May 07, 2008
Q. A lower interest rate has caused several U.S. banks to announce a substantial decline in quarterly earnings. How have lower interest rates impacted your bank?
Anderson: As a member-owned cooperative, Mid Oregon Credit Union is impacted differently from our for-profit brethren in the financial institution world. The bottom line for the Credit Union is value to members. The primary impacts to our organization are lower loan rates for borrowing members and, unfortunately, lower dividend rates for our depositing members. Like for-profit institutions, interest revenues have declined significantly and at a faster pace than the cost of deposits. The end result is lower net income until interest income and dividend expense can be rebalanced.
Farnsworth: Lower interest rates have impacted all financial institutions, not excluding Umpqua Bank. However, unlike many other banks, Umpqua Bank has not participated in sub-prime lending and does not have investments backed by sub-prime loans.
In spite of this, the company has not been immune to the impact of the housing crisis. The prime rate reductions have reduced our loan yields for loans tied to prime, which has led to a decline in our short-term interest rates and several deposit accounts have seen lower rates in response. However, Umpqua Bank recognized the opportunities and challenges early on and is well positioned for continued growth in the coming year.
Freeman: It is not as much the lower rates but the magnitude of the drop over a short period of time that has impacted Community First Bank. A significant portion of our loan portfolio is tied to short-term interest rates (typically National Prime). When rates fall, the interest we earn on these types of loans will fall immediately. In addition, the bank’s deposit mix includes a large percentage of certificates of deposit, which do not reprice until the stated maturity. So as this happens, our net interest margin, which is the difference between what we earn and what we pay in interest on loans and deposits, compresses. A measured pace of increase or decrease is not usually a problem, but in this case we have seen a 200 basis point (2 percent) drop in the span of six months, which has caused a noticeable compression in our margin. Once the bottom of the rate reduction is reached, deposit rates will adjust and our margin will recover. But in the short term, since our net interest margin is the primary component of our revenues, the bank’s net income will decline. Growth in loans and deposits can help offset this compression, but since the regional economy has slowed, the bank’s growth has temporarily slowed, too.
Newton: I see quarterly earnings for U.S. banks declining due to elevated credit costs with lowering rates leading to more of a side effect of compressed margins for banks. In light of the economic downturn we are experiencing, we are pleased rates have come down as this leads to increased liquidity and lower costs to borrow money for individuals and businesses. These movements are both good for lenders and borrowers and assist to stimulate the economy. The slowing economy has, however, created more challenges for our customers and our communities. We are reaching out to these customers and also encourage them to look to us and their other trusted advisors for help and guidance to develop a manageable plan of action.
Snyder: With many loans tied to Prime Rate or Treasury Rates, they adjust immediately and the margin we receive, from our cost of funds to what we price our loans at, drops. Being a new bank, I have a projected "rate of return" or "spread" on my loans and lower interest rates do impact this.
Stednitz: Lower rates tend to stimulate business activity. However, they generally result in lower margins and earnings for banks. LibertyBank has seen some decrease in net interest margin due to lower rates.
Van Hemelryck: This is a difficult time for banks. The deep rate cuts by the Federal reserve, largely in response to the deteriorating real estate market, have resulted in a compression effect on margins here in Central Oregon and abroad. We are asset (loan) sensitive with a significant portion of our loans tied to the Prime Rate, meaning, in a declining rate environment, our loans re-price more rapidly than our deposits and margins compress. However, we have mitigated this with interest rate floors on our variable rate loans.
Q. What is your strategy for succeeding during this economically challenging time?
Anderson: Continue to make loans to the membership. Invest in high quality loan participations with other credit unions to keep excess funds earning strong yields. Keep deposit rates competitive in order to serve members and retain relationships. Implement cost control at every viable opportunity. Keep an eye out for opportunities caused by the economic downturn to increase the Credit Union’s presence throughout Central Oregon. E.g. Branch expansion.
Farnsworth: Umpqua Bank’s culture is our top priority. We continue to invest in our people and strengthen our ties in the community. As always, we are operating as a community bank with local decision making and a focused strategy for growth, while aggressively working to resolve any potential problem loans impacted by the housing market downturn.
The economic environment has been and continues to be challenging for the financial services industry as a whole. Umpqua Bank is backed by a strong financial team who recognized challenges early on and is prepared to navigate the company through tough times. We credit their talents and experience to the successes we have had in one of the toughest economic environments our industry has seen and are happy to report positive earnings in the first quarter of 2008.
Freeman: Continue to invest in our team, our products and our service locations to facilitate ongoing growth. This is tempered by the need to be diligent in our loan underwriting. We do not intend to pull back from growing our loan portfolio, nor do we intend to reduce our commitment to the communities we serve.
Newton: The strong foundation of Bank of the Cascades has been built in a profitable, sound and thoughtful manner throughout prosperous times. This foundation allows us to respond effectively from a place of strength in a down real estate cycle. We continue to be profitable and "well-capitalized" according to federal regulatory guidelines, and are working actively to assist our customers impacted by this downturn. As a regional bank, we are actively monitored and measured through extensive federal regulation which provides reassurance to those we serve.
Our strategy to succeed during this challenging economy is the same as it has always been; we remain focused on how to best serve our customers and communities. With a strong commitment to deliver the best in community banking for the financial well-being of customers and shareholders, we combine outstanding service, competitive financial products, local expertise and advanced technology in meaningful and specific ways for each individual customer.
