Banks today are navigating cautiously through a difficult pandemic economy that has left them flush with cash yet they have fewer profitable options to put the money to work and boost earnings power.
Stockpiles of cash normally create opportunities to extend more loans to consumers and businesses, which in turn would strengthen earnings. That's not happening.
Instead, banks are operating in a lopsided landscape. Earning assets are not earning, lending activity has stagnated and returns on securities investments are depressed. Net interest income and margins continue to drop.
Every quarter since the pandemic began, Arkansas bankers have bemoaned the excess liquidity that has flooded the market.
[LIQUIDITY: Interactive bar chart not appearing above? Click here » arkansasonline.com/95liquidity/]
"This is a unique situation where there is a glut of deposits that keep coming in and at the same time there are fewer loans going out," said Arkansas State Bank Commissioner Susannah Marshall. "Banks of all sizes are facing the same problem and it's a nationwide issue across the entire industry."
When the pandemic began ransacking the economy in March 2020, businesses and builders pulled back on projects and consumers conserved cash even as some $5.3 trillion in federal economic stimulus payments were rolled out to Americans to boost consumer spending and help small businesses survive the pandemic.
In Arkansas, pandemic-related stimulus payments are estimated at $28.3 billion, including $7.9 billion in stimulus checks sent directly to Arkansans, $2.8 billion in unemployment relief and $6.7 billion in small business support through initiatives like the Paycheck Protection Program.
Much of that money has turned up in the banking system as deposits. Businesses and consumers are holding on to their cash while the pandemic lingers and has spiked with the delta variant.
PPP borrowers have been holding their loans in the bank -- further increasing the deposit bloat -- until they're certain to get approved for forgiveness, according to Jay Brogdon, chief financial officer at Simmons First National Bank. Individuals are doing the same with stimulus checks.
"The double-whammy is we have individuals and businesses just sitting on the [stimulus] money they received and that money is sitting in our bank as a deposit," Brogdon said. "They're not using that money to reinvest in their business or to buy a new car, and that's diminishing loan demand and increasing liquidity in the system."
On the flip side, companies and individuals began paying down or paying off their loans as borrowing stopped.
"The biggest impact on banks has been the significant increase of deposits," said Matt Olney, a Stephens Inc. analyst who tracks banks in the Southwest Region, which includes Arkansas. "And there is much less lending activity than there has been in the past. If everybody has cash, then nobody needs to borrow."
FitchRatings reported this month that U.S. bank deposits grew by $3.6 trillion, or 26%, from March 31, 2020, to May 31 of this year. That is about nine times higher than loan growth of 3% over the same period.
Fitch reports that loan-to-deposit ratios are at a record low of 59%, well below the 20-year average of 81%.
Also this month, Olney issued a report on the regional banks that noted "liquidity deployment remains the wildcard" in influencing future earnings.
As a percentage of earning assets, liquidity has increased substantially since the pandemic began for Arkansas' three public banks: Bank OZK of Little Rock, Home BancShares of Conway and Simmons First National Corp. of Pine Bluff.
At OZK, Arkansas' largest bank, excess liquidity was up from 3% in December 2019 to 8% as of June 30 this year. Home BancShares had excess liquidity levels of 2% at year-end 2019 and 16 percent at the end of June 2021. Simmons reported excess liquidity of 5% in December 2019 and 13% as of June 30.
Generally, banks prefer to have liquidity in the 3% range.
The region as a whole -- the 31 public banks Stephens follows -- had excess liquidity of 3% in December 2019 and 10% at the end of this year's second quarter.
Over the same period, lending activity has fallen sharply for the most part except at Bank OZK, which reports total loans increased from $17.5 billion in December 2019 to $18.3 billion as of June 30. However, this year loans are down by $937 million at the Little Rock bank. Total deposits are up $2.2 billion over the 18-month period.
Home BancShares reports loans are down by $1.7 billion from June 2020 to the end of June this year. Meanwhile, deposits ballooned by 23% -- without the bank taking any steps to encourage more deposits from consumers and businesses. "The money just keeps rolling in," Chief Financial Officer Brian Davis said.
Simmons has seen loans drop from $14.4 billion at year-end 2019 to $11.4 billion as of June 30. Deposits have increased 13.6% over the same period, leaping from $16.1 billion in December 2019 to $18.3 billion as of June 30.
Bankers note that lending today is highly competitive and there is some demand out there -- but customers are looking to lock in for longer terms and at lower rates, both of which would depress earnings even more if pursued vigorously.
