Interest rates were at record lows for a long time in a bid to stimulate a sluggish economy. Now that the economy is improving and rates are headed up, what is the economic impact?
T.E. “Gene” Walker, chairman of the board of the Mississippi Bankers Association and CEO of the Bank of Forest said the increase in rates for short-term interest rates has affected business loan demand.
“But real estate lending has not been affected at all,” Walker said. “We’ve seen very little slow-down because of the change in the Fed’s policy on residential housing rates. There’s been a flattening of the yield curve as short-term rates have risen, but long-term rates have remained stable.”
The drop in rates to the lowest levels in 40 years benefited borrowers and helped spur economic growth, said Zach Wasson, executive vice president and chief financial officer for Trustmark in Jackson.
“More people were able to participate in the American dream of home ownership, and existing home owners were able to refinance their mortgage at more attractive rates to get a lower mortgage monthly payment,” Wasson said. “With the money saved on the mortgage payment, many of them made additional purchases, which helped the economy to grow. Once economic growth picked up, interest rates began to increase.”
Lower rates benefited borrowers and penalized savers, Wasson said. Conversely, when rates rise, savers often benefit with higher savings rates, while borrowers pay more interest on their loans.
“The bottom line is that the economy is healthier and growing, a case where everyone should fare better,” Wasson said.
Interest rates were decreased after economic growth in the U.S. slowed considerably from 2001-2003.
“Real GDP declined from 4.7% in the fourth quarter of 1999 to 2.2% in 2000 to 0.2% in 2001,” Wasson said. “In an effort to stimulate economic growth, the Federal Reserve lowered interest rates. During the fourth quarter of 2000, the prime rate was 9.5%. One year later, the prime rate averaged approximately 5%. In June 2003, the prime rate fell to 4% and stayed there 11 months. Beginning in June 2004, interest rates began increasing and today the prime stands at 5.25%.”
Changes in interest rates may not impact bank profitability as much now as in the past. Wasson said banks today have more sophisticated asset-liability management systems and are better able to manage the interest earned from borrowers and the interest paid to savers, through interest rate cycles.
“To a great extent, the increase in cost paid to our savers is offset by the increase in cost paid to us by our borrowers,” Wasson said. “The impact to banks is somewhat balanced between increasing cost and increasing income.”
Most observers expect interest rates to continue upward as economic growth continues. Wasson said that this shouldn’t be a big concern because rates are still relatively low and very attractive to borrowers. Savings rates are expected to rise in the coming months as are loan rates, but only time will tell just how much.
Mississippi Banking Commissioner John S. Allison expects the Federal Reserve to bump up the prime rate another quarter point at their next meeting.
“The Fed may go up another quarter point after that, and then see where things are going,” Allison said. “That is the gist I’m getting now. Even with that, rates are still low historically compared to the average 10 to 15 years ago.”
Consumers who could be hurt by the increasing interest rates are those with variable home mortgage loans. Allison said people who got these types of loans when rates were at historic lows should have known the only way for the rate to go was up.
“Hopefully consumers took into account that they would have to pay a little more in a few years,” Allison said.
On the side of business loans, most businesses will pass along higher costs for financing.
“The price of goods could possibly start back up again,” Allison said. “That is probably the downside. By raising rates, the Fed hopes to control inflation factors, which is a good thing, too, so inflation won’t go rampant. The main tool the Fed has in controlling the economy is the movement of this rate.”
Hancock Bank vice president an asset liability manager Paul Queyrouze said their current forecast is for the upswing in rates to continue through 2005.
“We believe that the Federal Open Market Committee will continue its measured pace by adjusting in 25-basis-point increments, or 1/4 of a percentage point, at least three, and no more than five, times this year,” Queyrouze said.
Queyrouze said that while the consumer will realize some increase in the cost of borrowing, there are two important factors that will mitigate this: First, while the shorter-term rates that are used as the basis for variable rate credit instruments are expected to rise steadily, the longer-term rates structure has been holding a relatively stable position. This is what is known as a flattening of the yield curve. A record number of consumers capitalized on historically low equity rates to refinance their debt. They will continue to enjoy the benefit as long as they don’t run up excessively high debt on their remaining available credit facilities, such things as credit cards, that are variable rate in structure.
Secondly, the flattening of the yield curve will still provide ample opportunity for consumers to take advantage of relatively cheap financing throughout this year.
“Remember, we are increasing from historically low interest rates,” Queyrouze said.
Gregg Cowsert, vice chairman and chief lending officer for BancorpSouth, said the impact of rising rates on banks can depend on whether they are asset or liability sensitive during this time of increasing rates. He said rising rates will have more of a negative impact on liability sensitive banks, and will have a more positive impact on earnings for asset sensitive banks.
“That mix is really key to the impact of rising or declining rates,” Cowsert said.
Despite higher rates, Cowsert said they are seeing steadily increasing loan demand.
“It is not as brisk as we would like it to be, but it is improving,” Cowsert said. “Our loan growth is looking good starting the year off. BancorpSouth is in six states, and we have a lot of good markets in all of those states that have strong and improving economies. In addition to Tupelo, other areas doing particularly well include Nashville, Birmingham, Little Rock, Memphis, the Mississippi Gulf Coast, Shreveport and Baton Rouge. Those are all really good sized markets for us that have good strong economies. We look forward to positive growth opportunities in loans in those areas because of the strong economies they have.”
One impact of the increasing interest rate environment is that banks will need to work harder to earn the business of consumers, said T. Chad Cargile, senior vice president and consumer banking manager for AmSouth in Jackson.
“Banks will need to make every effort to proactively reach customers and sit down with them to map out a financial strategy for long-term financial success,” Cargile said. “It is important for us to educate our clients and give them short-term and long-term strategies or options that can help them save money on the credit side while earning more on their deposits and investments. Obviously, rising interest rates mean higher yields on your CDs, savings and Money Markets.
“There are some very attractive money market rates in the market that are paying yields comparable to one-, two- and even three-year CDs. On the loan side, the cost of credit will rise, but compared to history, we are still in a low interest rate environment, which is attractive to customers.”
Contact MBJ contributing writer Becky Gillette at email@example.com.