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  • Writer's pictureKeith Reagan

A Game of 20 Questions

A Game of 20 Banking Questions

Deposits | ALM Strategy | Loans

Twenty Questions is a game we have all played for fun and to pass the time on a long drive (before cell phones, that is). With all the uncertainly surrounding the industry this year, balance sheet managers would benefit from asking a wide array of questions.

Deductive reasoning and creativity are absolutely going to be needed to manage financial institution balance sheets in 2021. We are coming off an extremely challenging 2020 (on every imaginable level) and heading into 2021 with many unanswered questions.


From the Editor

In this month's Bulletin, Keith Reagan utilizes the popular “20 Questions” framework for crafting balance sheet strategy in 2021 (or in this case, 21 questions.) For those unfamiliar, it is simply a “guessing game” informed through multiple inquiries.

One participant picks a subject, and the other party attempts to determine that unsaid topic by asking carefully crafted questions (limited to 20 and only “yes” or “no” answers). The game demands deductive reasoning and creativity.

With all the uncertainly surrounding the industry this year, balance sheet managers would benefit from asking a wide array of questions. Keith’s article starts with inquiries into the characteristics of your deposit base, delves into the nuances of lending in this environment, and concludes with some difficult questions regarding investment portfolio management.

Finally, the “bonus” 21st question is the determination of institution-specific “tiebreakers” (for the aforementioned 20 questions). If you are saying “yes” to one of the questions, what are you implicitly saying “no” to (or vice versa)?

Instead of playing a “guessing game” with your balance sheet this year, we encourage your management team to utilize deductive reasoning and ask the right questions to optimize performance in 2021.

Vin Clevenger, Managing Director


Since we are all hoping for '21 to be better than '20, the following are 21 questions to ensure your balance sheet is optimized:

1. How does your overall deposit pricing compare to the lows experienced in the prior cycle (2014-2015)? Most institutions we work with are at or below the levels reached after the Great Recession. If you have not already reached these levels, a follow-up question would be: What are you waiting for? The industry has had substantial deposit growth, loan growth is inconsistent at best (more on this later), and the investment market presents a whole game of 20 Questions by itself.

2. Even if deposit rates have reached the lows from the prior cycle, is there more room to go? See the following Cross-Institution Analytics from DCG’s Deposits360°®. What would it take for your institution to be in the 20th percentile? How would that influence your bottom-line?

3. Have you identified "surge" deposits at your institution? Even with significant rate reductions, there has been an enormous deposit surge throughout the industry (please see the chart below). The surge can be attributed to many variables which occurred during 2020: A combination of PPP loans/deposits, stimulus activity, as well as business and consumer behavior changes.

Deposits, All Commercial Banks

4. Did the deposit growth come from new or existing customers? The answer to this question alone will not determine if the deposits are likely to stay on or leave the balance sheet, but it is a good starting point.

5. Is the growth in retail or public accounts? Similar to the preceding question, the response will not completely satisfy the question of stability moving forward, but we are getting closer to unlocking to how deposits might behave moving forward.

6. For existing relationships that have seen growth in the accounts, have you stratified each portfolio by different tiers and balances to determine growth above the prior median? It is time to be creative with the questions you are asking to help determine the stability of the recent deposit growth.

7. After answering the questions above (and more depending on the different types on relationships within your funding base), the following questions obviously need to be asked and answered. If the "surge" deposits revert to a mean or flow off the balance sheet, what is the impact to the liquidity and interest rate risk profiles of your institution?

8. Regardless of all the questions asked and answered, your institution will lose deposits in the next interest rate cycle. Given that and the need to continuously grow earnings (and therefore balance sheet size), deposit relationship acquisition should never stop. The relationships you really want are not driven by rate. Now is the time to differentiate your institution on something other than rate. What is your institution's value proposition, and how do you win relationships because of it?

9. If I told you at the start of 2020 you would have a substantial amount of loans on your balance sheet at 1.00% and that you were not going to want to see them mature, you likely would have had at least 20 questions for me. Nonetheless, that is what PPP round 1 gave us. Not including the fee income associated with the program, where else can you find a short-term, government-backed asset at 1.00% today? Most were happy to see the forgiveness extend into 2021. Now we have round 2 of PPP. How much do you anticipate in volume as compared to round 1? Most DCG clients have told us somewhere between 25-50% of previous volume while also expressing that they anticipate the money to be utilized faster and not "sit on the sidelines" like the first round.

