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  • Writer's pictureZach Zoia

5 Questions for ALCO in 2024

Deposits360°® Monthly Industry Review
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Craig Kilborn, formerly a host on SportsCenter, The Daily Show, and The Late Late Show, had a popular segment called “5 Questions” at the end of celebrity interviews. For those who remember, these questions were often obscure and quite funny.

As the banking industry approaches month 20 of yield curve inversion, (and what seems like perpetual drag on margins), bankers may not be in a laughing mood. 

Below are five serious questions that we believe the ALCO at your institution should be discussing and finding your own answers to.

We discussed these five questions ourselves with colleague Joe Kennerson on the most recent episode of DCG’s “On the Balance Sheet” podcast (join the conversation here). 

We hope you enjoy either (or both) formats, as we believe the outlined issues may be very influential on earnings performance for the coming year.


From the Editor

"In the fall of 2021, my colleague Zach Zoia and I were tossing around the idea of starting a podcast. Both of us use the medium to educate ourselves, but we needed a way to distinguish our podcast from the myriad of listening options available. 

While we initially thought about doing market updates and discussing real-time industry developments, we were hesitant to produce content which might not “age well.”

Instead, we opted to showcase the highly talented and engaging personalities in the industry that we have the pleasure of working with on a daily basis. So, in early January of 2022, On the Balance Sheet (OTBS) was born and we now have 25 episodes “in the can.” It’s been a rewarding journey as we have been able to learn from each interviewee about what makes them and their organizations highly successful.

Along the way we have learned lessons. One of which is that when we feature “our own” (DCG teammates) we notice a significant uptick in downloads. Perhaps we take for granted whom we walk by every day in the office as there is obviously an appetite to hear their thoughts on the industry.

In this month’s Bulletin, DCG Managing Director and OTBS co-host Zach Zoia provides a summary of our most recent podcast during which we were joined by colleague Joe Kennerson.

Joe, a Managing Director here at DCG, shares some of his perspectives fresh from the Bank Director Acquired or Be Acquired conference. The conversation is framed around five critical questions balance sheet managers should be asking themselves this year.

For those unfamiliar with Joe, he has golden “pipes” and is a captivating listen. And while we hope you can make time to tune into the podcast, Zach's Bulletin highlights the key discussions from that episode. Now let’s just hope they all age well!

Vinny Clevenger, Managing Director


1.) Will the deposit pricing pressure ever end?

2023 was the year of funding cost pressures as mixes continued to shift to higher cost alternatives and deposit rates increased across the board. As we progress through the first quarter of 2024, banks and credit unions are still at battle with the cost of funds, but we observe that pressure starting to slow (with the maturity schedule of CD books being a possible near-term accelerant).

For many, the pathway of the Fed is key to understand how much more cost drift and mix shifting may be in store. DCG’s data from the Deposits360°® analytics platform show the following, at an industry level:

NMD Rate History & Forecast

The graph captures two sets of potential outcomes for non-maturity deposit costs over the next twelve months. The “higher for longer” scenario with the Fed “staying put” projects another 11bps of cost increase on the NMD base. The forward curve scenario (inclusive of 6 Fed rate cuts) may be described as a “soft landing” (so to speak) and illustrates a potential 10bp decrease in NMD costs. 

Understanding an array of possible outcomes is the starting point for helping to answer this question for your institution. 

As always, we encourage you to dig into your own data to understand the drivers of the cost increases over the past 12-18 months, and how much residual exposure you may have if rates stay up here for longer. Which categories? Which tier of balances? Which accounts or relationships? Be honest.

We also believe it is important to understand the differences between any scenarios you may analyze. Timing is a critical variable. Please note the cost relief generated from the Forward scenario as the Fed cuts is very much backloaded. In other words, we may not achieve the cost relief we are hoping for as quickly as desired, which brings us to our next question…

2.) How much deposit cost relief can we expect if the Fed cuts?

In our conversations and in the data, the global answer could be best described as not as much as you may initially think. While banks and credit unions may have the best intentions of cutting deposit rates in lockstep with the Fed, there are usually three obstacles that slow things down:

  • Tightening liquidity

  • Potential credit issues

  • Competition (aka human nature)

With that said, we find it helpful to evaluate the different paths the Fed could take as rates fall (e.g., slow/fast, a few cuts/lots of cuts) and how you would take into consideration those three obstacles.

The graph below shows a few hypothetical rate trajectories and corresponding NMD rate decreases.  Note the differences in how quickly NMD rates fall below current levels, depending on the pace and scale of market rate decreases.

