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After a year of turmoil, the banking sector still faces headwinds in 2024. We checked in with community bankers for their take on the state of business and predictions for what’s to come.

Moderator: We are having this discussion in the spring of 2024, a little more than a year since the high-profile failures of a handful of U.S. banks made headlines and unsettled American consumers. Since then, banks have faced a slew of complicated factors like rising interest rates, fallout in the commercial real estate sector and the continuing specter of recession. I’d like to go around the table and have a few of you talk first about one key challenge that you see banks facing right now.

Adrian Brown: It’s around interest margin. Prolonged periods of inverted yield curve always create challenges for banks, and this has been the longest such period in my 20-year career that we’re going through right now. Universal banking practice is taking in deposits of liquid or near liquid maturities and lending them out at longer term maturities. The short end of the curve is higher than the long end. It’s going to create a challenge for banks, that interest margin, which is the largest driver of our earnings, and particularly for community banks that’s the case. Our margin has held up better than most, but we are still certainly facing that challenge due to the inverted yield curve.

Tom Crockett: I would certainly agree with all of those, but one of the things that comes to mind for us is cybersecurity and fraud. The amount of money and time that regional banks are having to invest to protect our customers and the banking system in general is pretty startling.

Felisha Dowdy: The challenges around interest margin and the inverted yield curve we have all experienced. However, one in particular that’s come up repeatedly is a customer will ask about FDIC insurance limits and how they can protect the deposits they have. There are products available for them to use and we have ways to help them maximize their FDIC limits. There’s an insured cash sweep and brokered CDs. There are ways to do that, but I think for the most part, conversations have been around FDIC insurance.

Moderator: I mentioned earlier that we are 13 months post the Silicon Valley failure. Let’s talk about how that has played out since. What have been the ripple effects of that situation?

Phil Poindexter: I think the immediate concern was liquidity in the system and I think that the Fed and the Treasury, the FDIC did a very nice job of ensuring the deposits were safe. I think it calmed the system down, but liquidity for a long period of time in banks was the major concern, and it became very expensive. At the end of the day, Silicon Valley failed and some of the other banks that failed at the same time failed because they were poorly managed. They had runs on the bank. The runs were the symptom, not the cause. The cause was that the balance sheets were mismatched. They were very short-funded and had gone out further in term in the securities portfolios, and that’s still going on in the industry.

Adrian was talking about this margin compression, and when you talk about the challenges in our industry right now, certainly it’s compressing net interest margin. At Stock Yards Bank, net interest margin represents around 72% of our revenue. I would say for most banks on this call, it’s probably that or more. It’s the elephant in the room. The margins have come down as short-term rates increased rapidly. That’s the big challenge of having inflation, trying to combat that and having the inversion in the yield curve as Adrian was saying.

I think at the end of the day, the banks that had failed were poorly managed. I think you saw the initial ones had runs because of this mismatch. I think that the more recent ones — New York Community Bank — that had to do with some concentrations of exposure in downtown office markets, and I think those are isolated cases. I think the strength of the industry is still there.

Andrew Pyles: One thing that we probably didn’t talk about as much prior to all this is your percentage of uninsured deposits and as Phil alluded to, that’s what came back to bite a couple of those banks that went down last year. That’s something that gets talked about a bit more now. I echo a lot of what Phil said. The net interest margin pressure, obviously, because rates have gone up and deposit competition has gone up in that amount of time as well.

That being said, we are seeing in the Louisville market at least, deposit competition in Louisville slow a bit. That’s been a welcome change over the last quarter or so and the FDIC data supports that. It shows that overall bank deposits were up last quarter for the first time in six quarters nationally and so that is a bit of a tailwind that is welcome.

Moderator: What would you say was the peak of when that competition was hottest?

Pyles: Right after the bank failures. The interesting thing at that time, a lot of banks were still growing relatively quickly. Loan demand was still pretty strong at the time, so banks needed to fund new loan opportunities. They were not only trying to obtain funding to fund new loans, but also to play defense on the deposits they already had on the books. It was interesting around that time with a lot of heavy competition, but again, we’ve seen that dissipate over the last couple of quarters.

Moderator: What are the continued effects you are seeing of the inverted yield curve and long-term rates?

