Garnet Capital Advisors Blog

September 28, 2015

Low Interest Rates: The Good and the Bad for Banking Industry

As the Fed continues to keep a lid on rates, banks are in the position to cut costs and come up with other money-making opportunities.

In the wake of the Federal Reserve's latest decision to delay increasing interest rates, a growing number of economists and analysts are contemplating what might happen if rates remain too low for too long.

Ultra-low interest rates continue to squeeze bank profits. While borrowers may have benefited from these low rates, lenders are losing out. Net interest margin - which tracks how much banks profit when they borrow from depositors, then lend these funds - has dropped since the economic crisis in 2008.

And while regulations have somewhat eased, the regulatory overhaul that banks experienced following the 2008 debacle is still a nuisance and has contributed to banks' growing dependence on lending income. The longer the Fed keeps interest rates at these levels, the more it will harm the banks' bottom line.

Many banks have been forced to replace their higher-yielding loans and securities that were acquired prior to the crisis as they mature. But the replacements often come in the form of assets that carry much lower rates.

With today's low interest rate world and a flat yield curve, banks have a much less chance of a healthy net interest rate margin. Banks would need to ensure that all the principal is paid back in full with a small spread in the interest in order to reap any rewards. Even less than 10 percent not paid back on a loan could send banks in a downward spiral. Careful analysis of every loan type is a necessary practice in order for banks to remain stable.

Banks are being forced therefore, to come up with new and creative ways to make money by changing the services they offer and re-evaluating their loan portfolios.

Tapping Into the Auto Loan Business

One of the ways some banks are offsetting heightened regulations and lower interest rates is by boosting auto lending practices.

Banks like Santander Consumer USA Holdings and Ally Financial have already tapped into this loan channel, and are playing hard-ball when it comes to going after borrowers - including those with flawed credit.

Dallas-based Santander sees a direct relationship between higher provisions and bigger profits in the subprime auto lending business. As a result, the company's 2015 second quarter profits increased by 16 percent to $285.5 million. Gains on investments spiked significantly to $86.6 million.

Much of these gains came from the sale of prime loans in securitizations. Over one-third of the bank's $7.6 billion in originations came from its financing relationship with Chrysler.

Taking on riskier loans can translate into heightened profits. Of course, such assets need to be held with a great deal of scrutiny.

Jumping on the RV Loans Trend

A unique opportunity for lenders over the recent past is the rising trend in RV purchases being financed. As baby boomers continue to retire in massive numbers, many of them are seeking new opportunities to spend their new-found free time by taking to the open road in a recreational vehicle.

RV loans have presented themselves as a unique opportunity to expand their loan portfolios.

With this rise in interest in RVs, many retirees are looking to financing options to fund this rather large purchase - and lenders are taking notice. RV loans can be fantastic consumer loan products considering their high performance and low risk.

RV loan volumes skyrocketed more $5 billion in 2014 according to a survey from the Recreation Vehicle Industry Association. In addition, loan delinquency rates are low at a mere 1.14 percent.

RV loans usually come with a quick approval process, and there are no appraisals or closing costs associated with RV loans for those who plan on living in these vehicles for the most part.

Finding Opportunities With Digital Lending

It's impossible to ignore the significant impact that online lenders have made in the world of lending. Rather than turning a blind eye, savvy bankers have not only taken notice, they've also taken steps to partner up with these fintech sources. New lending firms are putting tons of pressure on conventional financial institutions to step up their game and try new things that they previously wouldn't have even thought about.

These days, banks have a chance to team up with these online financial lenders to help them increase revenues and expand their market.

And while alternative lenders can benefit from referrals from banks for borrowers with less-than-par credit and financial histories, the bank can also receive referral fees from fintech lenders while still keeping the rest of the borrower's banking business.

Banks can loan out to borrowers who meet strict lending requirements, and non-bank lenders can provide loans to consumers that are considered 'non-bankable.' This can be a fabulous opportunity for growth for banks who are otherwise feeling the crunch from a sustained low interest environment.

Diversifying and Growing Banks' Loan Portfolios to Remain Profitable

In the world of lending, the low interest rates of today leave very little room for banks and other conventional lenders to earn a decent profit. But that doesn't mean that banks have to roll over and die. While this sustained low interest environment certainly is putting downward pressure on banks' bottom line, this can be a great opportunity to come up with creative ways to beef up the loan portfolio while looking for ways to cut costs.

Although this might sound like a tall order, it doesn't have to be when enlisting the expertise of a third party that's experienced in the realm of lending and in managing loan portfolios. This is exactly where Garnet Capital comes into the picture.

While we may be in a low interest period, it won't last forever. Not only can Garnet Capital help banks manage their loan portfolios during this extended low interest forecast, we can also prepare banks for the inevitable rise in rates. Contact us today to learn more.