Snyder: Prudent underwriting of our loan requests – cash flow, liquidity, strong Loan to Values and looking for other sources of repayment.
Stednitz The strategy is to pay even closer attention to lending/underwriting fundamentals, ensuring we make quality loans and avoiding unnecessary risk. We are also monitoring the existing portfolio closely to ensure that we understand where future problems may arise and are able to take action quickly when problems surface. Otherwise, we continue to focus on providing the highest level of service to all of our relationship clients while focusing on meeting their needs.
Van Hemelryck: To stay externally focused on the customer and take advantage of growth opportunities that are present. The challenges in the real estate industry remain in the headlines. However, many of our commercial/industrial customers selling nationally and internationally have not experienced a downturn. Columbia River Bank also has a significant amount of its loan portfolio in agriculture, which is enjoying high commodity prices and revenues. Finally, our income stream is not entirely dependent on net interest income. It also comes from our mortgage team, which is experiencing large volumes in this active refinancing environment and from our financial services team. In short, we are staying the course of being well-diversified and externally focused.
Q. What, in your opinion, is the overall effect of these lowered rates on the economy?
Anderson: The current low interest rate environment is helping business and individual borrowers alike. It can also be devastating to fixed-income households that depend on low-risk investments such as savings and certificates. Low interest rates may very well lead to inflation in the future.
Farnsworth: The lowered rates are intended to increase economic activity by lowering overall costs of funds for market participants. In my opinion, the offset, and wildcard, is inflation, as short-term rates would need to be increased to hold inflation at manageable levels. We’ll see this in the price of gas, food, travel and everyday consumer items.
Simply stated, what comes down must go up. Currently, we’re seeing everyone trying to call rock bottom. We won’t know when that is until things start to turn up. Until then, we are continuing to invest in our people. Umpqua has a great management team in place that continues to recognize situations early on; making sure that the company is positioned for further success.
Freeman: Lower rates will undoubtedly help businesses, builders and consumers with respect to the interest costs that they service. Lower rates likely helped liquidity in the credit markets. But, the oversupply of housing will not be solved as much by lower rates as by time and a growing economy that creates jobs and income for housing.
Newton: While it doesn’t do savers any good with lower returns on their money, it does benefit borrowers who are the engine that generate economic growth. In time, we all benefit from a more robust economy.
Snyder: It gives a short-term boost, but the best results come from stabilized interest rates; then, there is not so much "swing" in the market place.
Stednitz Lower rates should help stimulate the economy by freeing up funds for both business and consumers. Until the credit markets settle, however, credit will likely remain tight, counteracting the normal effect of lower rates. Once the markets stabilize, I think you will see these lower rates take hold and encourage business and consumer activity. The Fed, however, will need to be diligent in watching for signs of a recovery because, if they fall behind in increasing rates as the recovery takes hold, inflation could be a real concern.
Van Hemelryck: The interest rate decreases have had the effect of relieving debt burdens and, for business this means retention of critical working capital. Especially in the real estate industry, working capital equates to staying power to weather the correction. Provided access to funds and consumer confidence exists, it also makes it easier to borrow. That said, consumer confidence and business spending has fallen, credit availability has tightened in the wake of the housing downturn and lower rates alone are not spurring economic expansion. The lackluster sales in the automobile industry is a good example. Even with many zero interest rate offerings, consumers won’t buy if they are concerned about keeping their job or cannot afford gasoline.
Q. How would you suggest the Federal Reserve address these issues in coming months?
Anderson: As inflation presents itself, the FED will be forced to increase short- term interest rates. The FED will have to walk a fine line between stimulating the economy and controlling inflation.
Farnsworth: I wouldn’t suggest that the Federal Reserve do anything different than they are doing now, noting their goal here is to revive economic activity and/or create a "soft landing". In my opinion, I expect they'll be increasing the federal funds rate over the coming year to head off inflation.
Freeman: I don’t have the perspective of the Federal Reserve regarding the data, but further lowering of rates will likely fuel inflationary concerns and lead to an increase sooner rather than later.
Newton: The Fed has taken historic measures to help stabilize and reinvigorate the economy as well as rebuild trust in the financial system. The true impact of the Fed’s efforts has not fully unfolded and will be felt in the coming months. The immediate need is to help relieve pressure on people struggling with their mortgages through fiscal programs as well as assist first-time home buyers. To own a home is the American dream and a cornerstone to the health of our NW economy.
Snyder: Stabilize interest rates and the banks that have loan loss issues need to address them, reserve accordingly and do not look to the government for assistance.
Stednitz: The Fed is working hard to ensure liquidity remains available in the market place. They should continue in this mode until we see indications of a recovery, at which point they will need to tighten in order to avoid significant inflation.
Van Hemelryck: Another rate cut is likely, but the Fed has already acted extensively, including its bailout of Bear Stearns. Inflation is rising and they have almost exhausted the monetary policy option. In any event, it is generally believed that in the long run, monetary policy does not affect economic output. Our economy lives and dies on confidence and the Fed cannot restore it on its own. As an example, there is a great deal of capital sitting on the sidelines in this country, including here in Central Oregon. Buying opportunities are plentiful and it will be very helpful when it gets put to work. When a few of the major players become active, a very positive snowball effect is likely.