Lenders ride out challenges of chaotic ‘20

Analyses find 3 large banks in state now well capitalized

Financial institutions have endured tumultuous economic conditions this year, challenged by a global pandemic that crippled lending along with new federal regulations and lower interest rates that zapped earnings.

Nevertheless, lenders are entering the home stretch of 2020 on a high note with capital available that could be used on stock-repurchase programs or as fuel to ignite merger-and-acquisition activity in the financial sector next year, according to three recent industry reports.

On Tuesday, the Federal Deposit Insurance Corp. released its third-quarter financial analysis of earnings for commercial banks and savings institutions across the nation and praised the industry for pressing through economic difficulties.

“The banking industry exhibited operational resiliency in the third quarter, with improvements in profitability despite continued headwinds and economic uncertainties resulting from the effects of the covid-19 pandemic,” FDIC Chairman Jelena McWilliams said in the agency’s report.

Likewise, analyses released last month by the Federal Reserve and Little Rock investment firm Stephens Inc. also noted that banks will enter 2021 with robust capital levels that can be deployed to drive growth.

Arkansas’ three large public banks — Bank OZK of Little Rock, Home BancShares lnc. of Conway and Simmons First National Corp. of Pine Bluff — seem to be well-situated entering the new year.

Bankers are seeing the “light at the end of the tunnel” and are optimistic that delivery of coronavirus vaccines should boost economic recovery and support “a return to more normal loan demand in 2021,” the Stephens Inc. research team reported after the investment firm’s annual investment conference held Nov. 16-20.

Executives from all three Arkansas banks, along with management from banks

across the Stephens coverage area, participated to give state-of-the-industry updates.

From those meetings, the Stephens team is projecting that stock repurchases and mergers and acquisitions (M&A) should pick up in 2021. Stephens reports banks may be leaning more toward growth through merger activity.

Interest in “buyback activity slowed moderately as companies await more attractive entry reports,” the report said. “Moreover, we’re surprised how quickly company commentary has pivoted towards M&A as the preferred use of excess capital.

“We sense increased M&A optimism for 2021 that could start as early as 1Q (first quarter) and build throughout the year.”

When asked for comment last week, all three Arkansas banks said they are interested in pursuing mergers and acquisitions.

Though banks are wellarmed to capitalize on growth opportunities, there is uncertainty around the lingering coronavirus and the long-term effect on outstanding loans, the Federal Reserve noted.

The pandemic has led banks to offer loan modifications to customers — with heavy participation from the hotel, retail and hospitality sectors — that needed relief to survive the pandemic. Predicting future industry needs and the effect on bank earnings is uncertain with spiking infection rates.

“While economic activity has picked up and economic indicators have shown marked improvement since the second quarter, a high degree of uncertainty persists,” the Fed reported in its third-quarter analysis. “While measures of asset quality are relatively stable, recent loan modification activity may obscure credit quality issues.”

Stephens’ analysts noted they were “encouraged to see the decline in deferrals to what we feel is a manageable level at most institutions,” the report said.

However, Arkansas banks had the highest deferral rates in the 17 banks examined by the Stephens team.

Excluding paycheck protection program loans, Simmons has deferred 8.7% of its loans for a total of $1.1 million. That was the highest level that Stephens found. Home BancShares was right behind with an 8.6% deferral rate for $933,800. The next closest bank was at 6%; the lowest was 0.2%. Bank OZK fell in the middle with deferrals of 2.9%, or $550,000.

Deferrals have declined substantially since a peak in June when Stephens found that aggregate loan deferrals across its coverage area reached 16%.

Below are highlights from Stephens’ reports on the three Arkansas banks along with comments from the institutions on key points.

BANK OZK

The Real Estate Specialties Group (RESG) is OZK’s dominant growth engine, generating 63% of the bank’s loans. Stephens raised concern about elevated paydowns going forward that likely “will serve as a revenue headwind” for the bank.

Loan repayments in the division, which makes commercial real estate loans for the construction and land-development sectors, have been troubling this year because of construction delays and disruption in financial markets related to the pandemic, according to Tim Hicks, chief credit and administrative officer at the bank.

The bank is looking for a rebound this quarter and into 2021. “At this time, construction and development activity has returned to essentially normal levels on the projects RESG is financing, and we continued to witness the return of more bridge and permanent lenders to the market,” Hicks said. “Given these factors, we expect RESG loan repayments to return to more typical levels in the fourth quarter of 2020 and most future quarters.”

