Global events like COVID send ripples through the economy which can cause uncertainty on the part of consumers and businesses. With the pandemic creating havoc for normal business operations and occurring just over a decade since the official end of the Great Recession, some economic uncertainty is to be expected.
“I started with the bank 20 years ago and I came into the role of president close to 12 years ago,” said Andrew Ryback, president and CEO, Plumas Bank. “The Great Recession prepared banks well as far as allowing them to diversify portfolios and just be in a better, stronger position to respond to different uncertainties that occur.”
Banks were also in a better position to weather the pandemic-caused, economic crisis because the federal government pumped stimulus monies into the U.S. economy at unprecedented levels, and the Paycheck Protection Program (PPP) helped keep businesses open. For banks, the year 2021 resulted in record earnings and institutional growth. Record low interest rates brought about demand for loans. Low margins were offset by diversified portfolios. All in all, 2021 was a good year for the banking industry.
“Looking back at 2021, we did well as clients did well, and in the end, it resulted in record earnings for us, which was terrific,” said Al Welch, market president Las Vegas, Bank of America. “What we were able to accomplish, given the environment, was managing expenses and generating positive operating leverage, meaning we grew revenue at a faster clip than we grew expenses.”
That doesn’t mean there wasn’t economic uncertainty. Banks were watching inflation levels elevate, labor shortages impact their clients and institutions, housing prices soar and relations between the U.S. and China become increasingly strained. All of which could have sent consumers and businesses into their own versions of lockdown.
City National Bank stayed in close contact with clients throughout the pandemic, helping many of their business clients with the PPP loans. Bruce Ford, Nevada regional banking manager, explains City National is big enough to compete with large banks and small enough to be local. Being local meant being more available during the pandemic. The bank has a thorough automation process but took a personal approach when clients of larger banks couldn’t get through the automation in time to get into round one of PPP. “We took a more personal approach, and we actually generated some new clients because of that,” said Ford.
Banks have been making loans throughout the pandemic. In fact, because of the long-term interest rates environment, commercial real estate loans and mortgage loans are especially popular, because people want to fix their interest rates for an extended period.
“There’s actually been strong loan demand during the pandemic, and we were able to meet that demand,” said Ford. “Deposit growth has been strong and of course banks like to lend out deposits, so we’ve actually been doing a lot more lending. We’ve helped a lot of our clients grow and expand during this time of uncertainty.”
“I think clients, both consumer and business, are taking advantage of the low interest rate environment and are either purchasing new homes or refinancing existing homes,” said Shannon Petersen, EVP, corporate banking manager, Nevada State Bank. “We’ve seen quite a bit in the way of business clients purchasing the buildings they’re leasing. Maybe at the beginning of the pandemic they felt unstable to make decisions, but now they’re comfortable.”
“Lines of credit and Small Business Administration loans have been pretty positive, too,” said Ford. “People have been wanting to expand. At first, we were asking them, ‘Okay, tell us your strategy. Why expand now?’” Most responded that the pandemic and lockdowns gave them time to take a breath. Since they couldn’t run at full speed, they sat back and thought about making changes and finding ways they wanted to grow.
“We’re really seeing strong growth in our auto lending, and also increased growth in credit card balances now,” said Stephanie Cisneros, consumer and business banking market leader, U.S. Bank. “We’ve also had really strong mortgage numbers and that’s based both on the housing market and the appetite for refinancing. Where we’re beginning to see activity is in areas such as commercial lending and commercial real estate.”
Loans, Interest Rates and Margins
Banks did well as their clients did well in 2021. But sometimes the clients did better than the banks, taking advantage of historically low interest rates to lock in long-term rates.
“With rates being near zero, that really impacts our net interest income and simply put, look at interest income, all that really is, is the difference between the cost we pay on deposit and the amount we charge on loans,” said Welch. “So, in these low rate environments, that number is very compressed.” Even so, he said, being able to increase market share and to deepen relationships with existing clients both helped the bank through the uncertain economic year.
