Pinch Proof

Tennessee banks mostly miss taking the brunt of the subprime crisis

Amidst fallout from the national housing and mortgage-lending slump, Tennessee banking institutions appear to be holding their own. And although economic ripples from such conditions will continue in 2008, most of the state's institutions seem equipped to weather the storm.

First, it is necessary to note that community banks typically do not offer subprime loans, so for the most part, the subprime mortgage crisis has not directly impacted Tennessee banks. It's the real estate market in general that stands to cause the bulk of the problems.

"Much of what we read about nationally is not happening to the same degree in Tennessee," says Brad Barrett, president of the Tennessee Bankers Association. "There are states that are really suffering from a soft real estate market—where real estate had been overbuilt and there are a lot of problems there now. We're seeing a slowdown in Tennessee but nothing to the degree that we're seeing in a handful of other states."

Tennessee banks are coming off a good year, with many institutions experiencing deposit and loan growth, but that real estate slowdown is expected to continue in 2008, and as it does, banks will feel the pain. Jeff Davis, a banking analyst with FTN Midwest Securities Corp., says the typical Tennessee bank will experience net income declines this year.

"They will likely see net income down between 5% and 10%," Davis says. "Very few banks will have flat earnings in 2008 because all of them are going to have to build loan loss reserves to some degree."

Davis says real estate-related lending for residential building and other construction projects has been a big profit driver for banks over the last few years. But demand for those loans has fallen off precipitously and existing construction-related loans are experiencing asset quality issues. In addition, Davis explains, when the Federal Reserve cuts rates—which it did in December—net interest margins (a ratio that measures how much a bank earns on loans and investments after interest payments to depositors and creditors) actually decline for the typical commercial bank.

"The traditional commercial bank will have a majority of its loans that float with the prime rate, so the yields on those loans are going down," he says. "Until deposit competition lessens sufficiently in a declining rate environment, banks have to lag deposit rates because if they cut too much, they're going to lose deposits."

Although margins will be down for at least the first half of the year, Davis says that at some point, loan demand will have slowed so much that banks will more aggressively cut deposit rates—causing net margins to rise.

"So, there are really three ways that banks generate earnings—loan growth, improving credit quality and improving net interest margins, and all three of those are going against banks right now," he says.

Currently, Memphis is probably feeling the pinch a bit more than other Tennessee markets, as the commercial real estate market there is softer than in Middle and East Tennessee. But the other markets may be catching up. The Nashville market, for example, is anchored by Williamson, Wilson and Rutherford counties, and the Rutherford market, Davis says, has slowed. Again, though, comparatively, Tennessee is in relatively good shape.

"It's still good compared to markets like North Georgia, which will have two, three or four banks go under because they've been living too much off the construction market," he says.

Although Tennessee probably will not see any banks go under, Davis says a few banks on equal footing may merge—but there should not be any outright acquisitions. And competition throughout the state is fierce, as the deposit gathering business—which represents the primary earnings driver for banks—has been tough in the last few years.

"There are too many banks and alternative places for people to put their money," he says. "The financial services industry is highly competitive, and the result of that is the banks have had the rest of the industry nicking away at the heart of their franchise value—core deposits." Tennessee will even see some new bank activity this year. For example, Barrett points out that Metropolitan Bank is set to open in Memphis, and CapStar Bank is opening in Nashville. And while that means competition will only intensify, with tough times and less-than-rosy earnings projections on the horizon, that's a strong indication of confidence in the marketplace.

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