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  • Writer's pictureZach Zoia

Changing the Conversation

Changing the Conversation in the current banking environment

ALM Strategy | ALCO

For fans of the critically acclaimed television show Mad Men, you may recall this famous quote from lead protagonist and advertising executive, Don Draper:

“If you don’t like what is being said, change the conversation.”

We all know that despite the challenges in our world with the pandemic, 2020 was a very strong year for earnings. 2021 has followed suit for many as well.

However, the discussions we are having with financial institutions throughout the industry point toward a less optimistic outlook for earnings in 2022 and 2023. The benefits from PPP fee income, historic mortgage banking activity, and other one-time income events are projected to fade, while net interest margin pressures continue to persist.

I think we can all agree these trends are certainly not what bankers like to see.

These discussions were also consistent with feedback we received at our annual conference in June, where “changing the conversation” was the central theme.

Essentially, how can you approach things differently in this current banking environment to achieve your goals? As times are changing, are you looking through multiple lenses from a strategic perspective, or the same one you always have?

The DCG Conference was conducted virtually this year for the first time, and the format allowed us the opportunity to engage participants in a different manner throughout the presentations via polling questions. While I know many of us would rather have been enjoying a drink together (in true Don Draper fashion) on a boat in Boston Harbor, the results from the polling questions did reveal interesting insights about the conversations many of you are currently having.

Overall, the questions centered around the outlook for the following key items on bankers’ minds:

  • Net interest margin pressure

  • Loan growth challenges

  • Deploying excess cash

  • Deposit uncertainty

The results depicted in the subsequent paragraphs are sourced from hundreds of community bankers around the country. As you read through them, keep in mind that if you don’t like what is being said, or effectively, where the trends are heading, you should ask yourself what you can do to change the conversation at your Asset-Liability Committee (ALCO) and your overall institution to outperform.

Net Interest Margin is the biggest concern moving ahead

Overwhelmingly, the biggest concern on bankers’ minds as we progress through the end of 2021 and into 2022 is sustained margin pressure (nearly 60%).

Biggest concern on bankers’ minds is sustained margin pressure (nearly 60%)

It should be no surprise to anyone that this low interest rate environment is exerting considerable pressure on net interest margins as investments and loans continue to cash flow quickly into lower market rates, exacerbated by immense competition for quality assets, while incremental relief on the funding side is generally exhausted. This is the reality for many of the financial institutions we speak with, who did a nice job cutting deposit rates over the past 18 months to help offset asset yield deterioration but have more limited ability to continue doing so.

Nonetheless, with the unprecedented environment we find ourselves in, financial institutions are challenging themselves, and their historical deposit rate floor levels, in the quest to preserve margin. The conversation is changing from “cutting a few bps from savings or checking accounts is not material” to “if I can cut deposit rates further, does that mean I don’t have to do something else on the asset side I may not be fully comfortable with to generate the same P&L impact?.”

Everyone wants loans

When we asked the question about loan growth projections for 2021, excluding PPP, over 70% of the respondents noted an expectation for somewhere between 3 and 10%. Over 20% thought it would be less than 3%, or quite possibly even negative for the year. No matter where most groups think they will be in those ranges, it is very common to hear these are lower than prior years and overall loan growth is softer than many had hoped.

How Much Loan Growth Expecting in 2021?

What is the main reason for the dampened expectations?

In our poll, it was dead even (35% each), with bankers saying opportunities for new deals were more limited, while on the other side of the spectrum, loan payoffs were also creating obstacles for growth. Additionally, about 20% reasoned that pricing was too “rich,” inhibiting comfort levels with getting deals done. Credit concerns, at this point, do not appear (yet) to be a major worry.

Excluding PPP-Effect, Our Biggest Challenge Growing Loans in 2021

I know most of us would agree lower loan growth expectations are a conversation we don’t like, and certainly want to change. Many of the conversations we are having with clients revolve around what the main impediments are to growing quality loan volume, and how we can look at those differently.

For example, it is very common to hear discomfort with writing lower yield and longer duration fixed-rate commercial loans. While it is hard to argue yields are lower today on an absolute basis versus a few years ago, how does that translate to the actual credit spread? If loans are viewed via the spread lens instead of the absolute yield level, would that change your opinion on how “low” we could go to win the deals we want? The relative steepness in the yield curve (versus last year, not historically!) should also enhance our opportunities to change the conversation and be more flexible when negotiating with our best credits.