Crockett: We’re dealing with the same thing — the interest rate environment and that yield curve. We’re all having to manage through the repricing of our fixed rate loan books. That’s a constant issue for all banks right now and just the demand for regional banks to go out and acquire deposits to fund all their activity remains a key focus for us.

Brown: There’s still some uncertainty about where rates are going to go. I know earlier in the year, I would’ve probably said three rate hikes this year, but I think I’ve changed my tune on that a little bit. I think the Fed was probably a little slow to raise rates in the beginning, but I think right now, pausing to continue to look at the data is the right move. The economy’s still going pretty good. Inflation is still nearly at 4%, which is high, well above the Fed target. Unemployment is still low. There was a recent jobs report that started to show a little bit of softness, but I don’t necessarily see the rate hikes this year. The three that I would’ve predicted earlier in the year — I’d put my over-under about one right now.

Poindexter: The other thing that’s happened — the five-year treasuries have come up a little bit. So the curve is a little less inverted than it was before, and I think that’s maybe the bond market is finally getting the message, higher for longer. I don’t think rates are coming down this year. I think there’s a great deal of service sector inflation right now, and stuff just costs more, and I don’t think it’d be wise. When you look at the futures curve for Fed funds, I think it’s maybe one drop after the election and it was as many as five or six earlier this year. So it’s changed dramatically.

Dowdy: My hopes have been high because the ten- and the five-year treasury bonds have been running pretty close, like Phil said, I think as far as rates go, and as far as pricing, at least what we have seen has been stable the last few months. We have conducted rate shocks with increased rates to see where customers are. I think we’re probably going to remain where we are for the rest of the year.

Crockett: Pinnacle had originally forecasted four rate cuts this year. It’s already been modified down to two, certainly in the fourth quarter, if at all. I think we can all see a scenario where there are no rate cuts this year.

Moderator: I know our audience really has been watching the state of the commercial real estate industry closely and what will happen, especially to downtown office properties with high vacancy rates and possibilities of loan delinquencies. Let’s talk about CRE portfolios. How are they holding up against higher interest rates and vacancy? Is this impacting banks’ willingness to lend?

Brown: We’re seeing that. Asset quality at German American is still holding up well in the commercial real estate segment. Past due loans, credit losses remain low, even historically speaking. Our portfolio, though, hasn’t really seen all the impacts yet of repricing. We’ve had some reprice this year, but we’ve got a lot set to reprice in ‘25 and ‘26. Those that are going to experience some repricing and going to be at higher rates. Fortunately, a lot of those have good sponsors behind them, so if there’s equity that needs to be injected, they can. Some banks have slowed lending in the segment, but we still have plenty of dry powder to lend in that segment.

The real estate economics are just different today than they were several years ago. You know, the old days of the standard 20% down, that isn’t always the case and more than likely right now, that’s not the case.

Prices are higher to build, interest rates are higher, and rental rates have gone up, but they just haven’t kept up with those two things. So it’s hard to get a project done right now with 20% down and have that cash flow make sense for the bank and the borrower. So 30- 35% down on a real estate project is not at all uncommon right now.

Dowdy: We are still lending and the door’s still open. Credits are being analyzed a little closer. We are doing a lot of stress testing to make sure the customer can manage against any adverse activity. We are still lending. That’s not necessarily been an issue for us.

Poindexter: We’re still lending. If you’re consistent with how you do things, you’re probably a little more conservative during the good times, but you’re still lending through the cycles. Certainly, it’s the topic of conversation when we go out and talk to the investment community. They want to know about the commercial real estate portfolio, and I think there has been general tightening. I think larger banks are out of that business right now altogether. We look at the portfolio; it’s holding up really well. We did stress tests for interest rate risk as some of these loans are repricing in a much higher rate environment.

As a whole, the current economic cycle has been a little more disciplined than it was during the financial crisis. I remember before the financial crisis in 2008, I felt like underwriting standards were not as good. I think this has been a more disciplined cycle, a better capitalized cycle in the commercial real estate space. That being said, if you had a large exposure of office space in central business districts it is a problem. You can’t double the interest rates and look at 25- 30% vacancies and have a very good outcome. We’re granular in our exposures and conservative in the percentage of our capital that we’ve lent into this space. We’re diversified into the product types, and we just weren’t a tower lender. That just isn’t who we are, and I doubt anybody on this call is. I think that is going to present some credit challenges in the near term.