“There was a lot of one-time fee income related, primarily, to the zero Payroll Protection Program. As those loans were forgiven, that resulted in recognizing the one-time fee,” said Ryback. “The margins are important to banks, and adversely impact income, but the PPP program provided some pretty unique one-time type income channels for banks, so most banks have done pretty well in 2021.” A banner year for banks and their clients during a pandemic may seem unusual, but unemployment was low at the same time the economy was flooded with an amount of stimulus funds that’s historically unprecedented.
“As a result, we look at the consumer and ask, ‘How are you spending 20 percent more than you did two years ago when times were at record highs, and your savings rate is three times as high just in checking accounts,’” said Welch. There’s a lot of money in the economy and not as much to spend it on with supply chain issues holding up products, the housing market soaring and unemployment low.
Lowering interest rates makes borrowing money cheaper and can encourage consumers and businesses to borrow and spend. Along with the amount of stimulus money in the economy, today’s very low interest rates can also cause inflation as the economy grows. The Federal Reserve uses interest rates to calm inflation and is already expected to raise rates in 2022. Higher interest rates also mean higher margins for banks.
“Expectations of rates have changed in the last few months,” said Ryback. “A few months ago, there was the expectation there were not going to be any great increases in 2022, maybe one at the tail end and the rate increases would be coming in 2023 and beyond. With the persistence of inflationary pressures, we’ve seen that expectation shift and the Federal Reserve is now coalescing around rate increases occurring earlier.”
Ryback expects up to three rate increases in 2022, and probably more going into 2023. “While that signals higher rates, it’s really kind of relative when you think about, we’re coming out of the absolute historical low-rate environment. We’re still talking about federal funds rated 1 percent, which is extremely low rates, so we’ll be in low rates for some time even if it looks like the trend is rates will be moving higher.” Welch expects to see multiple rate increases in 2022 from the Federal Reserve. “Just as we sit here today in early 2022, we’ve seen the 10-year Treasury increase about 25 basis points; it currently stands at approximately 1.7 percent; that’s up 25 basis points over the last two weeks,” said Welch.
While the market would normally react very negatively to the Fed Reserve increasing rates, there’s a fear of inflation that makes the cooling off period not so unwarranted. Even if rates rise, they’re currently so low, banks will continue to operate in a low margin environment for some time to come.
“I think there’s a lot of focus on cooling off the stimulus and returning to some balance going forward,” said Welch.
Don’t Click on That
As more money flows in, there’s a greater increase for cyberattacks and banks are, oftentimes, at the forefront of those issues. There are three primary ways banks deal with the threat of cyberattacks: digital innovation, client education and partnership with other organizations.
“Banks remain the gold standard of cybersecurity, maintaining the highest level of security among critical U.S. industries and the most stringent regulatory requirements,” said Phyllis Gurgevich, president and CEO, Nevada Bankers Association (NBA). “Federal regulators have issued rules telling banks what to do if there is a data breach. Banks must incorporate these rules into their cyber risk management program.” Banks have spent billions building their digital platforms to serve customers from consumer to business to wealth management customers. Now there’s a need to protect those platforms.
“We’ve heightened our verification methods, we layer our data protection controls, and we have internally instituted information protection policies,” said Petersen. Nevada State Bank offers a fraud protection site to provide clients with information and tips for data protection.
“Our information security team works very closely with industry and federal authorities,” said Cisneros. U.S. Bank has fraud monitoring technology in place, constantly looking for suspicious activity. “That’s the highest priority and earning the trust of our customers is our most valuable asset. In the event of a confirmed fraudulent transaction, we work quickly and very closely with our client to resolve the issue as quickly as possible.”
“One of the things that I like that our bank does is train our employees to participate in guarding against cyberattacks,” said Ford. City National also holds cyber seminars to train clients in what they need to watch out for.
“Maybe most important, we work directly with our clients to educate them on the current issues and risks they’re facing, and if they’re corporate, what governance policies are, and individual with what their personal behaviors are,” said Welch.
