Community bank lenders are bracing for a “higher for longer” interest rate environment ahead in 2024. The silver lining? After a period of rate volatility and uncertainty, rates appear to be stabilizing.
Although more expensive debt financing has been a tough adjustment for borrowers, banks generally have continued to produce steady levels of loan originations. The total volume of loans and leases held by FDIC-insured institutions increased by 4.5% year-over-year in second quarter 2023 to $12.3 trillion.
Denver-based ANB Bank has maintained good lending volume for much of 2023 and is predicting another solid year ahead in 2024. The $3.2 billion-asset community bank credits that activity in part to its diverse lending business across different sectors, including consumer, mortgage, commercial, business loans, affordable housing and commercial real estate. A second factor contributing to that steady volume is that many of its competitors have pulled back.
“We’ve actually been very active, but it’s in part because the rest of the market has shut down,” says Koger Propst, president and CEO of ANB Bank.
Consumers, small businesses and others are more cautious when it comes to taking on debt in the current economic environment, where interest rates are higher. At the same time, the banking sector has been affected by higher interest rates, the cost of funding and, in some cases, a decline in deposits. If a bank has a high loan-to-deposit ratio and now has funding challenges, it has less firepower to fund new loans.
“I’m not saying we weren’t impacted,” Propst says. “But for us, we have seen this as a time of opportunity. There are good customers wandering the streets that their current financial institutions haven’t been able to serve during this time.”
ANB Bank’s approach has been to be a steady, consistent lender, which is what customers need right now, Propst adds.
Economy will influence demand
Much of the outlook for lending in 2024 depends on how the economy performs. At the start of the fourth quarter, economists were generally predicting lower but flat or slight growth in 2024. The Conference Board’s U.S. economy forecast from November predicted a decline in GDP growth from 2.4% in 2023 to 0.8% in 2024.
“For us, we don’t go in and out of businesses; we try to stay consistent in how we lend.”
—Dave Seiler, First Business Financial Services Inc.
However, people have been talking about the possibility of a recession for more than two years, and it hasn’t materialized. “For us, we don’t go in and out of businesses; we try to stay consistent in how we lend,” says Dave Seiler, president and COO of First Business Financial Services Inc., parent company of First Business Bank in Madison, Wis.
Although the $3.3 billion-asset community bank still expects to grow in 2024, activity may shift to different products depending on what happens with the economy, he adds.
The macro numbers still show solid growth. Unemployment is still low, consumer spending is strong, and while inflation is still higher than the Fed would like, it’s come down significantly compared with its previous high levels. There are pockets of challenges in certain areas such as the housing market, transportation and office properties, but problems are not widespread in the economy, notes Seiler.
“I would say we’re in a ‘steady as she goes’ mode. We’re doing this like we always have and keeping our eyes open to see if the economy changes,” he says. “But right now, we feel like it’s going really well.”
Differing fortunes across sectors
Lending opportunities and challenges ahead in the coming year vary widely across loan types, industries and geographies. In the mortgage sector, high housing costs and a limited supply of for-sale inventory remain big challenges. Single-family mortgage originations are down substantially from their high of $2.37 trillion in 2022.
However, the latest Fannie Mae Housing Forecast calls for an uptick in activity in the coming year. Single‑family mortgage originations are expected to climb to $1.4 trillion in 2024 after dipping to $1.3 trillion in 2023.
“I wouldn’t say that the doors are blown off with demand for those loans, but we are aware that the larger banks have pulled back a little bit. … I do think that could offer us some opportunities in areas where we are actively lending.”
—James W. Gore, Lumbee Guaranty Bank
For commercial real estate loans, construction activity has slowed, and sales activity also dropped sharply in 2023 due to the higher interest rates and potential distress in CRE loans. The flip side of that is that it is a very capital-intensive sector and there is huge demand for financing from borrowers with maturing loans. According to the Mortgage Bankers Association, an estimated $2.6 trillion in commercial and multifamily loans are expected to mature between 2023 and 2027.
Lumbee Guaranty Bank in Pembroke, N.C., is continuing to look at both commercial and multifamily loans within its footprint as a good book of business. Vacancy rates in multifamily have remained very low, says James W. Gore, chief credit officer of the $500 million-asset community bank. “I wouldn’t say that the doors are blown off with demand for those loans, but we are aware that the larger banks have pulled back a little bit,” he says. “So, as we go forward ... I do think that could offer us some opportunities in areas where we are actively lending.”
On a positive note, the strength of existing loan portfolios appears to be holding up very well.
Although there are concerns about pockets of distressed loans emerging among the bigger banks, particularly those holding maturing CRE loans on office properties, that distress has yet to show up in the numbers. According to the FDIC, the percentage of loans and leases that were more than 90 days past due was 0.76% as of the second quarter of 2023.
“We have not really seen a deterioration in the creditworthiness of our borrowers at this point. Our metrics for problem loans and past dues are lower than ever,” says Gore.
However, the higher interest rates have really gotten the attention of the borrowers and their decisions as to whether they want to take on a new project, whether it’s buying new equipment or building a new facility, he adds.
Lenders are still cautious on credit risk, with lingering uncertainty on the direction of the economy. If there ends up being a recession, it will likely hit consumers first, and the impact will be uneven with certain geographies and industries that are more or less affected. ANB Bank’s approach is to build a loan policy that works in both good and challenging times.
Many community banks remain “open for business” on the lending front because they have good diversification and don’t have heavy concentration risk in a particular market segment. Consistent lending strategies allow them to provide needed capital to consumers and businesses within their communities.
“During 2020 and 2021, community banks were champions in that PPP arena,” says Gore. “They assisted businesses in areas that would have otherwise been left out, and that exemplifies what the community banks do every day.
“Community banks in urban and suburban areas also reach a segment of the population in the economy that seems to be in need of banking services in which there’s still a personal touch. So, I think the future’s bright for community bank lending activity once the interest rate stabilizes.”
Interest rate headwinds
Borrowers are feeling the pinch from higher interest rates. As of mid-December, the prime rate was hovering at 8.5% and borrowers across the board are experiencing “sticker shock” from loan rates that have more than doubled compared with early 2022. Looking ahead to 2024, higher interest rates will continue to be the primary challenge for borrowers. The higher rates are weighing on demand for loans and making it more difficult for banks to qualify some borrowers due to the higher interest rate expense. To varying degrees, community banks are seeing higher rates affect demand for loans. For example, Lumbee Guaranty Bank in Pembroke, N.C., experienced relatively strong demand during the first half of 2023, with year-over-year loan growth that stood at 7.1% based on its reported second quarter results. However, it began to see its lending activity plateau as the community bank moved into the second half of the year. “Because of the current outlook on interest rates maybe going up a little bit or staying pretty flat, we expect very slow or no growth during 2024,” notes James W. Gore, chief credit officer. First Business Bank in Madison, Wis., experienced strong lending activity in the first half of 2023, with loan originations up more than 10% year over year. Part of that increase is coming from accelerating growth in its commercial and industrial (C&I) business. “What we hear from our business clients, particularly on the conventional side, is that their businesses are doing well, and they’ve got plenty of demand,” says Dave Seiler, president and COO of the community bank’s parent company, First Business Financial Services Inc. He adds that the number one challenge is still finding talent—not interest rates.