Kentucky bankers say they have reason to be optimistic about the state’s economy as better mortgage rates and bank profits are expected in the coming year.
Commonwealth bankers told The Lane Report they expect the Federal Reserve to follow up September’s half-percentage-point cut in the Fed’s lending rates to banks with further cuts this year and next.
“The current consensus is the Fed will lower its benchmark rate another 50 to 75 basis points by the end of the year, and an additional 100 basis points in 2025,” said Traditional Bank Chief Financial Officer Chas Sargent.
This makes it cheaper for businesses to borrow, to invest and create jobs. It also gives bankers better flexibility to manage the interest rate spread between what they charge for loans versus what they pay depositors.
“The community banking sector did a solid job of managing a very volatile and aggressive interest rate increase cycle; now we need to be just as mindful on the way down,” said Doug Lawson, president and chief operating officer for Field & Main Bank. “Overall, the industry will feel better, and it should relieve some cost-of-funding pressure and net interest margin compression that has been making profitability challenging.”
Lawson, who was among some 200 banking professionals who attended the Kentucky Bankers Association’s annual convention in late September, said the impacts of the Federal Reserve’s interest rate pivot was the topic of most conversations between sessions.
This is good news for the residential real estate market also, where a spike in financial system interest rates that began around three years ago has contributed to fewer homes available to buy with higher prices but fewer sales.
The benchmark that mortgage lenders peg their rates against is now considered likely to drop through 2025 and even beyond.
“Long-term mortgage rates dropped prior to the announcement of the 50-basis-point decrease (Sept. 18) and we expect mortgage rates to decline more if the Fed continues lowering the target short-term rate,” said Mark Gooch, chairman and CEO of Pikeville-based Community Trust Bank. “Long-term rates typically follow short-term rates, and lower long-term rates will make housing more affordable for many potential borrowers, particularly if rates continue to decline into 2026.”
An indication inflation is tamed
“Lower interest rates typically help the economy,” said Louis Prichard, Central Kentucky market president for Louisville-based Stock Yards Bank, the largest commonwealth-based bank. “Lower rates mean lower borrowing costs and also can reflect that the Fed has reached or is close to reaching its goal of reducing inflation.”
The short-term interest-rate adjustments the Fed is expected to make almost certainly will impact mortgage interest rates, Prichard said.
“The longer-term rates that impact mortgage rates,” he said, “would likely follow suit and to some degree that has already happened: The 30-year mortgage rate as of Sept. 14 was 6.10%. Depending on how quickly and how much short-term rates are lowered, it’s possible that mortgage rates could continue to decline as well.”
With an expected sustained and stable environment of lower rates, the banking industry could be positively impacted as net interest margins improve over time, Prichard said.
Gooch of Community Trust, among the top three Kentucky-headquartered banks by deposits, said his bank foresees the Fed continuing to lower rates, “based on comments of Chairman (Jerome) Powell, if inflation appears to be under control and if the economy continues to grow slowly while keeping unemployment under control.”
He expects an additional 25-basis-point rate cut will occur before year end and additional rate cuts to continue into the first part of 2025 and probably throughout 2025.
“We would not be surprised to see rates down 150-200 basis points from the highest point,” Gooch said. “Prime rate was 8.50% prior to the initial rate cut and may be 6.50% or lower by year-end next year.”
Federal monetary policy works on the economy with a lag, PNC Chief Economist Gus Faucher points out. Therefore, it will take some time for the fed funds rate cuts to boost the Kentucky economy. But strong labor force gains and falling interest rates should support growth.
Kentucky’s gross domestic product was $285 billion in 2023, according to the St. Louis Federal Reserve. State GDP grew 3.1% in 2023, according to the federal Bureau of Labor Statistics.
“In particular, lower interest rates will support car and truck sales, boosting auto manufacturing areas of the state like Louisville, Lexington and Bowling Green,” Faucher said. “Stronger manufacturing activity nationally with lower interest rates will also support the commonwealth’s important logistics industry.”
As the cost to borrow decreases, expect dealmaking activity across industries to increase, and banks will help will facilitate this. But the interest rate environment is only one among many factors driving decision-making for CFOs across all industries, Faucher noted.
It’s just one factor, but a good one
Pittsburg-headquartered PNC, one of the nation’s largest banks and the deposit market share leader in Kentucky, sponsored a survey this year of 300 CFOs across the nation to understand their expectations about Federal Reserve interest rates through the end of 2024, as well as their intended actions and business implications if rates were to be cut.
“What that survey showed us is that CFOs are less concerned about Fed rate decisions than the political environment, geopolitical tensions abroad, and cybersecurity,” he said. “That said, 91% of the CFOs surveyed indicated a rate cut would have a positive impact on their company, and CFOs identified the following as the top ways their companies would increase spending after a rate cut: technology spending (75%), capital expenditures (73%), hiring (70%), bank borrowing (69%), introducing new products/services (68%) and refinancing debt (68%).
As inflation continues to slow and job growth eases, PNC expects additional 25-basis point cuts at each of the Federal Open Market Committee’s meetings this year, in early November and mid-December. That would take the fed funds rate to a range between 4.25% and 4.50% at the end of 2024. PNC then expects additional rate cuts in the first half of 2025, with the fed funds rate down to around 3.50% by the middle of next year. This is consistent with the Summary of Economic Projections released after the Sept. 18 meeting.
Republic Bank, another of Kentucky’s three largest domestically headquartered banking service providers, is optimistic about the outlook as interest rates decline.
“We think this will have a positive impact for Kentucky and for banking as commercial lending has slowed for a year or more,” said Todd Ziegler, president for the Central Kentucky market. “New commercial development and investment should be able to show positive returns quicker with lower interest rates, so more new initiatives should get off the ground.”
He foresees relief for new home buyers ahead also.
“While we have seen and will most likely continue to see mortgage rates follow the trend of overall rates, that’s only part of what will offer new homebuyers relief,” Ziegler said. “Housing inventory appears to be a much bigger factor today for people trying to purchase their first home or new homes than in the past.”
What interest rate is neutral?
Owensboro-headquartered Independence Bank expects the federal funds rate to fall back to a neutral rate that is neither restrictive nor inflationary.
“The current real question is the speed at which they get to the neutral rate — as well as what that actual destination may be,” said CEO Greg Mullican. Public Federal Reserve guidance “states that they expect to lower rates an additional 150 basis points over the next 12-15 months. However, we still think that future economic data will dictate that actual path to the neutral rate.”
Mortgage rates more closely follow longer-term rates, such as the 10- and 30-year Treasury rates, which declined in anticipation of the Sept. 18 meeting’s formal action.
“This recent decline has, in turn, been reflected in mortgage rates also coming down,” Mullican said. “However, with the 10- and 30-year Treasury rates running in a range from 3.6% to 4.10% versus the fed funds rate, which is currently 5%, clearly the fed funds rate has much more room to come down than do the longer-term Treasury rates.”
He cautions that while the short-term rates may decline significantly in the next year plus, the housing market may only see a slight additional decline in mortgage rates.
Sargent, at Mount Sterling-based Traditional Bank, cites the view of industry experts who predict mortgage rates will continue to decline in the fourth quarter of 2024 and into early 2025.
“A lower interest rate environment will make owning a home somewhat more affordable and should spur home sales as previously hesitant homebuyers will consider entering the market,” Sargent said.
While Kentucky is not as susceptible to the more volatile swings in economic activity that other states have, he said, lower interest rates will enable businesses to continue to invest in their operations and thus the local economy.
