Fed Rate Cut Implications and Considerations

Deposits | ALM Strategy | Interest Rates

On 9/17/25, the Fed announced a 25bps rate cut – its fourth since the tightening cycle ended in mid-2023, but the first since last December (total of 125bps thus far).

While the announcement was in line with expectations, it does come at a time with continued uncertainty regarding the forward paths of employment, inflation, and economic activity. Mixed messaging from economic indicators, and the potential for political influence, continue to raise questions as to “where we go from here?”. And where short-medium-longer term rates go from here, and the resulting yield curve shape, can have notable and varying degrees of impact on the banking industry in general, and your institution in particular. Uncertainty remains high and thus net interest income (NII), liquidity, and credit risk trajectories are yet to be played out.

Some Good News

Notwithstanding ongoing economic and rate uncertainties, the Fed rate cut will provide some important cover for reducing funding costs that had become notably “sticky” for most banks and credit unions in the face of the Fed pause over the past 9 months. If the Fed eases again at the late October meeting as is currently expected, then market rates will move below the current 4.00% “psychological hurdle”. This will enable all rates on CDs, higher rate non-maturity deposit specials, and negotiated rates to jump more readily and confidently onto the “3% downward rate slide”, providing a nice boost to funding cost reductions as we head into the end of the year. For other than perhaps more asset-sensitive institutions (e.g., floating rate lenders), this will create welcome additional NII momentum going into 2026, especially if the Fed were to ease again in December.

Also, keep in mind that intermediate term rate levels matter greatly and can accentuate or mitigate deposit pricing enhanced margin expansion. This is particularly the case for the majority of community banks and credit unions whereby most of their asset cashflow reinvestment and repricing yields are influenced by the belly of the curve (most notably the 5 year point). Thus, intermediate term rates remaining near current levels and a resulting steepening of market yield curves will add to “the good news” in terms of current NIM. However, institutions hoping for a notable pick-up in residential mortgage activity will likely continue to be disappointed.

While it is insightful to have a perspective on rates, it is important to not lose sight of your balance sheet and the “implied rate bet” embedded in its structure. Be careful in letting a rate perspective become an undue rate bias in terms of your ALCO strategy development activities.

As DCG thinks through the implications for our clients and their unique balance sheet needs, there are some considerations we believe all institutions should evaluate. There are clear opportunities as well as challenges associated with this current environment.

Deposit Pricing: Importance of Establishing Tie-Breakers

What the market gives you and what competition is doing are relevant pieces of the deposit strategy puzzle. So are your institution’s specific liquidity, interest rate risk, earnings, and overall growth and strategic plans. Our conversations with bank and credit union leadership teams clearly support the notion that maintaining current deposit balances is a high priority for seemingly all but an explainable few.  Be sure to establish clarity as to the trade-offs of funding cost reductions and deposit growth.

For a deeper discussion of current market implications for overall deposit strategy, we invite you to listen to a special episode of DCG’s On the Balance Sheet® podcast with Managing Director Billy Guthrie, DCG’s lead deposit consultant. 

Also, for institutions with more diverse market areas with differing deposit mix, market share, and competitive dynamics, appreciate the potential value of developing distributed pricing and product strategies that leverage the differences as opposed to one-size-fits all approaches. Having both offensive and defensive strategies can be invaluable in simultaneously realizing deposit growth and funding cost reductions.

In the spirit of tie-breakers, consider the following illustration we like to use in reinforcing the importance of tie-breakers when establishing not only deposit strategies, but also strategies for lending, investments, wholesale funding, derivatives, etc.

Time Deposits

The six-month Treasury rate is down 50bps in the last 45 days to 3.81%, and brokered deposit offering rates are below 4% across the board. This should also give cover for your CD pricing strategy considerations.

Most CD activity is rollovers, and DCG data shows that most rollovers are occurring at lower rates than the 4% specials that many institutions have been holding onto. Also, DCG’s Deposits360°® analytics platform clearly demonstrates that the more CDs roll, the less rate sensitive they are. Use this to your advantage.

Remain cognizant of the yield curve inversion that continues to exist out to 2 years and factor this into your CD pricing strategy. If you are targeting term funding, you are better off from a cost perspective to roll funding short and swapping out the term (e.g., to 2 years) rather than paying up to incentivize short-term CDs to extend maturities.

Notwithstanding, if market rates play out as currently expected, 2026 could produce a positively sloped yield curve. Given the tsunami of near-term CD maturities at the vast majority of institutions, next year will be the appropriate time for most to address the term structure of their CD base. Be mindful of the fact that your tactics for doing so matter and can impact not only the results, but also the impact on your cost of funds.

As you implement deposit pricing changes, be sure to ensure that you have appropriate monitoring of daily activity and receive feedback from the field; both will be instrumental for assessing any issues/concerns or opportunities reflected in how customer behaviors occur or don’t occur given your incremental changes.

Non-Maturity Deposits

Establish a clear Fed readiness strategy for the next 25bp and the next one, and if 50bp, and if they were to pause again. A marginal cost of funds analysis is a simple and effective way to highlight the impact of rate reduction considerations vs. potential balance implications, and thus break-even considerations for holding rates steady vs. varying degrees of rate reductions.

For institutions with premium money market or savings rates in the low 3s, discuss your plan for the next hurdle: when and how to lower rates below 3.00% to the extent the Fed eases again this year as is currently expected.

