Texas Financial Firms: Too Much Liquidity

Texas banks and other lenders are “flush with liquidity” in spite of rising loan demand, according to the latest Beige Book report from the Federal Reserve Bank of Dallas, which came out today.

Competition among banks for loans and a reluctance to relax credit standards to boost lending to small businesses is making it harder for banks generate positive real returns.

“Loan pricing remained competitive, and multiple contacts said they were flush with liquidity and that it was difficult to deploy the excess capital to generate reasonable returns,” says the latest Beige Book report.

The Fed’s Beige Book is an eight-time yearly report based on anecdotal information from interviewed business executives. The Dallas Fed portion of the Beige Book covers Texas, southern New Mexico, and northern Louisiana.

As the economy heats up, banks are boosting lending. The report states, “Loan volumes rose robustly over the past six weeks supported by continued strength in commercial and residential real estate activity. Commercial and industrial loan volumes ticked up, while consumer lending was flat.”

However, mortgage demand has trended lower in recent weeks, weighed down by rising interest rates. According to the Mortgage Bankers Association, mortgage volume nationally last week dropped to its lowest point in 15 months. That could negatively affect banks and credit unions that rely on mortgages as as steady revenue driver.

Even so, the Dallas Fed reports that many financial executives are still positive: “Outlooks were optimistic, with contacts expecting continued declines in non-performing loans, strong loan demand, and increased general business activity six months from now.”

The Beige Book also suggested that ample liquidity is helping to drive up prices in the real estate market, particularly in the market for apartment buildings: “Contacts said that there is a lot of money chasing multifamily deals and pricing on assets is quite aggressive.”

On the other hand, demand for office space remains “weak” and vacancies continue to increase, despite the strengthening economy. Those trends, however, haven’t significant harmed office property values, as cash-flush investors continue to bet on real estate.

The excess of liquidity stems partly from central bank stimulus in the form of low rates and bond-buying, which removes treasuries and mortgage-backed securities from circulation.

Over the past year inflation expectations have risen significantly. The 10-year breakeven rate, a measure of inflation expectations based on the spread between 10-year Treasury bonds and inflation-protected Treasury bonds, has doubled from 1.2% in June 2020 to about 2.4% today.

The rise in inflation is pushing real yields for government securities well into negative territory, making it all the more important for banks to derive higher returns from mortgages and loans.

During the past year, however, corporate demand for bank loans dropped as the economy contracted, and many corporations were able to borrow at lower rates in the corporate bond market, which was also central bank-supported.

In an interview last week, Dallas Federal Reserve President Robert Kaplan conceded that the central bank’s policy of buying $40 billion per month of mortgage-backed securities might be distorting the housing market. “At this stage as opposed to a year ago, these mortgage purchases… might be having some unintended consequences and side effects,” he said.

Other highlights from the Beige Book:

• “Employment expanded at a moderate pace. Lack of labor availability, particularly for low-skilled positions, was a growing concern among firms trying to hire or recall workers, with a majority noting a lack of applicants and generous unemployment benefits as impediments to hiring.”
• “Wages continued to increase, with reports of significant upward pressure in industries having trouble finding and retaining workers. There were multiple reports of considerable wage pressures for mechanics, warehouse employees, construction specialty trades, and truck drivers.”
• “Price pressures intensified further in part due to persistent supply chain issues, and multiple firms noted that this was affecting business growth. Input costs surged, with contacts in the construction, manufacturing, and retail sectors citing the steepest increases.”
• “Refining operations were recovering from the disruption caused by the Colonial pipeline outage, and contacts were increasingly optimistic for strong U.S. fuel demand in the third quarter.”
• “Retail sales grew robustly in April but dipped in May, which contacts attributed to supply chain issues and low inventories. Auto sales expanded as well during the reporting period, though new car supplies were limited by microchip shortages.”

Originally published at https://www.honestaustin.com on June 2, 2021.