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BOOK OF LISTS 2015-2016 Banking & Finance 20 Hartford Business Journal • decemBer 28, 2015 www.HartfordBusiness.com Margin pressures remain By Rick Cantele, President/CEO, Salisbury Bank & Trust, and president of the Connecticut Bankers Association W hile a modest interest rate increase is now in the cards, I don't think it will have much impact on the national or local bank- ing industry. Persistent slow economic growth, coupled with continued pressure on net-interest margins, will again be the theme for 2016, and will challenge banks to improve earnings in any way. I think the best performing banks will be those that can combine efficient management of their operations with a disciplined approach to pricing and loan underwriting. Maintaining this disciplined approach becomes more and more chal- lenging when the economy is not growing, as loan demand decreases and rates remain at historic lows, creating an extremely dif- ficult earnings environment. I believe that history has shown that when banks deviate too much from tried-and-true underwriting standards and compromise too much on rates, bad things tend to happen. Although credit quality has been strong, the economy seems to still be somewhat fragile and it may not take a whole lot of negative news to negatively impact those metrics. On the positive side, banks in Connecticut gen- erally are well managed and well capitalized, and have success- fully navigated this challenging environment for several years. I have no reason to think that will not continue even in the most difficult and uncertain times. As bankers, we spend a lot of time think- ing about what could go wrong, or said dif- ferently, we spend a great deal of time iden- tifying, quantifying and managing various risks that can impact our businesses. Every day, we think about credit risk, cyber risk, operational risk, reputation risk, interest rate risk, etc. As a management team, we can control and mitigate some of these risks; others are beyond our control, which is why the question is so hard to answer. With that in mind, if I had to identify one thing that is beyond all of our control and would impact us negatively it would be the potential for the yield curve to flatten or even invert. Most regional and community banks rely primarily on our net interest mar- gin to generate our revenue. In simple terms, the margin is the differ- ence (expressed as a percentage) between what we earn in interest and what we pay in interest. A typical yield curve has a slope to it with rates on the short end of the curve lower than rates on the longer end of the curve. As bankers we manage our balance sheet to optimize the difference in the curve at the different points in time. There are many variables that impact the Fed's decisions on interest rates, but they continue to indicate a bias towards raising rates (possibly raising the short end of the curve) and yet our economy is experi- encing low inflation and low growth (possi- bly keeping the long end of the curve down). Should this scenario materialize (the Fed decided to raise short-term rates Dec. 16), further downward pressure on bank earnings will occur, making it more diffi- cult for many banks to operate profitability. While difficult to zero in on one event, a flatter or inverted yield curve for a sustained period of time would cre- ate a significantly more difficult operat- ing environment for the majority of the banks in our state. n 2016 BANKING OUTLOOK Interest rates: Time to climb By Nicholas Perna, Economist, Webster Bank T he New Year starts with abnormal- ly low interest rates. Short rates have been near zero since 2008 when the Fed slashed them to combat the Great Recession. Then the Fed start- ed buying Treasury bonds and mortgage- backed securities in order to pull down long-term yields. More than $4 trillion in purchases have helped bring the 10-year note to a little above 2 percent. However, interest rates are starting their inevitable climb (the Fed recently decided to raise short-term rates). While there's no inflation problem now, there could be one down the road if the Fed waits too long. Plus, low rates are dis- torting financial decisions. They pump up stock prices and encourage people to take on too much risk as they "reach for yields." What's ahead? The Wall Street Journal survey of economists sees fed funds rising 200 basis points (100 basis points equal one percentage point) over the next two years and long-term bond yields up about 150 basis points. This is really pretty modest. Inflation is expected to remain low. And the Fed doesn't want to wreck the recov- ery. Plus, most of the world seems to be growing slowly — if at all. Bottom line: Today's 30-year fixed-rate mort- gage of just under 4 percent will be around 5.5 percent two years from now. Bank certificates of deposit will be paying about 200 basis points more. The prime rate will be in the vicinity of 5.25 percent. We can live with these against the backdrop of a stronger economy, with more jobs and incomes and higher house prices. Attention will soon start shifting to when the Fed will shrink that massive portfolio it acquired since 2008. Since downsizing reduces the demand for these securities, the Fed could put some addi- tional pressure on long-term interest rates. My bet is that the Fed will just let it run off gradually as the securities mature to mini- mize uncertainty in the financial markets. There are some risks to forecast: • If Greece exits the Eurozone it will lead to chaos — a real Greek trag- edy. Vultures may start hovering over Portugal and Italy. Greece will never be able to repay its debts so the only question is: Will Europe give up before or after Greece collapses? • Middle East — who knows where this ISIS thing will lead? • What do we do if we have another recession? We're out of ammo. But the Wall Street Journal consensus puts odds of another recession at only 15 percent for the coming year. • Europe — can it avoid deflation? Some are even worried about defla- tion in China. Here's what you shouldn't worry about, at least for the next few years: • Inflation is low and will stay low. • Interest rates are low and will rise slowly, provided that extreme tax cuts or spending increases don't get enacted by Congress after the election. These could explode the budget deficit. n Nicholas Perna Rick Cantele CT firms will be courted By Peter Samson, Senior vice president and commer- cial regional leader, Berkshire Bank T he Hartford region and Connecticut commercial banking in general will continue to be challenged with stiff competition and lower growth. Traditional commercial and industrial companies are performing well having sur- vived the economic downturn and lower growth over the past several years. Invest- ments in capital projects will continue to be on the low side and centered in manufactur- ing efficiencies to reduce labor costs and remain competitive. Sales projec- tions and forecasts for companies without high value- add products and services continue to be difficult to predict, which has added to the less than robust invest - ment in the future. Well-positioned companies will continue to seek strategic acquisitions for add-on growth both in market and out of market. At the same time, Connecticut com- panies will continue to be courted and acquired by out-of-market companies and private equity firms. This and opportunities to move to more attractive states, will put further pressure on the local commercial- banking market as the pool of well-heeled companies shrinks. The underlying economics of investment real estate in the Hartford region, and in Con- necticut in general, remain healthy and both debt and equity are abundantly available. As the Fairfield County, New York and Boston markets have become extremely pricey, there is renewed interest in Hart- ford, and up-state Connecticut in general, from commercial real estate investors. Finally, migration to urban centers is beginning to show with higher demand and upward trending rental rates. Subur- ban markets have seen increased vacan- cies and as leases roll there will be some downward pressure on lease rates and increased concessions. Despite the high competition and lack of robust growth in the Connecticut market, most local and regional banks will continue to show growth in their commercial foot- ings as a result of aggressive commercial real estate lending as well as niche com- mercial-industrial lending both in market and out of market. The regional commercial banking mar- ket has been highly competitive and there once again appears to be a lack of discipline in the market. Terms typically reserved for quality deals have reached down to the lower quality deals. In the commercial real estate market we appear to be at or near the top of the market with a potential for prices to drop if rates finally rise. n Peter Samson