At This Rate: Financial Institutions Dealing with Higher Interest Rates and Lower Loan Demand

The economy is marked by a “tale of two banking systems,” says analyst Christopher Wolfe.

The managing director of banks for North America at Fitch Ratings, Wolfe said 2023 has been a different experience for institutions such as JPMorgan Chase Bank and Bank of America, which have been relatively unaffected by recent industry turmoil. Chase Bank, for instance, grew as a result of the collapse of First Republic Bank, because it acquired a majority of the failed bank’s assets and some of its liabilities.

For regional banks, this environment has been another story. Much of the upheaval has settled down, Wolfe said, and the industry appears to be returning to a path of normalizing. In light of the Federal Reserve’s efforts to slow down inflation, Wolfe said liquidity is less abundant, and the credit environment is likely to be tighter than it had been. That creates pressure on banks’ bottom lines, he said.

Banks nationally had net income of $79.8 billion in the first quarter of the year, according to the Federal Deposit Insurance Corp. That was up about 16.9% from the fourth quarter of 2022, when the acquisitions of two failed banks are included. Excluding those purchases, the FDIC said, net income would have been flat from the prior quarter.

Looking ahead, Wolfe said he anticipates loan growth will be softer this year than last. That could affect everyone from potential home buyers and sellers to business owners and developers.

“I think you’re going to probably see pockets of weakness on the demand side and the supply side,” Wolfe said, highlighting in particular the office segment of commercial real estate.

The residential mortgage business is another that has been hurting across the country, driven not only by increasing interest rates but also because of dynamics specific to the housing market. As the Greater Milwaukee Association of Realtors has highlighted, construction of single-family houses and condominiums has slowed, and demand for a home to purchase outstrips the available supply.

Meanwhile, bank executives told the Milwaukee Business Journal, people who locked into a lower interest rate are reluctant to sell their homes and take on debt at a higher cost.

Research by the Mortgage Bankers Association found the average production volume per company fell from 16,590 loans and $4.9 billion in 2021 to 8,371 loans and $2.6 billion last year at independent mortgage banks and the mortgage subsidiaries of chartered banks.

The downturn in the mortgage market has resulted in lenders locally and nationally revising their operations. Pewaukee-based Inlanta Mortgage Inc. for instance, sold to a San Diego firm called Guild Mortgage, citing the dampened demand for mortgages.

More recently, Colonial Savings in Fort Worth, Texas, announced in mid-June it would stop originating mortgages. Bank net income depositsexpand Bank net income and deposits

David George, a senior research analyst at Baird who covers U.S. banks, said financial institutions also are in a “food fight” for deposits, and originating new loans is less attractive.

Relative to the past couple years, which George said were characterized by “healthy growth,” loan growth rates are reverting to a more typical level.

“(Banks are) focused on managing the economics of their balance sheet,” George said. “You’re seeing some banks start to de-emphasize lower yielding loans that don’t make economic sense or pricing themselves out of markets that may not meet their return profile or characteristics or risk and reward characteristics.”

The Milwaukee Business Journal spoke with executives from local banks about how they’re navigating this environment. Read on for their perspectives. 

Johnson Financial Group

The credit crunch is real, says Johnson Financial Group CEO Jim Popp, and that makes credit more valuable.

Popp, whose organization owns Johnson Financial Group, said the credit crunch is a function of the Federal Reserve trying to cool the economy and slow inflation. Now, all financial institutions are determining the best uses of their balance sheets under the circumstances, “because we only have so much of it,” Popp said.

The environment has shifted from earlier in the pandemic, when he said deposits were not worth as much and loans were cheap. Now, Popp said, banks’ cost of capital has increased, and financial institutions are paying depositors higher rates as a “fight in the streets right now for deposits” wages on.

From a mortgage perspective, Popp said the pipeline of approvals is strong, but transactions are down. That’s not because people can’t obtain credit, he said, but because they’re unable to find a house to purchase.

On the commercial side, he said some Johnson Financial Group borrowers are taking out less than they might have otherwise, because of the increased cost of capital and uncertainty in the market. That means customers are deciding whether to go ahead and construct a new building or acquire equipment.

On the other hand, Popp said, customers who have hit their borrowing limits at other institutions are turning to Johnson Financial Group. 

“All of a sudden, business is calling us, and you’re getting inbound calls from individuals and companies who want to borrow money, because they’re feeling the crunch where they are today,” Popp said.

By the Numbers

Johnson Financial Group:  (Metrics as of the end of 2022)

Assets: $6.1 billion

Net loans and leases: $4.4 billion

Net income attributable to bank: $57.4 million

Net interest margin: 3.27% 

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