Community banks are grappling with surging deposit costs and increased expectations for weaker economic conditions that could hamper
Lenders and investors had warned of this one-two punch to the gut ahead of the
"You pretty much have to expect lending activity to slow down in response" as bankers "try to avoid mounting risk," said Mike Matousek, head trader at U.S. Global Investors.
These concerns are amplified by the results of a new survey by the Conference of State Bank Supervisors. Community bankers' outlook on economic conditions fell to a new low in the most recent CSBS
Worries about monetary policy — the Federal Reserve has boosted interest rates 10 times since early 2022 — as well as future business conditions and threats to profitability dropped the CBSI to 73. It slipped 10 points from the previous quarter and to the lowest recorded level since the survey began in 2019.
The CBSI surveys community bankers nationwide in the last month of each quarter to capture their thoughts on future economic conditions. An index reading above 100 indicates a positive sentiment, and anything below 100 is negative.
In response to a special question in the latest survey, 95% of small bank executives said they believed the U.S. economy was in a recession.
"Community banker sentiment has been pessimistic for six straight quarters. They are navigating the effects of higher interest rates that have stressed liquidity, lending growth and fixed-rate securities portfolios," said CSBS Chief Economist Tom Siems. "Moreover, following the
The Fed has lifted rates to combat a surge in inflation following the depths of the pandemic. The policy has worked — inflation is roughly half the level of last year — but consumer prices remain about twice as high as policymakers say is healthy. As such, rates are likely to remain elevated through 2023. Historically, when spiking rates intersect with inflation, the U.S. economy has dipped into a downturn.
Additionally, the failures of Silicon Valley Bank and Signature Bank in March — followed by the demise of First Republic Bank in May — punctuated pessimism. The failures were hastened in part by surging rates and runs on deposits. This bolstered already intense competition for deposits, further increasing funding costs that were already high following the rate hikes.
When deposit costs jump, banks' net interest margins get squeezed. NIMs measure the difference between what banks pay on deposits and earn in interest on loans. When the key measure of profitability dwindles, banks tend to scale back lending. They do this to reduce their need for high-cost deposits to fund loans and to minimize exposure to sectors vulnerable to a recession. In the current market, community bankers are concerned about commercial real estate broadly and urban office properties in particular, given enduring remote work trends and high vacancy rates.
Banks "that can best defend their" interest income outlooks "and avoid credit migration should fare best on a relative basis" during earnings season, said Keefe, Bruyette & Woods analyst Christopher McGratty.
Against that backdrop, Optimum Bank in Fort Lauderdale, Florida, is methodically slowing its lending this year after strong growth in 2022. It still expects to expand this year, but investors should expect a noticeably slower pace, Moishe Gubin, chairman of the $622 million-asset bank, told shareholders in a June letter.
"I, for one, am in
As for the CBSI survey, all its components decreased from the previous quarterly poll. At 68, the profitability component had the greatest quarterly decline for the third consecutive quarter, falling 14 points from the first quarter and down 33 points from a year earlier. The regulatory burden component remains the lowest at 18 points, dropping 4 points from the prior quarter to its lowest recorded level.
Expectations that the Fed's monetary policy decisions will negatively impact market conditions continue to push the overall index down. It decreased 6 points to 33 from the prior quarter and tied at its lowest recorded level. The outlook for future business conditions declined 8 points to 43.
In response to another special question, community bankers rated the following as their top concerns for 2023: government regulation, cyberattacks, inflation, the federal debt and deficit and the cost and availability of labor.
