While shrinking net interest margins are squeezing earnings, banks in the state of Iowa are in very good condition, concurred three regulators speaking on a panel presented at the 52nd annual convention of the Community Bankers of Iowa in Okoboji on July 20.
At the end of the first quarter, the net interest margin at Iowa’s 232 banks was 3.10 percent, compared to the national figure of 3.56 percent, reported Jeff Plagge, Iowa Superintendent of Banking. He presented data which shows NIM across the industry bottomed out at the end of Q4 2021 and has been on the rise since then. NIM among Iowa banks, on the other hand, hasn’t risen since Q4 2019, and even then the increase was only 0.01 percent year-over-year.
During Q1 2023, Plagge said 51 percent of the state’s banks saw an increase in NIM, and 49 percent saw a decline. “I would have expected those statistics to be worse,” he said.
In addition to squeezing NIM, rising interest rates are wreaking havoc with bank bond portfolios. As a percentage of tier 1 capital, only four banks in the state saw appreciation in their bond portfolios during the first quarter. Many banks (113) saw portfolio depreciation of 0-19 percent; 76 banks saw depreciation of 20-39 percent, and 33 saw depreciation of 40-59 percent. “This has stopped M&A in its tracks,” Plagge said.
To put bank performance in perspective, Plagge concluded his opening comments with a look at asset quality. Classified loans to total loans at June 30, 2023 was 1.81 percent, he reported. “It’s the lowest it has been in a long time,” Plagge said. “No matter what you see, what you hear, banks remain really solid.”
James LaPierre, Director of the FDIC Kansas City region, also was upbeat on the banking industry. “As a federal bank regulator I know I am supposed to be incredibly pessimistic, but I am actually not. I am pretty optimistic,” he said. “Things are probably a little better than we think.”
LaPierre focused on regulatory compliance for safety and soundness, reporting that more than 95 percent of banks across the country have a CAMELS rating of 1 or 2. “In the Kansas City region, that’s more than 97 percent,” he said. “Those numbers are better than pre-pandemic. These numbers are as good as we have seen in my nearly 18 years in the Kansas City region.”
He also reported solid asset quality. The median Iowa bank’s past-due/nonaccrual rating is 0.46 percent as of March 31, 2023. That compares with 1.21 percent on March 31, 2019. “At 0.46 percent, asset quality is really strong in the state of Iowa,” he said.
When the discussion turned to commercial real estate lending, Plagge and LaPierre said CRE is too broad of a term to be meaningful by itself. “There is a big difference between a three- or four-story office building in the suburbs, and a 34-floor office tower, like the one that houses the FDIC Kansas City regional offices,” LaPierre pointed out.
“We don’t have banks in Iowa that are financing towers,” Plagge said.
LaPierre said CRE loan portfolios need to be segmented to be analyzed in a meaningful way. But even retail real estate is doing pretty well, he said.
“Pre-pandemic, the thought was retail is dead,” LaPierre explained. “Then we had the pandemic and we thought retail was really dead because everyone was buying from Amazon. But in the big six markets in the Kansas City region – Kansas City, St. Louis, Minneapolis, Des Moines, Omaha, Wichita – you can’t find a retail vacancy rate above about 6 percent. It is very nuanced. You have to look at what exactly is in that portfolio.”
Plagge said the real estate lending market today is more favorable than it was decades ago. “Banking 30 years ago, most CRE lending was in banks or insurance companies,” Plagge said. “Today, it is everywhere – venture funds, REITs.” He said that means the quality of the real estate loans in the banking sector represents the better end of the spectrum, given the underwriting and regulatory factors associated with bank loans.
“Second,” Plagge said, “even if it becomes a bigger disaster, the fact that it is everywhere, I think, softens the landing on it. If it is a hard landing, it has an impact on all levels of CRE, but if it is a softer landing some of that valuation pressure doesn’t happen quite so fast.”
Julie Williams, EVP Supervision and Regulation at the Federal Reserve Bank of Chicago, agreed it is necessary to consider the type of real estate when analyzing CRE lending portfolios, but she cautioned banks against building CRE concentrations many times their capital. “I have a bank that is 600 percent concentrated in CRE,” she said. “They are not a big bank. In my mind, there is only so much risk management that can mitigate that kind of concentration.”
The panel discussed the three recent bank failures, and LaPierre urged bankers to consider their sources of contingency funding. “It is important to understand how your contingency funding lines work,” he said. “Actually test them.” He commented that when a large depositor wants their money, it won’t work to assure them they can get it by “5 p.m. the next day.”