NMD Rate History & Forecast

Based on DCG’s analysis via Deposits360°, it could be at least four Fed rate cuts before the industry begins to see actual NMD relief. Nevertheless, it is imperative to start building your Fed easing playbook now. 

  • Where could we reduce rates?

  • How quickly? 

  • What would be our catalyst(s)?

The time deposit base is another crucial variable. While the focus above is on NMDs, we are seeing many groups begin to cut those rates now as wholesale term funding rates have decreased. This is especially relevant for institutions that view their strategy as more defensive in nature than offensive. It is important that the ALCO delineates between the two, as it will most certainly impact rates and terms offered as well as the potential for incremental cost relief if the Fed eases. 

3.)    When will margins recover?

There is some momentum building in the industry for the idea that once we get through the first half of this year, we should begin to see margin recovery. It’s evident on earnings calls, in media publications, and even within many of the interest rate risk models we see. 

The rationale: 

  • More asset cash flow is expected and able to recast into higher coupons / rates

  • Time deposit maturities will reset higher in the first half, and will be able to experience relief later in the year on the “re-roll”

  • Fed easing, if it happens, should allow for some other incremental funding relief

It is a viable story, but there are some clear wildcards that could adversely influence this sanguine outlook. It is important your ALCO is thinking through the following variables that could dampen the outlook of your IRR models and be impactful to the bottom line as well as the overall ending of this margin recovery narrative:

  • Slower asset prepayments: What if we receive less cash flow than the models project and thus achieve less lift from asset yields?

  • Continued deposit mix shift and cost drift: What if the deposit pricing and mix pressures of 2023 persist longer than expected / hoped / modeled?

  • Deposit pricing stickiness on way down: What if we are not able to execute on deposit rate reductions as quickly?


4.)    Why should we not “sleep” on bond strategy in 2024?

While it is understandable to have fatigue from the unrealized loss discussions over the past two years, ALCOs would be wise to think more strategically about the bond portfolio in 2024.   

Whether it is OCI risk, tighter liquidity, or not wanting to deploy capital for assets that may be yielding less than cash, the reasons for not investing more this year are aplenty. The question groups should be asking, especially in an environment where no stone should be left unturned, is: will we wish we were more active today if rates fall tomorrow?

In every rate cycle, we often find that institutions in hindsight wish they looked more seriously at capturing some of the higher investment yields. 

At your next ALCO, make sure there is discussion on how your liquidity minimums are trending and how pledging bond collateral to Fed and/or FHLB can help manage that. Review merits of pre-investing upcoming cash flow, or even if there is spread to be locked in via leverage transactions (*depending on your current capital and liquidity profiles). If hedging falling rates is a high-priority item, discuss how securities can offer certain structures that can be advantageous.

It is very possible that given your risk profile, being more active in the bond markets may “not be for us.” The important thing is having a healthy dialogue to ensure you are “not sleeping on” an area of the balance sheet that could help achieve a variety of other goals and fortify our risk position.

5.)    Will falling rates be the answer the industry is looking for?

As with most things in life, the answer here is: “it depends.” The speed and severity of Fed rate cuts, as well as the evolving slope of the yield curve, will be incredibly influential. 

ALCOs need to understand the drivers of the potential balance sheet benefits or risk across the spectrum of falling rate environments. Parallel vs steepening slopes. Down 100bp vs Down 400bp. Shocks or ramps. Funding costs and asset yields can react very differently. Betas can lag and be non-linear.

It is not uncommon to see projected earnings benefit from a slower, more modest yield curve reduction whereby positive slope returns. Conversely, it is quite common to see pressure on earnings emanate from a faster collapse of the yield curve. What do these differing scenarios look like for your institution?  Can you pinpoint the key drivers?

Overall, falling rates could be the panacea, especially if a recession is ultimately avoided. Nevertheless, we should be careful of what more sustained falling rates historically portend: slowing growth, recessionary activity, and credit events. 

ALCOs need to consider that falling rates could be a tradeoff of recent margin pressures for future credit issues and prepare accordingly. Flexibility, patience, and deliberate planning will go a long way to help navigate the potential challenges of the next rate cycle.


For more insights from Darling Consulting Group, click here.


Zach Zoia is a Managing Director at Darling Consulting Group. He helps management teams throughout the country develop strategies to improve financial performance and more efficiently and effectively manage liquidity, capital, and interest rate risks.

Zach began his career with DCG in 2008 as a financial analyst. He earned a BS in finance from Boston College and his MBA from Babson College.


© 2024 Darling Consulting Group, Inc.


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