Moderator: Do we need to be worried about downtown Louisville and the state of our downtown towers? From the outside looking in, what’s your take on the state of commercial real estate downtown?

Pyles: There’s definite concern about the vacancies downtown and just the broader economic impact on the market as a whole. In terms of the banks that are represented on this call, I doubt any of us had a lot of exposure to downtown office properties. Those tend to be towers and larger credits that are often syndicated. But obviously it is a negative impact on the economy.

Moderator: A few of you on this roundtable have been involved in real estate expansions of your own recently. For example, Eclipse Bank’s new headquarters and Pinnacle’s coming location in St. Matthews. Let’s talk for a minute about the future of brick-and-mortar banking. Why was it important to have a new brick and mortar location in the region?

Pyles: For us, and I think probably a lot of the bankers on the call, brick and mortar remains important. We just believe it serves a different purpose. It’s not that clients need to come in and cash their checks and get cash. That used to be a primary function of the bank. It’s more for consultative purposes now, but it also represents a commitment to the community. It also serves as a billboard, quite honestly. We believe in the branch, obviously. We just put a new one up — a large one — and we think that they remain important, just serving a slightly different purpose. And we don’t need as many of them maybe as 20 years ago were needed in a given market.

Crockett: We believe brick and mortar will always be necessary to some degree and as has been mentioned, from a brand awareness perspective, it’s vitally important. Now, we’re not going to come into Louisville and blanket the city with 25 branches, but we will have certainly more than one. I don’t know what that number’s going to be yet, but we believe it’s important. There are a lot of people out there who still want to visit a branch. They might do it differently than they used to, but there are a lot of people who value that experience.

Poindexter: There is a need from a branding standpoint. There is a need relative to where you put your folks, and if you’re a community bank and you want to provide that kind of service, you’re going to have branch locations. You’re just going to have fewer of them. We look at Indianapolis and Cincinnati as developing markets. We’re continuing to add branches in those markets. We bought a lot in Bardstown, and we’ll probably put a branch there in the next couple years. But in the Greater Louisville area, we’re not going to open any new branches.

Moderator: Let’s continue to look to the future and, of course, artificial intelligence continues to be the buzzword that impacts just about every industry. What are the latest developments for AI in banking?

Brown: I think banks are looking more deeply at AI. You know, banks in general aren’t necessarily cutting- or leading-edge in technology and certainly German American, I wouldn’t put us in that category with the role that we play. But I think there are opportunities there to strengthen physical security solutions, fraud, looking at other cybersecurity tools to try to create efficiencies in workflow. Customer service and efficiency are the couple things that I think of most when I think of AI, and I think banks that are focused on technologies that help their people and more deeply connect with their clients and become more efficient have an opportunity to win and help their business in that space.

Moderator: It does seem like cybersecurity would be an important area where AI could bring some real tools and efficiencies. Tom, you mentioned cybersecurity. Maybe you can elaborate a little bit more on what you’re seeing in that space.

Crockett: We go to great lengths to protect our customers, like everybody on this call does. It is shocking to me how different things are today than they were even five years ago. You have to be very, very conscious of what links you click on in emails and who you’re forwarding emails to because there is someone out there all the time trying to lure you into doing something, sharing some information you shouldn’t be sharing. We do a lot of training on that issue. If you have one large fraud event at your organization, it can be a very, very expensive ordeal. I would say that everybody on this call is spending a lot of time and effort to protect their customers.

Moderator: What other kinds of technology or innovations are you all watching right now?

Pyles: Instant payments are a big topic right now, probably one of the hotter topics. A clear front-runner has not emerged yet. There are a couple of options out there, and I think banks — going back to the fraud and cybersecurity perspective — are leery as well about that. Faster could be scarier, right? And it obviously provides less opportunity to react to a fraudulent situation.

Moderator: When you say “instant payments,” you mean like a Venmo or a CashApp?

Pyles: Venmo, obviously that’s been out for some time, but looking at FedNow, that’s one more for business — instant payment transfers for businesses. Payment rails are a really hot topic right now in banking and Fintech’s trying to innovate in that space. But it brings with it a lot of risk, and so banks are treading cautiously.