Also, as short rates declined, the difference between CD rates and premium MMDA/Savings rates has compressed and will continue to do so. This creates an opportunity to shift CD maturities into non-maturity products, which don’t continue to receive renewal notices and provide broader opportunities for pricing strategies. This compression also opens up more doors for repatriating deposit balances that left for brokered CDs, money funds, or even treasuries. Try it, it works.

Revisit your tiering structure for deposits. It’s time to be more surgical and better align your tiers with your actual balance spectrum.

Wholesale Funding

Short-term market rates have declined and are currently expected to continue in that direction. Keeping wholesale funding short may help take advantage of a falling rate environment while providing important flexibility for cost of funds management and interest rate risk management.

For example, if your institution is liability sensitive (as many are), it may be more advantageous to reduce rising rate exposure with interest rate caps (currently very inexpensive) rather than terming out maturities.

Also, it typically is much more challenging and thus costly to incentivize depositors to extend CD maturities vs. synthetically extending wholesale funding with interest rate swaps. A key consideration is always how far to extend. As with all maturity questions, it’s important to let your balance sheet define your needs (interest rate and liquidity risks) rather than the current yield curve or your “gut instinct”.

Loan Portfolios

Loans originated over the past couple of years were at higher coupons, and borrowers may see incentive to refinance, so the ability to forecast prepayment risk is critical. A sound first step is to segment portfolios by size/coupon/origination date, etc., and develop offensive and defensive strategies to enhance and protect borrowing relationships.

What is your philosophy on prepayment penalties (enforce, waive, or modify)? Be prepared for these conversations. There is no “one size fits all” across portfolios. Some view this as a “penalty” that they are uncomfortable enforcing, while others look at it as an “option or a luxury” for a borrower. Take pause before giving away valuable options “for free”, and if you do, at least educate your customer as to the actual economic value given to them and get some goodwill for it.

Will you be able to maintain credit spreads as rates fall? Credit metrics throughout the industry suggest that spreads should be expanding, while in many cases, deals are getting done at tighter spreads. Our extensive set of client simulation models continues to reflect an expected upward trend in NII, which has influenced interesting and productive conversations as to loan pricing discipline vs. desired/needed loan growth, as well as conversations regarding relationship vs. transactional activity.

Loan pricing and strategy discussions are under-represented in ALCOs. Strive to change that; it matters.

Investment Portfolio

The sting of unrealized losses lingers for many. As time passes and the extent to which term rates decline further, the losses should continue to trend lower, and there will once again be elevated discussions on potential loss trades. Remember, there’s no free lunch, ever.

ALCOs need to fully vet the assumptions in any trade to understand the “payback” proposition and resulting changes in their risk profiles, since the payback does not come from rebuying the same securities but rather from accepting additional risk(s). Loss trades are not black and white; they are and should be circumstantial, in relation to your circumstances.

For institutions exposed to declining rates, look seriously at pre-investing security cashflow and giving up some current yield for call protection. While earlier would have been better, it’s still not too late.

Also, don’t underestimate the value of call protection and potential for producing reliable gains that can be monetized if the economy deteriorated and credit issues materialized. Such environments are typically accompanied by lower rates across the yield curve and thus harvesting gains could be important in offsetting earnings reductions and hits to capital.

Derivatives (Insurance Policies to Reduce Risk)

It may not be too late to layer in protection against falling rates. While the cost is certainly higher, it may still be an appropriate strategy. The key is to understand the risk/return of both action and inaction.

The cost of rising rate protection (caps, swaps, etc.) has become much less expensive. Consider adding protection against rising rates while rates are falling. When’s the best time to buy insurance? Before you need it!

If derivatives are not a tool in your toolbox, investigate them. Become educated on them. They can be critical risk reduction tools and even add to current earnings.

Your ALM Model

Revisit your key assumptions. Remember the degree to which model assumptions and actual results diverged materially when rates rose in the recent cycle. Revisit your declining rate assumptions and make sure that they are defensible and not unduly optimistic.

Ensure behavioral assumptions (deposit decay/rate-sensitivity, prepayments, loan betas, etc.) have been updated (with both quantitative and qualitative factors). What materialized in prior declining rate cycles may not play out the same way. Understand the sensitivities and related impact of key/material assumptions. Be mindful that deposit and loan betas are not linear, that betas have very relevant life cycles, and that betas and decay are correlated. The data exists to ascertain and understand these important assumption variables for both declining and rising rate environments.

Also, remember that stress testing is not for “bad times.” If you wait to stress test until you are in a time of stress, it’s far too late.

We hope this brief discussion sparked a few ideas. While yesterday’s Fed easing is welcoming for most bank and credit union earnings, uncertainty still prevails.

As DCG is well known to say: “Change the conversation” and “look at yourself through different lenses” at ALCO. Don’t underestimate the value of doing so. The path ahead will remain uncertain, but thoughtful planning doesn’t need to be. This is an opportune time to revisit deposit, lending, and investment strategies, as well as to reassess key balance sheet assumptions and prepare for a range of outcomes.

We are available to discuss how these dynamics may affect your institution and to help ensure strategies remain grounded in reality, not speculation.

---

Talk With Us

---

© 2025 Darling Consulting Group, Inc.