Rising rates and roiling markets require a broader risk perspective
By Karen Epper Hoffman
For the past several years, regulatory burden has been top of mind for community bankers. But with interest rates finally taking their first tentative steps upward, some community bank executives turning sharper attention to potential international balance-sheet risks on their lending portfolios, some consultants say.
“Interest rate risk management is a critical concern for banks in this rising rate environment,” offers Mayra Rodríguez Valladares, managing principal at MRV Associates LLC, a capital markets and financial regulatory consulting and training firm in New York.
Indeed, loan demand and the interest rate environment now rank as the top concerns for community bank executives, eclipsing regulatory burdens as a top concern for the first time in five years, according to research released by Cornerstone Advisors in early February. The Scottsdale, Ariz. consultancy’s report, “What’s Going on 2016,” that identifies that changing outlook on risk is based on a survey of 231 executives from community banks and credit unions.
Community Bank Executive Concerns
Interest rate environment
Weak economy/loan demand
Efficiency, expense control
Cost of funds
Source: “What’s Going on 2016” industry survey by Cornerstone Advisors Inc., December 2015.
In fact, close to two-thirds of the survey’s respondents cited loan demand as a top concern for 2016 compared with nearly three-fourths of community banks that responded to a similar survey in 2015. “Bank CEOs feel increased pressure from a heavily competitive lending market,” says Ron Shevlin, research director at Cornerstone Advisors, in a release.
Valladares recommends that community bank executives look for possible risk exposures from considerable economic shifts afoot in both the domestic and global fronts. To begin with, she advises reviewing their borrowers and loan portfolios for “wrong-way risk,” wherein borrowers experience declining revenues and simultaneously start paying more for their loans when they refinance in a rising-rate environment.
Community bank executives should ask more questions about how their commercial borrowers are managing their risks, including interest-rate and market risk, Valladares says. Banks should determine what their clients’ biggest risks are and whether their clients understand and can manage them well, she says. Lending departments should be reviewing their due diligence list at least once a year, staying on top of regulator guidance on interest rate risk. Board members and senior management should also be involved.
In addition, community banks may need to consider improving the process by which they monitor borrowers with floating-rate loans or ones due to be refinanced, with an eye toward making sure that collateral will hold value and could cover losses in the case of a loan default. “Does your bank have a process in place to monitor to quality of that collateral, especially if [the borrower] is putting up machinery or commodities?” she says. “Collateral management is very important in this environment.”
Valladares underscores the importance of paying attention to events outside the United States.
The economic slowdown in China, potential developing recessions in Brazil and Russia and relatively anemic growth in Europe are all “largely affecting exports from the United States, global energy prices and the U.S. equity markets,” she says. These developments are also causing foreign investors to buy more U.S. corporate bonds and treasuries, which could have an even greater long-term impact on domestic banking.
“Community banks really should be monitoring how much foreign investors are buying and have to be a lot more global in their views and knowledge,” Valladares says. “Most community banks know their own local economies so well, but not a lot of them are focused on the outside world. And we are increasingly becoming more interconnected and dependent on other countries.”
Karen Epper Hoffman is a freelance financial writer in Washington state.