Who’s swimming naked on prime rates?
“Like a wise man once said, when the tide goes out, you see who is swimming naked.”
We now have the elections behind us. I hope we will see a slowdown in some of the radical ideas coming out of Washington that have and will affect our banks — and more importantly our customers. There is enough risk in our banks with higher interest rates, higher energy costs, a war in Europe and supply chain issues, without adding political risk to our banks. The good news is, as I travel the state, I continue to hear from bankers about how clean all of our balance sheets are today. That positions us to better handle these unknowns and risks, but I want to caution bankers about being complacent. Rising rates may help our net interest margins, but they may be creating some credit problems we all need to monitor.
Today, as I write this article, we have a prime rate of 7.0%. The last time we saw prime rate at 7.0% was January 2008 when it dropped from 7.25% to 6.50%. You all may remember how tough banking was in 2008. This past spring, we had prime rate at 3.50%. It was raised to 4.0% on May 4. It was raised again on June 15 to 4.75%. On July 27, prime rose to 5.50% and on September 21 it rose to 6.25%. The last increase came on November 2 when it rose to 7.0%.
If you made a real estate loan on April 1, 2022, for $100,000 at floating prime rate on a 20-year amortization, the monthly payment would have been around $580. I have learned that many bankers are not adjusting these payments as rates have risen. If you have not adjusted the monthly payment on this loan, then you now have a negatively amortizing loan today. If your bank is adjusting your payments to maintain the original amortization, the monthly payment on this hypothetical loan will now have gone up to about $775.
The concern is what that is doing to the borrower. Let’s say this loan was approved because the monthly payment of $580 represented a debt coverage ratio of 1.35 based on the customer’s capacity to repay. Meaning that the customer showed debt service capability of $783 with a payment of $580 for a coverage of 1.35 times. Assuming his debt service capability has not increase since April 1, 2022, or the last six months, the loan now has a debt coverage ratio of 1.01X.
It has been great hearing from bankers about their past due ratios being low and classified assets to capital being ratios in the single digits; but as bankers, we need to be diligent in this rising rate environment and not disguising problem loans simply because we are not adjusting debt service requirements in line with the rising rate environment. If your bank is asset rate sensitive, you are enjoying better spreads and profitability. But if you peel back the onion, you could have loan problems developing. Like a wise man once said, when the tide goes out, you see who is swimming naked.
I want to finish this article by complimenting the bankers of Texas. Us bankers believe capitalism works and that markets will go up over time. Our economy is a dynamic marketplace and, regardless of the conditions, there are always opportunities out there. Bankers are the ones who make those opportunities become reality.
The thing I have enjoyed the most about being your Chairman this year has been meeting with bankers and seeing the great things they do for the communities they serve. Yes we lend money, but it is so much more than that.
I compliment Chad Stary, president and CEO of the First State Bank of Uvalde, for his leadership in his community these past six months, as well as the bankers across our great state who joined him in providing funds to the community as it tries to heal from the tragedy last May. Thank you for what you do Texas bankers.