Patrick Ryan is the president and CEO at Hamilton-based First Bank. – FIRST BANK
Community banks have historically been at the forefront of providing much-needed funds to small businesses in times of economic stress. Once again, the economy hangs in the balance. The Federal Reserve has been hiking interest rates systematically to combat rising inflation, which is at its highest mark in 40-plus years. Recession concerns are mounting.
The pendulum of economic priorities has swung from sustaining growth to preventing unsustainable growth, impacting you and your community bank in numerous ways.
Main Street needs our help to move through another period of uncertainty. Like a dependable neighbor, community banks will answer the call.
During the COVID-19 lockdowns, for example, community banks had a greater share in approving Paycheck Protection Program loans to small businesses than their larger, more complex counterparts.
That’s not a surprise.
With our long-term relationships and specialized knowledge of local markets, businesses and customers, community banks made PPP funds quickly available to businesses needing an economic shot in the arm. That was not easy to do, but we made it happen.
And we’ll need to help our customers during economic turmoil once more.
Starting out ahead
Initially, rate hikes are advantageous to community banks. A portion of our assets include floating-rate loans which price daily, weekly or monthly off an index. So, as rates move higher, the index moves higher. So does the interest the borrower needs to pay to the bank.
Furthermore, the loans we’re making today carry higher interest rates than the loans we did last year or the year before. Therefore, we will earn more revenue and interest income on these new loans.
While our liability costs ultimately move higher, there’s a lag. Plus, community banks have non-interest earning deposits that don’t change. We also have some deposits set at low rates that are not automatically repriced.
Over time, as rates grow higher and the competition for the deposits intensifies, community banks move up the rate they pay for the deposits. Still, there’s a window where the bank does better financially as rates increase because the revenue pickup happens immediately. The higher cost of the deposits plays out over time.
Hamilton-based First Bank – FIRST BANK
That all happens during the early stages of a rate-increase cycle.
However, over time, as borrowers pay more for their debt, it can begin to put a strain on the cash flow of the business.
For instance, if a business borrowed a million dollars at 4% interest, they did that knowing how much revenue and income they were projected to take in and how much debt they could afford at that rate. Two years later, that interest rate could be 6% or more.
Suddenly, that puts more stress and pressure on their business. Is the company making the same amount of revenue as it did before? Maybe. Perhaps it’s even higher. But in some situations, revenue is down, and the interest-cost line item has increased.
And if the economy slows down enough, a segment of the borrowing population will not be able to repay their debts because expenses eventually exceed revenue, creating losses and cash flow short falls.
That hurts our customers and us. Community banks need their borrowers to pay them back. Otherwise, delinquencies and charge-offs in our loan portfolio drive our expenses higher.
Higher interest rates also have a dampening effect on economic activity and demand for new loans. This can also hurt community banks because if new loans are not made to replace loans that get paid off, revenue for the bank will decline.
These trends can hurt businesses and banks alike. We are in this struggle together.
What community banks can do
While this type of economic scenario does not provide easy answers, community bankers are here to help business find the right solution for them.
One option includes reducing levels of debt.
That means allocating the dollars that might have been used toward capital expenditures or growth and applying those dollars to pay down debt. That helps de-risk the business, which allows them to weather the storm during a slower economic period.
This is where community banks come in.
Our job as community bankers is to help our customers and local businesses figure out the optimal capital structure and debt levels given the current economic realities.
In other words, we need to be good advisors.
Businesses need guidance on how to strike the right balance. For example, how much debt is the right amount of debt? How do you de-risk your business during economic uncertainty?
Businesses have many questions, just as they did just two years ago. So do bankers. But community banks have the robust financial resources their customers need to steer them through yet another major economic turn and find the right answers together.
Patrick Ryan is the president and CEO at Hamilton-based First Bank.
