Georgia’s Banking Prospects

Georgia’s banking industry is fundamentally strong, and will get even stronger this year. Improving labor market conditions, the continued growth of gross state product and corporate profits, moderating inflation and steady to slightly stronger equity markets all favor Georgia’s banking industry. Banks that cater to business clients are likely to do better than those targeting individual customers.

This expectation reflects faster growth in demand for commercial and industrial loans, improved credit for commercial customers, more active capital markets, stronger export markets and slightly better performance of equity markets. In contrast, softer conditions in the housing market, less mortgage refinancing and restraint in consumer spending for durables will limit growth opportunities for community banks. Financial institutions will have to cope with slower growth of non-revolving loans to consumers, more instances of identity theft, increased concerns about privacy, persistent overcapacity, a flat yield curve and new regulations to follow.

Georgia’s above-average economic growth rate enhances immediate prospects for banks operating primarily within the state. Bankers should benefit from slightly higher demand for consumer revolving credit and faster growth in corporate lending. Georgia’s banks will continue to benefit from positive demographic trends because the steady influx of new residents increases demand for banking services, props up asset prices and encourages new business formation.

The Federal Reserve will neither raise nor lower key interest rates aggressively in 2007. The flat yield curve will continue to challenge profit margins, which will limit growth in net interest income.

The slow growth of customers’ deposits will continue to compress interest margins. These funds have dropped because rates paid on deposits are extremely low, fees have increased and higher-yield alternatives exist.

In the meantime, to bolster loanable funds, banks must continue to rely on more expensive sources, such as wholesale markets or sales of equities. Slower growth in loans may mean less need for these costly funds, but competition for loans will intensify and may force banks to trim margins even more.

Assuming that damage from the bursting of asset price bubbles elsewhere in the nation is avoided, the growth rate of non-performing loans in Georgia will not rise too dramatically in 2007. It is true that Georgia’s banks have issued many more credit cards and expanded these lines of credit, but improved labor market conditions should keep loan default rates relatively steady. Because the spate of mortgage refinancing helped lower monthly payments, many households can afford to make heftier payments on installment credit.

In 2007, the quality of corporate and business loans outstanding will improve. Lower delinquency rates will stem from sustained profit growth. Non-residential real estate markets are expanding, which bodes well for banks because most short-term lending to businesses is secured by real estate. Decreases in non-performing loans will lead to lower charge-offs and lower set-asides for loan losses; and the reduced reserves to cover these carrying costs will aid banks’ profits.

In 2007, consumers’ disposable personal income will grow faster than spending. One result is little or no increase in non-mortgage consumer credit. Due to higher mortgage rates and lower home appreciation rates, there will be substantially less substitution of mortgages for consumer debt. Statewide activity in originating and refinancing mortgages will lessen, reducing profits.

A number of factors point to increased commercial lending in the coming year. Businesses will borrow appreciably more to buy new equipment and to build new plants, and businesses’ confidence in the economic situation should hold steady.

Due to less economic uncertainty and a slightly firmer commercial real estate market, banks probably will loosen lending conditions, boosting loan growth. Stronger export markets will support more commercial lending. High levels of corporate profits will continue to generate substantial internal funding, but as the rate of increase in corporate profits decelerates sharply, businesses will turn to banks for funds to finance capital spending.

Dr. Jeffrey Humphreys is the director of the Selig Center for Economic Growth at the Terry College of Business at the University of Georgia.