Banks Are Set For Steady Rise In Interest Rate

Randy Dennis, President of DD&F Consulting Group of Little Rock

The rise in interest rates is not taking any Arkansas bankers by surprise.

The Federal Reserve is expected to raise the federal funds rate — the overnight rate banks pay for borrowing — by as much as 1 percentage point at its next meeting later this month. A month ago, it raised the rate 0.75 percentage point, and many predict the July rate increase will not be the last of the year.

The FFR is important because it serves as a benchmark for rates on mortgages, credit cards and other loans. The Federal Reserve is hoping its rate increases will tamp down inflation, which has been steadily rising. The consumer price index surged 9.1% in June.

“Most banks are set for a rising interest rate environment,” said Randy Scott, the CEO of Farmers Bank & Trust of Blytheville and the chairman of the Arkansas Bankers Association. “Rates have been low for so long that we have it pretty managed, as long as it is a slow rise. A real quick increase, where it goes up 2 or 3 percentage points all at one time or within a year — that makes it a little tougher to manage for banks. We have been anticipating rising interest rates for several years now and most banks are ready for it.”

Randy Dennis is the president of DD&F Consulting Group Inc., a national banking consulting firm in Little Rock. He said the rise in interest rates for residential mortgages may slow home purchasing since low interest rates were a factor in homebuying despite high prices; home prices are not expected to come down significantly.

Jim Bullard, the president and CEO of the Federal Reserve Bank of St. Louis, said as much during a presentation at the Little Rock Regional Chamber on July 7. 

“That’s supposed to happen,” Dennis said of a reduction in home loans. “President Bullard said there was already a slowdown in lending activity according to the Fed’s numbers. On the other side, he said they weren’t projecting any decrease in home prices. I think what you will see is more home equity loans out there and, instead of new construction, more sales of used homes. It is kind of a double-edged sword.”

Managing the Spread

Higher interest rates mean banks will generally make more money from interest payments on loans, provided, of course, there isn’t a drastic reduction in the number of loans given.

Darrin Williams, CEO of Southern Bancorp Inc. (Karen E. Segrave)

While most expect a slowing of loans issued, it is not thought that will be bad for banks. Darrin Williams, the CEO of Southern Bancorp Inc. in Little Rock, said his bank is on pace to surpass the number of loans it issued in 2021, an achievement partially based on the overall growth of the bank.

“I don’t know if I would categorize it as good news or bad news,” Williams said of the Fed’s probable actions. “I think from a banker’s perspective, it is not our to guess the rates. We try to manage the spread. We try to manage being able to provide safe, secure loans for our customers that they are able to pay back at a rate where we make enough margin to stay in business and honor our mission.”

Higher rates mean more revenue from loans, but they also mean the cost of having the money to loan goes up, Williams said. People deposit money to earn interest through certificates of deposits or interest-bearing savings accounts. 

The rates on those accounts go up when the Fed boosts its FFR. A bank CD that might have earned 0.4% two years ago is now earning closer to 2%.

“It is like when my youngest daughter was in high school, and I asked her about this fella who had been calling. She said, ‘You know, Dad, it’s complicated,’” Dennis said. “In the long run, if it tamps down inflation that’s good, but hopefully it will help banks increase their interest income, get a higher yield on their loan portfolio over time as their portfolio adjusts. 

“Typically in history, the asset yields will go up faster than the deposit costs. In theory, if rates go up deposit costs are going to go up and yields are going to go up and everything is going to stay the same.” 

Retiring Side

Arvest Bank of Fayetteville hasn’t seen a noticeable dip in loan demand, said Scott Phillips, its chief investment officer. Arvest, the largest bank chartered in Arkansas with $26.6 billion in assets as of March 31, has raised its CD rates and terms to be “more attractive” than they have been in some time.

“Generally speaking, the most obvious effect is banks typically raise loan rates when interest rates rise,” Phillips said in an email to Arkansas Business. “On the flip side, rising rates can sometimes dampen loan demand. Additionally, a higher federal funds rate may stoke competition among financial institutions in terms of higher rates for savings accounts, CDs, etc. Banks have investment portfolios as well, and when interest rates rise, bonds can become less valuable.”

The increase in CDs rates is a boon for some consumers, Dennis said. Scott, whose Farmers Bank & Trust has $332.1 million in assets, said low interest rates hurt those who are retired or soon to retire and don’t have a lot of investments in the stock market.

“It is going to be good for the older folks, people with CDs and deposits out there,” Dennis said. “For depositors, it is a good thing — the banks that are going to be bidding up the costs of deposits and paying more in CDs.”

The inflationary times can be tough on the less affluent. While gas and grocery prices are high, those blessed with money don’t really go without food or gas; the poorer among us are hit harder, Williams said.

With $2.1 billion in assets, Southern Bancorp serves all who walk through its doors, but it focuses on the underbanked. The bank issued 8,150 loans in 2021, and nearly half were for less than $10,000; it costs banks as much to process a $1 million loan as it does a $10,000 loan, Williams said.

“For our small-business customers, an entrepreneur who is not financially strong or a major company, we try to craft our loan packages in a way that we can help them,” Williams said. “This type of environment may require us to be more creative. Rates are going to rise; the rain is going to come.”

Banks have expected the rate increases since the country, at least socially and economically, emerged from the COVID-19 pandemic.

“Banks continually monitor their asset vs. liability position in order to prepare for rate movements of various magnitude and rapidity,” Phillips said. “Most banks tend to benefit from rising interest rates.”

Scott said that if a recession hits the country, the banking industry is at least ready for it. 

“The banking industry is very healthy right now,” Scott said. “A lot of banks have had their best years in the last year or two. We are prepared for a recession, and I think the banking industry is a lot more prepared than we were in 2008, 2009 and 2010. 

“They were expecting the worst in 2020 but that has us more prepared if a recession does come.”