One industry expert told the Massachusetts Mortgage Bankers Association last week that because larger banks such as Bank of America need time to “digest” their newly acquired banks, there should be fewer mergers and acquisitions in 2005.

Bankers and lenders can expect a decent 2005. The economy is expected to show continued growth, but at a slower pace. Mergers and acquisitions will slow and interest rates will continue to increase, placing pressure on the housing market throughout the country and specifically in Massachusetts, according to one industry expert.

“The [Federal Reserve] has been very accommodating,” said Gerard Cassidy, managing director of RBC Capital Markets, adding that the Fed is expected to raise rates again in March. Cassidy offered his 2005 economic outlook to a group of mortgage bankers at a luncheon sponsored by the Massachusetts Mortgage Bankers Association last Thursday.

Nationally, the economy is expected to grow, and that news is comforting to consumers throughout the United States.

“Consumer confidence has come up strongly from the lows of 2003,” Cassidy said, adding consumers represent two-thirds of the economy.

Increases in jobs also will determine the strength of 2005, Cassidy said.

“Employment is the backbone of this economy,” he said. “We just need positive job growth.”

Consumer spending is expected to be a driving force of the U.S. economy in 2005. The 2005 personal consumption expenditure increase is estimated at 3.4 percent, according to RBC.

Based on statistics from the national Mortgage Bankers Association, Cassidy said housing activity is expected to slow because interest rates are likely to rise. Existing home sales are also predicted to slow down. However, Cassidy said home-sale estimates have been off in years past due to the strength of mortgage originations. Calling the volume of mortgage originations “unbelievable,” Cassidy said homeownership is unprecedented in the United States.

“Homeownership in this country is at levels we have never seen before,” he said.

‘Extraordinary’ Growth

While it wasn’t news to mortgage bankers in the room, Cassidy pointed out that home equity lines of credit were stable from the 1980s until 2001, but since then, the rate of growth has been “extraordinary” in the last several years. However, home equity lines are expected to slow in 2005 because many consumers already have one.

Based on information provided by Freddie Mac, Cassidy said home equity cashed-out through prime, first-lien refinances will fall from $134.5 billion in 2004 to $96 billion in 2005 to $61 billion in 2006.

In general, the U.S. banking system has generated a considerable amount of loans in the past five years, according to Cassidy.

Commercial and industrial loans had dropped off in recent years, but that is about to change, he added.

“These loans tend to be more profitable,” Cassidy said.

He said he expects a 10 percent to 13 percent rate of growth in 2005 for C&I loans.

Business outlays, another driving force of the 2005 economy, have a 4 percent growth forecast for 2005, according to RBC estimates.

Cassidy said the national deficit is in line with historical averages. There are estimates of $364 billion and $268 billion for the 2005 and 2006 budget deficit.

Cassidy advised banks and mortgage companies to watch inflation. Investors believe inflation will go higher, but history won’t be repeated.

“No one expects a [1974] or 1980 inflation environment,” Cassidy said.

While the banking industry has enjoyed profitability for the last five to 10 years, Cassidy said quarterly profitability has drifted down slightly. To combat rising interest rates, banks are being more aggressive in lending.

The Fed’s decision to raise short-term rates will affect institutions because it will put pressure on net interest margins, Cassidy said. Reducing costs helps combat that pressure.

“This is going to be a challenge in 2005,” he said.

Because of rising health care costs, other expenses and general inflation, banks are being challenged to grow earnings in 2005, Cassidy said.

Nonperforming assets have declined and net charge-offs are low and expected to remain stable into 2005.

Cassidy also provided an outlook for the New England economy in 2005, saying the area usually sees a slower recovery compared to the rest of the country. However, he said New England’s economy has recovered and expansion is under way.

“Banks are only as good as their local economy,” Cassidy said.

Regional unemployment is below the national average and employment growth is expected in the area for 2005.

Western states, like Nevada and California, tend to have faster wage and salary employment growth compared to New England, Cassidy said.

Cassidy pointed to Massachusetts’ high home prices and warned there could be problems in the future.

“New England and Massachusetts have had a real robust run in housing prices,” he said.

However, Cassidy said he is concerned that if interest rates rise too quickly, housing affordability will be difficult and the housing supply will rise.

“I do worry about the affordability of houses,” he said.

If prices become too high, borrowers won’t qualify for as many properties and will lower their expectations, Cassidy said. He warned that house prices could soften if there is too much supply.

Interest rates, he said, will have a greater impact on housing than in years past. He acknowledged lenders’ creative solutions to high home prices, but said when those ideas run out, housing prices are bound to slow down.

Cassidy also warned that the recent Fannie Mae accounting scandal could impact local lenders. Because Fannie Mae and Freddie Mac have been told by the federal government to shrink down, the two organizations are expected to have less influence in the mortgage industry than before. More banks, Cassidy said, may be forced to keep loans on the books.

Nationally and locally, bank mergers and acquisitions were popular in 2004, but consolidation is expected to slow down in 2005.

“This year we got off to a slow start,” Cassidy said.

Because larger banks such as Bank of America need time to “digest” their newly acquired banks, Cassidy said there should be less M&A action in 2005.

Banks like Fleet, Charter One and Bank One, which all acquired other institutions in the past, have since been acquired by larger companies.

“The serial acquirers are selling out,” Cassidy said.

He added that he expects the United States is heading toward a more centralized banking system.

Cassidy said his advice to bankers and lenders for 2005 is to closely watch inflation and the U.S. dollar.

Jennifer Jope may be reached at jjope@thewarrengroup.com.