like Kryptonite for Superman. It weakens you, your [net interest margin] just gets smaller and smaller, you start to get closer and closer to all of your fixed costs. And the longer you stay in a low interest rate environment, just like Superman and Kryptonite, the worse it gets, and the lower interest rates go, the worse it gets," Elder said.

While rates and how to prepare for the changing operating environment came up in many conversations at the conference, participants spent even more time discussing growth strategies for community banks.

One community banker, David Bright, CFO at Mountain Commerce Bancorp Inc., noted that the company's compensation incentives have helped the institution grow and in particular build its deposit franchise. The bank's relationship managers earn a bonus at year-end based on their profitability, as opposed to loan production, he said. The bank also rewards relationship managers by paying them a 50-basis-point commission for bringing in deposits. Under the structure, Bright said some relationship managers earn more than the bank's CEO.