Poindexter: I would add that certainly cyberfraud is the scariest thing there is, and all the banks are spending a ton of money on it. But when talking about artificial intelligence, I think people think of artificial intelligence is this new thing that’s in the news recently because of all the ChatGPT. But it’s been around for a long time. There’s a lot of anomaly software that is used, probably at all the banks here, that look at transactions that are anomalies and flag them for fraud. We’re all using that right now as one more layer of security against cyberfraud.

Moderator: We’ve talked a little bit about this, and I feel like there’s still some uncertainty about the economy and where things are headed. We’re in an election year, of course. Let’s go around the horn and talk about what are some of the top concerns you’re hearing from your commercial clients specifically right now.

Dowdy: Some conversations we have been having are coming from what we have discussed. In addition, cybersecurity has been added to the list. With the economy in its current state, customers are concerned with where rates are going to be and where they are headed, as well what it looks like this time next year. Some questions are do we fix our rate, or do we float it? We haven’t really repriced our rates for a good number of our clients. If they do start coming down, we’re going to get inundated with requests to refinance, and we will see what that looks like.

Moderator: So how are you advising folks through that?

Dowdy: It depends on what product we’re looking at. Obviously if we’re looking at a line of credit, we’re going to float the rate. It depends on what the risk tolerance is, what they are willing to do, and what happens when we stress the rate.

Poindexter: For us we are hearing about, obviously, interest rates and just a general economic outlook. I think on the surface things are pretty good right now, even though I think someone mentioned about some of these employment numbers that came out recently that weren’t great, but we are a consumer-driven economy. As long as people have jobs, the economy will be OK, and that’s always going to be their number one concern.

That’s the thing to watch right now: unemployment rate. I think customers are concerned a lot with cybersecurity, and we get those questions all the time. We do a seminar every year about it and so it is top of mind. Tom’s right. When something happens, it is very alarming. We’re going to spend a lot of money on the technology associated with that, and we’re going to educate and talk about it with our customers.

Moderator: I know workforce used to be the thing that everybody was worried about. Has that abated?

Pyles: Definitely. I don’t hear that as a concern anymore so much — a little maybe, but not nearly as much as, say, 2022. We saw that start to calm down substantially last year. We’re still hearing complaints about inflation. Although I think some of that is residual from the effects of the last couple of years, and they’re seeing that sink in now, the collective inflation that’s taken place. I think generally our clients believe that interest rates will come down, but there’s a little concern about the economy. I think in terms of the economy, the bigger concern that I’m hearing from businesses is the unsustainable fiscal path that we’re on nationally, and so I think there’s some concern that the deficits that we’re running right now are masking any negativity or weaknesses in the broader economy. I believe there’s some of that going on right now. I’m wondering if we scale back and get on a more sustainable fiscal path, will that then reveal the true underlying economy, and will it not look the way we think it does today.

Crockett: We touched earlier on the fallout of the regional bank crisis from a year ago and I would just say because of that, our clients, and I think everybody’s clients, are far more well-informed. They’re better informed now than they used to be. They ask a lot of questions around safety and soundness, and they seem to know a lot more about the quality of the institution that they’re doing business with. Maybe it’s because we’re new to the market and a lot of people locally aren’t as aware of Pinnacle Financial as in some of the other markets we’re in, but a lot of people want to make sure they know that we are a sound bank, and we are, thankfully. I’ve just found that our customer base is far better informed today than they’ve ever been.

Brown: Solidly run banks are going to be consistent, and we certainly feel like we’re in that category. We’ve had some customers’ capital investments slow down a little bit, but we’re still having those conversations about things they’re thinking about in the future or opportunities they’re researching and it’s more about just access to capital. Just making sure that when they’re ready to make that move, whether that’s M&A or an investment in their plant, that German American has got the capital to be able to provide when they’re ready. We’ve been involved in several of those conversations.

Moderator: What do you think the banking landscape might look like a year from now?

Dowdy: I’m not really sure what to say about rates. I have to be honest — it is anyone’s guess. As far as rates go on commercial loans and mortgages, we may be close to where we are now. Where I think we may go is with digital technology, connecting not only the bank with the customer such as the mobile apps, and online banking, but it also would be internal with the front end to the back end of the bank. As conservative as we are in this area, I do think, at some point, AI and machine learning will continue to drive innovation and help us with our responsiveness.