Hicks added: “We are optimistic that we can originate good loan volume next year and that new fundings will outpace paydowns without wavering from our long history of conservative lending practices.”

Stephens also projected the bank could consider a sharerepurchase program, an initiative it has not implemented in its 23-year history as a public company. The bank does not have a buyback program in place and Hicks emphasized that OZK will remain focused on cash dividends for stockholders.

As for pursuing merger-andacquisition opportunities, Hicks said Bank OZK acquired 15 banks after the last recession in 2008. Those takeovers occurred from 2010-2016. “We would expect to be active again at some point once future economic conditions become more clear, but the timing of future M&A is difficult to predict,” Hicks said.

HOME BANCSHARES

Home BancShares, which operates as Centennial Bank, has not been shy in telling investment analysts this year that it would be willing to invest if the right deal comes along.

Stephens predicts a deal could take place. “Given its impressive M&A history of completing and integrating triple accretive acquisitions … we believe this could represent the next catalyst for the stock,” the report said.

The bank is open to mergerand-acquisition opportunities, according to Donna Townsell, senior executive vice president and head of investor relations. “Deals are starting to be discussed more but it takes a little time to ascertain what is the ‘right deal’ for the company and its future,” she said. “All things considered, it’s highly possible that 2021 will bring about a transaction” for the bank.

Stephens noted another option for the bank’s use of capital is to reactivate its stock-repurchase program. Townsell said the bank cannot comment on buybacks until it reports earnings next month, but she said Home BancShares has about 3.85 million shares its board already has approved for repurchase.

The bank’s hotel portfolio, which represents about half of the bank’s deferrals, could face “heightened risk” through airport hotel loans as those facilities carry low occupancy rates because of reduced business air travel, according to the Stephens team.

The bank, Townsell said, has been proactive in reaching out to borrowers in that sector and others to help manage difficulties during the pandemic and avoid potential losses.

“We have seen decent occupancies in most all hotel categories — with airport hotels being of more concern than the rest of the group,” she added. “We work with our borrowers and remain in close contact with them, especially during a time like this.”

SIMMONS FIRST

The company, which operates 200 branches in seven states as Simmons Bank, also has been challenged by payoffs that have outpaced the funding of new loans.

George Makris, chairman and chief executive, said the trend likely will continue. “I do think the trend will continue into 2021 and the duration is dependent on the widespread availability of an effective vaccine,” he added.

Stephens projected the bank could activate a stockrepurchase plan as an effective way to return capital to shareholders with minimal dilution. The bank already is authorized to repurchase $77 million in shares, and Makris said that approach would be positive for the company.

“Based on current valuations, we believe buying our stock is a good use of capital and creates long-term shareholder value,” the chairman said.

Though Simmons has the highest deferral level of the 17 banks participating in the Stephens conference, Makris said modifications continue to decline and the bank is optimistic that will continue. He noted deferrals will stretch into 2021 and some of those loans will have to be restructured based on a return to normal cash flows.

As for acquisitions, he said, “M&A is a part of our growth strategy. In the past, our efforts have been focused on access to new markets. Going forward, our primary emphasis is to build scale in our current footprint,” Makris said, “but we would not rule out a strategic opportunity in a contiguous market.”

As with the other Arkansas banks, Makris noted Simmons is having a record year in the home financing business. “Mortgage rates are extremely low and have created a lot of demand for housing refinance,” he added. “We are experiencing a record year at Simmons for our mortgage group.”

Of course, low interest rates present challenges as well.

Margins for banks across the nation have been squeezed, leading to record lows in net interest margins for lenders, according to the FDIC report. “The average net interest margin fell by 68 basis points from a year ago to 2.68%, the lowest level reported in the history of the (agency’s) quarterly banking profile report,” the FDIC said in its Dec. 1 report.

Net interest income in the third quarter declined for a fourth-consecutive quarter, falling by $10 billion, or 7.2%. from third quarter 2019 — the largest year-over-year decline on record, the FDIC said.

Even so, lenders should produce solid financial results in 2021, according to FDIC Chairman McWilliams.

“Modest improvements in the economy and higher consumer spending supported stronger earnings results for the banking industry in the third quarter,” she said.

“However, economic uncertainties and pressure on revenue from unprecedented net interest margin compression continued to weigh on the banking industry,” McWilliams added. “Nonetheless, the industry remains well positioned to accommodate loan demand and support the economy.”