10. Should residential loans be originated and sold or held on the balance sheet? Clearly, residential loan volume has been very strong across the country. The answer to this question is dependent on many factors and needs to consider the liquidity, interest rate risk, and earnings of your institution. Nonetheless, even if your ALCO profile suggests you should be holding residential production, it is difficult to pass on the substantial fee income associated with selling today. Still, the loans that were sold last year would look good on the balance sheet this year, right?

11. What is the potential for additional residential refinancing? Could the answer to this question change your answer to question #10 above? The bond market sell-off in 2021 might suggest refinancing activity will slow. However, the spread between the loan origination rate and the rate at which the loan is sold (primary / secondary spread) is still above pre-pandemic averages and suggests further refinancing could occur (please see the following chart):

The spread between the loan origination rate and the rate at which the loan is sold (primary / secondary spread) is still above pre-pandemic averages.

12. Have commercial lending standards changed and are you being compensated fairly for the risks taken today? If you are selling residential production, presumably there are commercial deals in your market that meet your risk/return standards. The following chart, from DCG’s cross-institutional database, suggests rates on fixed-rate commercial real estate held steady throughout 2020. Nonetheless, ALCO discussions continue to include examples of extreme pricing in most markets (i.e. 20-year fixed at 2.75% without recourse). Very few credits are worth that type of risk, and now is not the time to change your credit standards.

Chart from DCG’s cross-institutional database suggests rates on fixed-rate commercial real estate held steady throughout 2020.

13. At what point on the yield curve can your institution receive the best spread (i.e. 5-year vs 10-year)? Could you even “coerce” the borrower? If not, can interest rate swaps be used? Competition is not going away in 2021. Cash levels are high, the investment world is challenging, and the best credits have more leverage in negotiations (and they know it).

14. What does the 2021 budget look like for loan volumes? While there is clear activity in most markets, DCG continues to hear that loan growth will be difficult in 2021. Overall growth (net of PPP forgiveness) will likely require a significant offensive strategy.

15. What is the defensive strategy to maintain existing relationships? So much focus goes into bringing in new loan relationships (offensive strategy), yet existing loans are walking out the back door and going to a competitor. Loans that are maturing/repricing within the next 18 months are "in play" and need to be defended. Realistically, any loan that does not have a prepayment penalty has the potential to be taken away. Even at these rate levels, prepayment penalties (even on floating-rate deals) remain critical.

16. Is now the time to consider loan purchases? There are institutions that are supplementing organic loan growth with loan purchases of all shapes and sizes. Often, the reaction is “the last time we made loans outside our lending footprint, those were the ones that had problems.” In many cases, that was true. However, following that logic, it would suggest every loan outside your marketplace is a bad loan. At a time when loan volume is under pressure and cash continues to build, understanding potential purchase options could reduce risk (not add to it).

17. How has the credit quality of your loan portfolios held up? While there are clearly areas and industries that are under pressure, the overall credit sentiment seems cautiously optimistic. Nonetheless, what are the specific credit characteristics that could cause a problem on your balance sheet? In DCG’s credit stress test analyses, unemployment (one of 13 economic factors employed in the model) is a driving force. As seen on the following chart, unemployment, while improved, remains elevated. What will the impact be on your institution?

Unemployment Rate from 2000-2021.

18. Given that asset generation/replenishment is challenged in most markets, what is your outlook for bond portfolio activity in 2021? Will it be maintained, expanded, or reduced?

19. The overall economic outlook and potential for inflation seem to be questioned more when discussing securities than other parts of the balance sheet. This is likely due to the fact it is the only part of the balance sheet that is held at market value (assuming AFS). Should you consider utilizing HTM for securities purchases?

20. What is your investment strategy in 2021? Some should be extending cash, while others should stay relatively short. Some should consider pre-investing where others may consider selling. There is no one-size-fits-all strategy for any part of the balance sheet, and the investment portfolio is no different.

21. What are the tiebreakers to all the questions above? Based on your strategic plan, can you answer the questions above and rank in order of tiebreakers? If your goal is to continuously optimize your balance sheet, precedence must be placed on specific objectives.


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Keith Reagan is an Executive Managing Director at Darling Consulting Group. He has more than 25 years of experience working directly with community institutions helping them to improve their overall performance through the proactive management of liquidity, interest rate risk and capital by developing strategies that best fit the risk/return dynamics of their balance sheets.


© 2021 Darling Consulting Group, Inc.

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