"We can get loans in here if we need them but there is a lot of competition out there because of the liquidity issue," said Davis of Home BancShares. "People are doing long-term loans at really low rates, and we're just not going to do that. We're not interested in locking in for 10 years at 3% on a loan."
Generally, commercial loans have fixed market rates with terms of three to five years. Businesses that are seeking loans today are not shy about shopping around, knowing they can probably get longer terms and lower rates.
"It's a very competitive environment for loans and everybody is fighting for the same loan dollars right now," said Tim Hicks, chief credit and administrative officer at OZK.
Generations Bank, a community bank with $659 million in assets, is finding inventive approaches to attract borrowers while maintaining its underwriting standards.
"We're having to be a bit more unique in how we structure our loan pricing," said Jon Harrell, chief executive officer and chairman of the bank. "We need to grow our loans and a lot of that today is coming up with some pricing options for customers."
The Rogers bank is extending loan terms out for seven to 10 years as opposed to the more traditional three to five year loan terms. Generations also is more flexible on interest rates. "The combination of those two grab the attention of customers," Harrell said.
"Assuming the credit quality is there for borrowers, there's stiff competition and you're seeing rates and terms you probably wouldn't have seen a year or 24 months ago," he added.
Another complication for banks is the near-zero-interest environment they are working around. The Federal Reserve reduced interest rates by 1.5% as the pandemic began, a move that cuts into banks' ability to increase interest earnings.
The rate cut also reduced the yields banks can earn on securities investments, which would normally be a safe harbor to dock excess cash and produce a healthy return.
Typically those types of investments -- money market funds, bonds, treasuries -- require investors to lock in for three to five years. Banks today are reluctant to do that because when the economy pivots and improves, interest rates likely will rise and they lose the ability to produce greater returns on those investments.
"In today's environment, banks are restrained in their ability to reinvest [deposit] monies, and that's another factor leading to excess liquidity in the market," said Garland Binns, a Little Rock attorney who works with bankers across the state.
Despite low yields, Arkansas bankers are pouring more money into securities investments.
From the end of the first quarter of this year to the end of the second quarter, Simmons invested $2.5 billion in its securities portfolio. That was a 46% jump quarter-over-quarter, the largest in increase in the southwest region, according to research from Stephens Inc. The median increase was 9%.
Home BancShares' securities portfolio increased 20% to $3.1 billion while OZK had a 13% rise to $4.7 billion.
Lately, interest on traditional securities banks invest in has been low -- in the 0.1% range.
Banks are searching for better yields through short-term investments. Hicks says OZK has doubled the 0.1% return. "That's not great but we didn't want to go long in the bonds we were buying," he said. "But it did allow us to double our money, so to speak."
Simmons made similar moves in the second quarter, moving about $1.1 billion in cash into variable-rate securities, according to Ed Bilek, director of investor relations. From the first quarter to the second quarter, the duration of the bank's securities portfolio was shortened to 4.9 years from 6.5 years.
At Generations Bank, Harrell said the company has been buying debentures issued by other community banks that are raising capital to grow. Those securities are packaged for sale and return interest ranging from 3.5% to 4.5%. "That's another way we've been able to deploy some of the liquidity we have," Harrell added.
In the end, the ripple effect of excess liquidity created by surging deposits, shrinking loans and lower yields on investments is squeezing profitability.
Of the three larger Arkansas banks, only OZK has reported improvements in net interest income and margins over the past year. Net interest income was a record $240.7 million as of June 30, up 11.2% from the second quarter of 2020. Margins increased to 3.95% from 3.74%, year-over-year for the second quarter.
At Home BancShares, net interest income fell to $141.3 million as of June 30 from $148.7 million last year. Margins dropped to 3.61% from 4.11%.
Likewise, Simmons reported decreases it says were driven by excess liquidity. Net interest income fell to $151.1 million in the second quarter from $166 million over the same period a year ago. Net interest margin dropped to 2.89% from 3.42%.
For the most part, Arkansas bankers are willing to wait out the topsy-turvy environment, confident the situation will calm and consumers and businesses will return for loans when the pandemic eases.
A surplus of cash will be a tremendous asset when that happens. "In our industry, the banking industry, capital and liquidity are not bad things," says Brogdon, the Simmons CFO. "Those are good things.
"We're going to make a really good return on investing that liquidity over time," he adds. "We're going to be patient in doing that. This is all about doing the right thing over the long term."