How Profitable Are Commercial Bank Loans?
Interest Rate and commercial loan demand forecast
Phill Rowley was once quoted in the newspaper as saying “Interest rates will go up, down or stay the same”. It was from an interview he had given and that is all the reporter wrote. He wanted to simplify it but the uncertainties in future interest rate moves have filled text books.
We all know interest rates move; we don’t when and how much. Eventually US rates will start rising too. Forbes writer Bill Conerly is now predicting that profitability of commercial loans at banks will improve this year. He expects interest rates to rise and that will improve the spreads, boosting the bank earnings on commercial loans. Expansion of the US economy will eventually prompt the Federal Reserve to raise short-term interest rates.
The very low prime rate has certainly stimulated the demand for commercial loans. However, with the prime rate so low, there was not much room for banks to make money on loans. Banks have had to rely on banking service fees to maintain profit levels. Banks are also cautious about offering high interest deposit products. The major commercial banks have experienced a slow drop in Net Interest Margins between 2011 and 2014, from an average 3.0% in 2011Q1 to around 2.5% in 2015Q4. Over the last three or four years, the net interest margin has dropped from around 3.5% in 2011 to just under 3.3% in 2013. It has finally leveled off and risen fractionally over the last year.
The New York Times reported two years ago that improvements in the industrial economy have led to a surge in demand for commercial loans. However, the spurt in business lending came with warnings. The concern was (and still is) that the banks are making business loans at interest rates that are so low, that the loans may end up not being profitable. At that time a Federal Reserve survey showed that banks are charging an average of just 2.83% on commercial and industrial loans. That interest rate was more than half-percent lower than the year before.
Last year, predictions were that the prime rate would begin to increase in the middle of this year. However, the Federal Reserve continues to hedge about the timing of any change.
The Hurdle Group offers expert loan pricing models for commercial loans. Please contact us for more information.