Challenging economic environment. Difficult period. Tough times.
Local bankers are using phrases like these to describe the first six months of 2008. Banks are under pressure from several directions, including a narrower margin spread, decreasing deposits and an increasing number of non-performing loans.
However, despite these problems, no one expects any local or regional banks to implode like the IndyMac Bank failure in Pasadena, Calif.
Spread thin
One benchmark that illustrates a bank’s financial health is the net interest margin, also known as the margin spread – that is, the difference between the average interest rate received on loans and the average interest rate paid on deposits. Regional banks, such as Riverview Community Bank, are seeing this margin pinched by the Federal Reserve rate cuts.
For example, according to its most recent financial statement, Riverview’s net interest margin was 4.2 percent in the first quarter of fiscal year 2009, compared to 4.83 percent in the first quarter of fiscal year 2008 – representing a drop in net interest margin of about 13 percent.
Danette LaChapelle, iQ Credit Union’s senior vice president of marketing, said the credit union’s spread was down about half a percent.
Bob Whareham, community bank president at Wells Fargo, said the bank’s spread had dropped from 4.95 percent in the first quarter of 2007 to 4.69 percent in the first quarter of 2008. And Randy Krenelka, chief financial officer at Regents Bank, cited a 9 percent drop in the bank’s net interest margin from 5.26 percent one year ago to 4.78 percent.
“Margin compression remains a challenge for Riverview as well as the entire banking industry, and we expect our margin to remain under pressure during the second half of the calendar year,” said Ron Wysaske, Riverview’s President and Chief Operating Officer.
Down on deposits
Banks make money by loaning money – and most smaller banks fund these loans primarily with deposits. Other bank sources of funds include investment portfolios, occasional short-term borrowing and fees, bankers said.
The problem is, Americans aren’t saving. In fact, the average national personal savings rate has decreased from about 10 percent in the 1970s and 1980s to its current level of between 0 percent and 4 percent.
The personal savings rate is defined as a fraction of personal income that is not consumed, and does not include retirement and 401(k) savings, according to the U.S. Department of Commerce Bureau of Economic Analysis.
Riverview’s deposits fell from $692 million a year ago to $629 million currently.
“If we didn’t have deposits, we’d be dead,” Wysaske said. “Lenders get all the glory, but the reality is that core customer deposits are the absolute lifeblood of banks – particularly community banks.”
Banks and credit unions look for ways to encourage additional deposits. For example, iQ Credit Union offers an “Easy Saver” product to business and consumer customers that rounds up debit card purchases. During the first 30 days, iQ matches half of the amount saved. After that, it matches 5 percent.
Another way to attract more deposits is to offer higher interest rates – but as LaChapelle pointed out, that can erode the institution’s net interest margin.
“The deposit market is particularly competitive right now,” said Mike Worthy, president and chief executive officer of Bank of Clark County. The bank is offering high interest rates but Worthy said, “prime hasn’t changed,” resulting in continuing margin compression.
Levels of deposits are affected by both the economy in general, and by competition, Wysaske said.
There are many other ways to invest your dollars besides the old-fashioned bank deposit, so banks are tempted to bid up the rates paid on deposits. But, Wysaske said, this tactic does not result in relationship-based bank customers, but rather in “rate chasers” who are not interested in doing other business with the bank or building a relationship long-term.
And relationships are important, especially if depositors get nervous after events like IndyMac’s federal takeover make headlines.
“When customers know and understand their bank, and the bank knows and understands its customers, the level of trust is much higher,” Wysaske said. “And this confidence is valuable during tough times.”
To counteract any nervousness, Washington Mutual issued a press release on July 15 stating that the bank has more than $40 billion in excess liquidity and that it “significantly exceeds all regulatory ‘well-capitalized’ minimums for depository institutions.”
Problem loans
Higher energy costs and a plummeting housing market have spelled disaster to some banks, such as those heavy in residential real estate lending. Here in Clark County, bankers such as Whareham and iQ Credit Union CEO Roger Michaelis, don’t expect any such catastrophes, but defaulted loans are still a concern.
“Our primary emphasis in fiscal 2009 continues to be managing the quality of our loan portfolio,” Wysaske said.
Riverview recently added $2.75 million to its loan loss reserve in response to an increase in non-performing assets. The bank saw non-performing loans rise from .03 percent of total assets on June 30, 2007, to 2.67 percent on June 30, 2008.
Competition for good loans can also put pressure on bank margins.
“Everybody wants to lend to the triple-A guy,” Whareham said. “Everyone is chasing that loan.”
Competition means lower interest rates on the loan, and that further reduces bank margins.
WHAT IT MEANS FOR BUSINESS BORROWERS
Various economic pressures on banks result in lower earnings. For example, Riverview Community Bank’s net income was 7 cents per diluted share for the first quarter of fiscal year 2009, compared to 25 cents a year ago.
But, said Regents Bank Chief Financial Officer Randy Krenelka, return on assets and return on equity also are useful benchmarks. The recommended minimums for these are 1 percent and 10 percent to 12 percent, respectively. Krenelka added that Regents is on track to make these targets.
To preserve capital, banks are less eager to lend than they historically have been, he said.
“Borrowing hurdles have gone up,” Krenelka said.
Businesses who want to borrow money need to show they are strong borrowers. Doing so includes the following criteria:
Adequate reserves: Do you have assets that can support your business through hard times?
Strong operating history: Are you a flash in the pan or do you have staying power?
Source of repayment: Will your business bring in sufficient dollars to make loan payments?
A good business plan: How will you sell the project to your customers to make the loan cost-effective?
“I don’t see it turning around any time soon,” said Tami Nesburg, senior vice president at Regents Bank.
She estimates it will be 2010 before bank margins start increasing significantly.
In the meantime, said Wells Fargo’s Community Bank President Bob Whareham, well-run financial institutions will “keep on doing what we’ve been doing,” – being prudent in all types of borrowing, mitigating risk by diversifying the loan portfolio and managing expenses closely.