The basis of what they work on is “don’t click on that”. “We can have the most sophisticated systems in the world, but when there are instances of corporate treasurers being attacked with incredibly sophisticated email schemes [there are going to be challenges],” said Welch. He added that these sophisticated fraudsters, “pretend to be somebody they work with, asking them to move money in a certain way. Unless there’s a governance and discipline policy in place to catch that, the human element is always the last part. Digital and technology can only go so far. Part of [cybersecurity] is talking to our clients and educating them, helping build cultures of looking out for this and catching it before it goes out the door,” he added.
Cybersecurity is about protecting the financial data of huge financial institutions, but it doesn’t happen in a vacuum. It includes every individual and business served by those institutions.
“There are other industries that may not be as secure, but whichever industry gets hit, it can ripple through and have impacts throughout the economy,” said Ryback. It’s important for all industries to be focused on cybersecurity; banks are extremely focused. “Promoting industrywide security awareness is an important aspect in banking.”
“Cyberattacks remain one of the biggest threats to any business, and banks remain one of the biggest targets,” said Gurgevich. “One of the ways banks responded to the impact of COVID was to enhance and accelerate digital offerings, a move that brings new security risks and heightens even further the importance of sharpening cybersecurity.” IBM released their 17th annual report on data breach which shows data breaches reached record highs during the pandemic, with costs averaging $4.24 million per incident.
The banking industry is one of the most highly regulated industries. In the years since the Great Recession, regulations have only become more stringent.
“Of course, my focus is on community banks, and oftentimes proposed legislation is coming from a good place,” said Ryback, who recently stepped down from the Federal Reserve Board’s Community Depository Institutions Advisory Council. “They think there’s a problem and they want to fix it. They sometimes think that every bank is exactly the same and the rule can be applied evenly, but there’s a pretty big difference between institutional sizes and what might make sense for a real large bank that serves the nation might not make sense for a rural bank serving a more limited area.”
“The banking industry is among the most highly regulated industries in the U.S. and banks spend significant amounts of time, money and resources on compliance,” said Gurgevich. “Community banks are the most burdened by excessive regulation. Compliance costs a small community bank about two and a half times that of a larger bank, funds that are being diverted from day-today operations and serving customers. Nevada Bankers Association advocates for regulation that is customized to a bank’s risk and business model. When regulators take into consideration a bank’s size, complexity, risk profile and systemic importance, the result is more meaningful regulation.”
During the fall, one piece of proposed legislation connected to the Build Back Better Bill struck a nerve with bankers and customers, said Ryback. “They were looking for ways to finance [the bill]. They proposed that banks would report to the IRS all financial transactions for their clients. Bankers were not interested in doing that and our clients were really not interested in having their transactions shared with the IRS. That seems to have fallen off the table, but the fact that it was discussed at some length was concerning, so that’s something we’re keeping our eye on.”
Meanwhile, Dodd-Frank Wall Street Reform and Consumer Protection Act, enacted in 2010, is still rolling out legislation. The most recent is 1071, which Ryback said is not dissimilar from the IRS proposal. “The Consumer Financial Protection Bureau is proposing that banks report certain identifying information on small business loans. They’re looking for almost two dozen different identifiers on those loans. Race, gender, ethnicity, other specifics about the loans, interest rate and such.” The information would be published. The stated intent is to look for variations in rates and terms and determine trends. But the bank’s job is to protect client information. “We don’t think they want their information disclosed,” said Ryback. “That’s another one where we’re trying to educate and make legislators understand the issues we see.”
“When a particular financial product becomes overly regulated, banks are forced to contemplate raising rates and fees, offering fewer or less complex products in that space, or exiting that space completely,” said Gurgevich. “That is why the current Consumer Financial Protection Bureau proposed rule for Dodd Frank Section 1071 is so concerning.”
Not only does the rule’s vague language and lack of definitions create unnecessary risk for lenders, said Gurgevich, but the upfront cost to create such a data collection system combined with annual costs to collect and report would be difficult for smaller banks.
“The end result may be fewer loan offerings and higher rates and fees for small businesses and startups. The public reporting of borrower information may also have a chilling effect for borrowers. These unintended consequences could be avoided through reasonable revisions of the rule.”