Poindexter: This will probably be the hardest year we’ve ever had to predict with the election coming up. My prediction would be that I don’t think interest rates are going to come down this year. I think you might see some normalization in the curve, meaning that the longer-term rates come up some. I just think inflation’s here and it’s going to be here for a while. As far as a recession, it’s funny — I feel like we’ve been predicting a recession for three years right now. And it’s not there on paper. I do share the sentiment that things don’t feel great, but I think that’s inflation. I think inflation is this one thing that no one can talk us out of because most people experience it every day and it doesn’t feel good. I would continue to watch the labor markets. You’re starting to hear about large layoffs in the tech sector. I think the financial services, some of the larger banks are going through some layoffs. Let’s see what goes on with employment because it has been so strong and looks to be softening.

We are a consumer-driven economy — people go out and buy stuff and that’s what drives our economy. If people don’t have jobs, they can’t do that. I don’t want to predict a recession, and anything could happen between now and the election. It is just anyone’s guess.

Pyles: I will be the contrarian here. I think there are too many forces bubbling up below the surface. I do believe that we’re heading toward a slow-down. I mentioned earlier that fiscal spending right now is unsustainable and that I believe is a lot of what’s propping the economy up. If you look at the rest of the world, it’s slow growth and America is kind of the standalone in the world right now in terms of the pace of growth that we’re experiencing. And we’re a standalone in terms of how much deficit spending we’re engaging in. There must come an end to that. The bond market is not going to support infinite deficit spending and so, I think at some point, the government will have to slow down that spending level. It may not be in the next 12 months, but I do believe that there’s going to be some slowing in the economy, and I’ll point out that as much as I’d love to believe that there will be a soft landing, history doesn’t really bear that out as well. There’s been maybe one example of that and especially now that the Fed, a few years ago, shifted their rate-setting focus on prior data. In other words, looking at incoming data, which is rear-facing and also using a very blunt instrument, to try to control inflation. It’s hard for me to imagine that looking at rear-facing data will give them the forward-facing insight that they need to cut rates in a timely fashion. My guess is that they wait too long, and it will be a fairly rapid series of decreases.

Crockett: I should probably get out of the prediction business since I’ve been wrong a couple of times in the last year. In my 35 years in banking, it’s the hardest environment to predict. With everything going on in the world — it’s an election year, the rate scenario — I have no prediction. I wish I did, but I don’t.

Brown: I think within our industry we’re going to continue to see some more consolidation over the next year. Some banks are getting short on capital. Some have eliminated dividends, and that gets a shareholder’s attention, that gets the board of director’s attention. Ultimately, it’s the board who decides who remains independent or not or if their bank remains independent or not.

It’s been a challenge to run any business since 2020, banks included. We talked about rising rates; we’ve talked about inflation; supply chain issues, of course, COVID in there. We spoke earlier about labor challenges. And we’re starting to see more and more consolidation in business in general, and I don’t think banks are going to be immune to that.

Moderator: Is there anything that we didn’t talk about today that you think is important for our audience at Business First to understand about trends in the banking industry?

Dowdy: I think what we have to say is that it all comes down to the customer, and the center focus must be the customer in what we do. It is a fine line because we’re in the business to make money; customers are in the business to save money. But with what’s happening and the uncertainty that we have, it’s going to be a very fine line to walk, and the hope is customers and banks the same have the patience needed.

Brown: I appreciate being here with these other community bankers. I think being a community banker is a noble profession. I think we play an important role in the ecosystem within our community. I appreciate the support that the communities give community banks. It really does mean a lot and we tend to be very consistent and so, when things are good, we’re there, when things aren’t so good, we’re there, and I think that’s very important.

Crockett: I would just say that for all of us, the key is how to combine that high-touch, high-feel personalized service with the changes in the technology that we all have to embrace. I think those of us that get that equation right, are going to be the best positioned to succeed.

Pyles: I would say after an active year for banking news last year — the last time we all got together like this it was a much different environment — banking is probably back to being a boring topic, and that’s the way we like it and the way it should be. 

Poindexter: This community is blessed to have a lot of good banks. These are very high-quality banks, well-run banks, and that’s not the case everywhere as you’ve seen over the last couple of years. It is a noble profession. I agree with Adrian. I think what we do is we move around capital and it’s good. We all compete against each other, but that’s a good thing for the community. There’s plenty of business for everybody.