It’s been something of a thrill ride for the banking industry these past few years. A strong economy and low interest rates have driven loan demand, particularly for all kinds of real estate transactions, and banks generally have logged strong earnings. But those fortunes may be shifting. While none are predicting a major turnaround, some anecdotal evidence that loan demand is softening, questions about consumer spending and a potential real estate downturn are all causing concern in the industry. Much of the concern is still hypothesis, a “what if” scenario that may or may not play out. But many bankers say they are already putting some cautionary measures into place, in case what if turns into what is. “As you begin to see a softening, banks tend to tighten underwriting criteria for lending,” said James D. Hicken, president and CEO of Bank of Santa Clarita. “They begin monitoring portfolios more closely and they respond faster if they see deterioration. They stay closer to the customer in terms of monitoring performance. The sooner you realize there’s a problem developing the sooner you can develop options to deal with it.” The most immediate issue is a flattening yield curve that is changing the earnings outlook. Banks typically borrow money at cheaper short term rates and lend it at higher, long term rates with the difference going to the bottom line. But the Fed’s recent rate hikes coupled with strong international demand for financing has meant that short term interest rates are higher than long term rates, squeezing margins for the industry. “Smaller banks have a harder time maintaining their net interest margin,” said Jim Hackbarth, chief credit officer at Mission Valley Bank. “It’s harder to hedge our investments like big banks.” At the same time, banks are paying higher rates on deposits, and they are under pressure to offer lower rates on loans. “There will be added pressure on interest rates by banks seeking additive deposits and customers seeking reduced loan rates, which will put a squeeze on interest margins at all banks,” said Jack Feldman, CEO of First Commerce Bancorp in Encino. Warnings about the inverted yield curve went out over a year ago, and bankers say they were prepared for what developed. Less predictable is just where the economy is going and how severe the slowdown may get. Real estate factor Banks that cater to retail consumers are already seeing a downturn in mortgage lending and, along with it, home equity loans that could ultimately affect other borrowing as well. Real estate loans, everything from home mortgages to home equity loans and commercial loans, have in recent years, represented a lion’s share of bank assets, growing to a record 33.5 percent of the industry’s $9.3 trillion in assets in July, according to data from the Federal Reserve. But even business banks are seeing signs that their business could cool considerably. “Rates have risen significantly in the past two-and a-half years,” said Gary Coleman, regional vice president at American Business Bank. “On the short end, rates have gotten to the point where people might think twice about borrowing.” Coleman said that, for now, based on loans in the bank’s pipeline, the change seems to be a pause rather than a stall. Particularly in the local area, business has been strong enough so that most companies are still willing to assume more debt to take advantage of business opportunities. But further interest rate increases, and even the slowing housing market could change that in the future. If housing prices begin to fall and homeowners have trouble keeping pace with rising adjustable rate mortgages, most agree the trickle down effect will result in a larger economic slowdown affecting banks of all kinds. “We have virtually no retail exposure,” said Hackbarth at Mission Valley. “But when the residential housing market declines, that has a ripple effect into other parts of the economy, materials, supplies and employment.” Bankers also point out that historically at least inverted yield curves have been precursors to recession. The other question for business banks is what to do about loan portfolios that, after years of rising values, are now very heavily weighted in the real estate sector. For now at least, especially in the San Fernando Valley, most say they are not taking any steps to modify those portfolios. Although transaction activity in commercial real estate has fallen off somewhat locally, there are other signs that the sector will remain strong. Commercial vacancy rates in the Valley are tight and demand for space has held up, all indications that the loan portfolios will remain strong as well. At the same time, the independent Valley banks say they have never based their marketing on offering the lowest loan rates or the highest deposit rates, but on the close relationships they foster with their customers. And even those that have focused their efforts on real estate lending have diversified their business in anticipation of a slowdown. “Our concentration was more heavily in real estate,” said Rich Taylor, president and CEO of First Private Bank & Trust in Granada Hills. “But for the last year and half or two years, we’ve been getting into other areas, which has taken the burden away. We have many profit centers that will pick up the pace when another area slows down.”
