Rate hike could signal improving economy

Washington Trust Bancorp Inc. reported first-quarter profit growing 7.7 percent to $11.8 million, or 68 cents per diluted share. Joseph J. MarcAurele (left), chairman and CEO of Washington Trust Bancorp Inc., stands with Ned Handy, president and COO. / PBN PHOTO/MICHAEL SALERNO
Washington Trust Bancorp reported first-quarter profit growth of 7.7 percent, as the Westerly-based bank posted net income of $11.8 million, or 68 cents per diluted share. Joseph J. MarcAurele (left), chairman and CEO of Washington Trust, stands with Ned Handy, president and COO. / PBN FILE PHOTO/MICHAEL SALERNO

Rhode Island banks – along with most of the financial-services industry – are watching closely as the Federal Reserve mulls whether to raise interest rates. The decision could impact multiple lines of business, and ultimately the banks’ bottom lines.

The Federal Reserve Board of Governors, which oversees the central bank’s monetary policies, will meet later this month and decide whether an increase to federal fund rates is warranted. Meeting minutes from the board’s previous meeting, which is what economists and capital-market watchers study for clues about possible policy decisions, indicate the central bank could raise interest rates “fairly soon.”

The suggestion has economic forecasters bullish about imminent rate hikes, and as many as three this year. If the Fed follows through, it would signal that the central bank truly believes the overall economy is improving, which could in turn impact banks, business and consumers.

“I would say it’s a sign of things improving,” said Joseph J. MarcAurele, chairman and CEO of Washington Trust Bancorp Inc., parent of The Washington Trust Co. based in Westerly.

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“Things were so difficult post-2008 [recession], that I think the Fed was reluctant to raise rates,” he added. “What this shows is that there’s at least some really legitimate confidence that the economy has gained some level of momentum.”

Whenever the Fed decides to move interest rates, it impacts banks, businesses and consumers in multiple ways. If federal fund rates increase, banks typically increase prime rates, in turn affecting mortgage rates, car loans, business loans and consumer loans, including credit cards.

It could also impact deposit rates, which have been next-to-nothing for a long time.

“Those of us who have gray hair can remember 6-8 percent CDs [certificate of deposit]. You have to go back a way, but you could put money in the bank and get paid for it,” noted Michael D. Ice, professor of finance at the University of Rhode Island.

Edward O. “Ned” Handy III, president and chief operating officer of Washington Trust, is watching the lending side of the business closely, saying increased borrowing costs could impact the cost of loan origination, and drive down refinance volume on the residential side, as rates would become less favorable.

There’s been a flurry of mortgage-refinance business over the last two years, as homeowners have flocked to lock in cheaper interest rates.

“Consumers enjoyed getting mortgages at 3-4 percent, and that’s ridiculously abnormal,” Ice said. “I think if people haven’t taken out a mortgage, they’re really sleepy. At some point, they’re not going to get 3-4 percent mortgages, it’s going to be 7-8 [percent]. If rates rise, it’s going to affect the mortgage market, and a home will become more expensive.”

On the commercial side, where variable – or floating – rates are common, bankers are expecting a slight downtick in activity.

“You’ve seen commercial real estate very, very robust and so I think as rates move up a little bit, you’ll see a little less of that activity,” said Citizens Financial Group Inc. Chairman and CEO Bruce Van Saun. Citizens Financial is the parent of Citizens Bank, based in Providence.

But central banks increasing rates typically signals companies are doing better financially, which could result in new business opportunities for banks.

“If you see the growth come through that the market is expecting, that hopefully is made up with loan demand that really is in support of a faster-growing, real economy,” he added.

The Fed has increased the federal funds rate twice in the last decade, most recently in December, when rates rose one-quarter of a percentage point, to between 0.5 percent and 0.75 percent.

If the Fed increases rates three times this year, the economy would still be in a historically low-rate environment. Prior to the Great Recession, federal fund rates hovered around 5 percent, and in the late ’80s it was closer to 10 percent.

“The economy is ready for another rate hike,” Ice said. “We’re 10 years into a recovery and that tells you that there’s another recession not too far off. … Economic cycles last between seven and eight years, and we’re now 10 years into a recovery.”

Ice says rates get a lot of attention, but paired with President Donald Trump’s policies there could be great potential for a bank’s bottom line. Especially, he said, if Trump is successful in lowering the corporate income tax rate and rolling back the Dodd-Frank Act, which tightened regulatory compliance requirements following the financial crisis of 2008.

“We’re operating with the federal [tax] rate of 35 [percent], and if you got to something like 25 or 20 [percent], that would be a meaningful benefit to, I think, the whole regional banking group,” Van Saun said.

Neither Citizens nor Washington Trust, however, is taking anything for granted.

“If time progresses and we don’t see concrete advances in some of those things that we expect to happen, I think we could have a little bit of a stalling, or a slowdown,” MarcAurele said. “Usually, it takes longer to effect those changes than you would anticipate.” •

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