Kevin Dobbsis a senior reporter and columnist. The views expressed in this piece representthose of the author or his sources and not necessarily those of S&P GlobalMarket Intelligence. Follow on Twitter @Kevin1Dobbs.
Asset-sensitivebanks want higher interest rates to boost lending profitability. But rates havegone nowhere in 2016 and nobody outside of the Federal Reserve's policymakingarm has a firm feel for if or when that might change.
TheU.S. economy continues to grow, with regional pockets of strength, but overalladvances are developing at an anemic pace, leaving the Fed cautious on ratesand bankers trying to generate loan growth on a shaky foundation. GDP expandedjust 0.5% in the first quarter, according to the U.S. Department of Commerce,marking the weakest advance in two years.
Abright spot, solid job growth, may have lost its luster. Employers on averagehave added more than 200,000 positions per month over the past year, accordingto the U.S. Department of Labor. But while they created 215,000 jobsin March and wages inched up — nonfarm payrollsclimbed 7 cents to $25.43 after a 2-cent dip in February — the pace ofjob advances across the first quarter slowed and sustainable upward momentum onwages has proven elusive.
Employerscreated more than 280,000 jobs per month on average in the final quarter of2015. The comparable figure for the first quarter of this year fell shy of220,000, Labor Department data show. Perhaps of greater concern, economistssay, the typical American's paycheck grew only about 2% in the first quarterfrom a year earlier. That was on par with the modest growth rate of the pastfour years.
"Theproblem we have is that a lot of jobs that are getting created are eitherpart-time or low-wage or both. They are not the jobs that drive GDP,"Ernest Goss, a Creighton University economist who tracks macroeconomic trendsand researches community banking, said in an interview.
Aheadof the Labor Department's jobs report for April, slated for release May 6, the ADP National Employment Report showed that privatesector employment increased by 156,000 jobs, the weakest reading of the past year.Slowing job growth, Goss said, does not bode well for Americans on the hunt forpay increases. That, in turn, is potentially disconcerting news for banks thathave looked to consumer lending as a driver of loan growth this year.
Bankersneed economic strength to fuel confidence among not just consumers. For smalllenders in particular, investments by commercial clients that require loans arevital. Small business is often the bread-and-butter lending category forcommunity banks. If the economic expansion remains frail, uncertainty may intensifyamong business borrowers.
Low rates, high costs
Thatwould come at a time when banks need loan volume to offset the impact of lowrates and the lofty regulatory costs that have dogged banks since the aftermathof the 2008 financial crisis. Fed policymakers boosted short-term rates off ofbasement levels late in 2015, offering modest relief to some banks' netinterest margins during the first quarter. But the additional rate hikes neededto genuinely drive greater lending profitability have yet to follow.
Analyst Joe Gladue of Merion Capital Group said in a report that,"while expectations for the number of additional interest rate hikes thisyear continue to fluctuate with each bit of negative or positive news, thetheme of 'lower for longer' remains unchanged." Though many banksgenerated modest loan growth in the first quarter, he added, "the U.S.economy is not growing fast enough, as exemplified by the 0.5% rise in GDPreported for 1Q16, to drive significant loan growth for the entire banking industry."
Recentmarket expectations have been for one or two rate increases before the yearends. "But I think that is in serious doubt," Goss said. "Theexpectation among community banks right now is for not much, if anything."
Meanwhile,regulatory challenges persist, keeping cost pressures high. Goss surveys smallbanks throughout the central U.S. each month. In April, he asked them to namethe greatest challenge they expect to face over the next five years. Nearly 44%reported rising regulatory costs; that was more than for any other headwindbankers identified, Goss said.
Now,a major new hurdle lurks.
TheFinancial Accounting Standards Board is in theprocess of finalizing a rule this year that would alter the way banks decidehow much to set aside for loan losses. Under the FASB's plan, banks would movefrom an incurred loss model to an expected-loss model. Following the change,which banks would have a few years to adapt to, lenders would forecast loanlosses years into the future and set aside allowances for such projected lossesat origination. Many community bankers fear that the cost of shifting to the newapproach could cripple them.
"Toput it in one word, I think the banks are cautious," Goss said. "There'sseveral good reasons for that."
ThomasRudkin, a FIG Partners principal who advises community banks, agreed. He saidin an interview that many lenders view the economy as one stuck in slow-growthmode, providing only modest hope for a new rate environment. And worries aboutcost pressures, meanwhile, fester much as they did all of last year.
"Isee 2016 as almost a mirror image of 2015," Rudkin said.
Energy and agriculture
Amongthe most pressing concerns, of course, is the drawn-out recession in the energysector. Oil prices, while rebounding some in recent weeks and hoveringcomfortably above $40 per barrel in early May, remain well below mid-2014 highsthat topped $100. The slump has cut deeply into many energy companies' bottomlines, affecting their abilities to make loan payments. That has hurt creditquality in lenders' energy books.
, forexample, said in a presentationthat its criticized energy credits reached 30.4% of total energy loans by theclose of the first quarter. That was up from an already elevated 27.4% at theend of 2015. MidSouth, a Louisiana-based bank long active in Gulf South energylending, said outstanding energy loans were down 4.6% in the first quarter to$252.5 million. But energy credits still make up more than 20% of its overallloan book, leaving it vulnerable to any downshift in oil prices.
MidSouthis one of dozens of banks peppering energy-heavy states that have reportedcredit quality deterioration this year because of the oil-price downturn. Evenwith prices steadying in recent weeks, many observers say energy borrowers arelikely to continue struggling for a few quarters, further pressuring creditquality.
"It'svery likely that defaults will go up," Goss said.
What'smore, he added, oil is not the only commodity sliding in recent years. Corn andother crop prices have sunk, hurting farm incomes and affecting manufacturersand others, including banks, that are active in agriculture. The U.S.Department of Agriculture forecastthat total farm income will decline 3% this year to $54.8 billion. That wouldmark the third straight year of decline and the lowest level of income since2002.
Thatis not only hurting farm operations but also cutting into land values and salesfor agriculture equipment dealers and manufacturers of farm equipment, Gosssaid. It also is threatening to affect small-town businesses that rely onfarmers to help drive local economic activity.
DavidSteffensmeier, chairman and president of First Community Bank in Beemer, Neb., said in response to Goss' Aprilsurvey that "low farm income and plummeting farmland values rankequally" with regulatory costs as a top threat to farm-focused communitybanks in coming years.
Ifthe crop-price downturn carries into next year and beyond, Goss said, banksthat work in agriculture and in rural markets dependent on healthy farm economiescould see notable credit problems.
"Thefarmers have been living on past glory," Goss said. "There are a lotof questions about how much longer they can do that."