November 5, 2019

Narrowing Margins Leading to Higher Anxiety

EXCERPT: The Federal Reserve's recent cuts to interest rates have narrowed profit margins for banks. This puts them in a position to make some strategic moves when it comes to their loan portfolios to ward off future risk.

Shrinking margins are cause for concern for banks after the Federal Reserve recently slashed rates for the second time in a row.

For the second time in a row, the Federal Reserve has slashed its interest rate, and bankers are concerned that such decisions will narrow their margins and cut into their Q3 and Q4 profits.

Lower Rates Threatens Bank Bottom Lines

Low rates have been a thorn in the side of bank profitability for years, and given the recent shift in the Fed's path for interest rates, this issue doesn’t seem to be ending any time soon. Margins will be an area of focus, particularly for small and midsize banks. In an effort to keep up with adjustable-rate loan changes, financial institutions have been trying to reduce deposit pricing. But they're having trouble doing so fast enough.

The environment is a difficult one that's contributing to shriveling margins. Some bankers anticipate that many banks will see a dip in third-quarter margins and an even more pronounced compression in the fourth quarter.

Banks will also be keeping a watchful eye on loan volumes and performance in order to balance the growing pressure from lower yields amidst concerns over future Fed decisions and credit deterioration. Some credit warnings have arisen over recent months that have been popping up in various banking sectors, including agriculture, energy, health care, and retail. And while some bankers have claimed that such issues are isolated in nature, it remains to be seen if this could be the start of a future trend.

Restaurant Chain Bankruptcies Increasing

There have been a number of restaurant chain bankruptcies and associated loan charge-offs throughout 2019 that have lenders holding such loan assets scrambling to make changes to their loan portfolios. Such a situation could be a prospective signal of credit issues in the retail sector as a whole.

A number of restaurant bankruptcies and associated charge-offs has put lenders holding such loan assets in a position to revamp their loan portfolios to ward off future losses.

More specifically, many banks revealed charge-offs on bad restaurant loans over Q1 and Q2. Consumer spending comprises approximately 70 percent of economic activity in the US, so any blip on this particular landscape can be detrimental for this sector.  

Holding Off a Potential Economic Downturn

While the Federal Reserve's change of pace on interest rates does not necessarily mean that a recession is definitely on the horizon, it is certainly cause for some concern, particularly when recent credit issues have arisen.

A potential economic downturn could exacerbate the issue and impact borrowers' ability to pay bank loans. An increase in credit costs and narrower margins would also be a cause for concern among investors. And even though credit may seem to be somewhat resilient for now, only time will tell if it will become shaky and cause credit issues to become more of a trend than a series of isolated incidents.

Overall economic conditions still seem strong. But it's still important for banks and lenders to take a proactive approach to any potentially serious issues in the near future. In an effort to address the concern of shrinking margins, banks would be wise to buy high-quality, shorter-duration consumer assets, and Garnet Capital has these portfolios available.

And with signs of credit deterioration taking place in various lending sectors, lenders are well-advised to sell these loans right away while optimism is still high. Garnet Capital can help with that as well.

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