Those more open to entertaining these conversations with current or prospective clients often find there are more deals out there to be won than they originally thought, and the loan payoff issue may be mitigated to some degree, both allowing for a higher probability of seeing that loan portfolio expand.

There is just too much cash to put to work…

It is all too common to hear institutions are trying hard to deploy excess cash into either loans or securities, but it has been incredibly challenging to keep pace with the asset cash flows each month, let alone increases in deposit balances. Per one of the questions at our conference on this topic, the lack of loan demand was the number one obstacle to getting the cash more efficiently deployed (46%). Fear of rising rates, whether in the form of opportunity costs (i.e. waiting for better times) or potential unrealized losses on bonds bought today, combined to account for approximately 34% of the vote. Deposit balance uncertainly totaled 20% (and more on this later).

What is Getting in the Way of Putting Excess Cash Balances to Work?

The folks who noted concerns about not wanting to invest in a low yield environment or the potential for unrealized losses can also benefit from viewing the cash accumulation issue through a different lens. Risk tolerances are different across management teams, but if you are choosing not to invest or hold duration at this time because of rising rate fears, have you quantified how much income you are not generating by making that decision?

By not investing, how fast and far does the yield on cash have to go to make up that lost income? If you are going to enter the bond market down the road, how do you decide that timing? What about unrealized losses is concerning to your balance sheet plans?

It is often very common to model out a strategy we want to execute to better analyze the risks and rewards, but what about the strategies you do not execute? Very often, those never get measured. We find that by doing so, it can absolutely change the conversation about whether it makes to deploy cash in this environment.

Some are “hedging” their bets (on rates) via mortgage strategy

Below are the results of how participants viewed their current mortgage lending strategy (i.e. as of Q2 2021). Overall, 23% noted selling most production, 34% indicated holding most production, and 43% maintain a more hybrid approach.

How to Best Characterize Our Mortgage Lending Strategy

What is driving your mortgage lending strategy decision? If margins are heading lower, could we change the conversation about holding more volume to better position the balance sheet for an annuity stream of income in 2022 and beyond? The right answer depends on your institution’s income goals and risk profile, but given the current environment as need for good quality assets, mortgages in your own backyard should be part of the conversation.

Don’t forget about deposit stability

Many in the industry went from worrying about not having enough liquidity back at the beginning of the pandemic to now having far too much, with deposit inflows playing a significant role. One of the biggest question marks is how long the deposits will stick around.

First though, it's critical to have the conversation to help quantify how much of the deposit inflow was actually potential “surge.” At our conference, over half of the responses were in the range of 11-20%, with another third indicating greater than 20%.

How Much Excess Deposits (Surge) Did You Garner Post-Pandemic?

Next, how about the source of the inflows? Consumer, business, or a mix of both? The results below were pretty evenly split.

What is the Source of Your Deposit Surge?

As for how much of the growth may actually leave, 76% of those who answered expected less than a quarter of those additional funds would leave.

How Do You Expect the Post-Pandemic Deposit Growth to Behave Over Next Year?

Given the perceived uncertainty within deposit bases, it is essential to dig deep to quantify the level of unexpected growth and delineate the sources, and further analyze how much of that may be more temporarily parked on the balance sheet. However, the timing of these potential outflows is a variable that is often overlooked.

Ostensibly, the longer it takes for any of the “surge” to flow out of your institution, the more time you have to offset with normal deposit growth and/or new deposit gathering initiatives, which should not be forgotten even if we may not currently “need” the funds.

As we put all of these variables together, for many the conversation changes from the influx of deposits and associated uncertainty being viewed as a problem to an opportunity. And depending on what you uncover, it may be an opportunity to more confidently put cash to work, grow the loan portfolio, and ultimately preserve margin.

Don’t like what the trends are saying?

Declining net interest margins. Tepid Loan growth. Excess cash. Deposit uncertainty. All four of these are clearly troubling the minds of bankers throughout the country. Not everyone may agree on the answers to the questions these challenges pose, but we should all agree that changing the conversation around how to best attack will provide the best chances for future success.


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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.


© 2021 Darling Consulting Group, Inc.

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