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  • Writer's pictureJoe Bona

Laying Groundwork or Throwing Darts? Budgeting Through Uncertain Times

Now Is the Time to Do Our Homework on Deposits

“There are two kinds of forecasters: those who don’t know, and those who don’t know they don’t know.”

A colleague recently shared this quote by Rolf Dobelli from The Art of Thinking Clearly, and I couldn’t help but think of the connection to budgeting for the year ahead.

The last 10 months have been a continuation of one of the most unprecedented environments many financial institutions have ever experienced. If history were any indication, accurately predicting what will occur next might feel virtually impossible.

As we all turn attention to the year to come, I’d like to share some key factors for management teams to consider when crafting their 2024 budgets.


From the Editor

As the calendar flips to November, most financial institutions initiate their annual budgeting exercise for the forthcoming year.

For some, they simply apply some generic growth rate to both loans and deposits. There isn’t much science behind the methodology, but it’s just “what they do.”

Others incorporate a more formulaic approach studying the most recent blue chip economic forecasts to get a clearer picture. They place it into a mathematical “blender” to develop a forecast that likely is just precisely incorrect.

Whatever your approach, 2024 might be the biggest crapshoot of them all.

Do you subscribe to the compelling case for rates moving higher as inflation refuses to relent and jobs are plentiful? Should we believe the Federal Reserve and its repeatedly promulgated narrative of “higher for longer?” Or do we think 2024 is the year the long-predicted recession finally reaches our economy?

In this month’s Bulletin, DCG Director Joe Bona writes about the various considerations forecasters need to contemplate as they develop budgets. He urges them to evaluate how asset growth dynamics influence their current liquidity positions. He questions the merit of growth if it occurs at spreads that aren’t accretive to capital.

And if all else fails, he mentions the utility of throwing darts as a backup plan. Hopefully, you discover a perspective that helps “dial in” your 2024 budget!

Vin Clevenger, Managing Director


Liquidity Review

Before we can unpack loan and deposit expectations for 2024, we must look at where liquidity levels sit today.

From an overall liquidity standpoint, levels have tightened for most groups over the last few years. Cash balances have dwindled down, used to fund loan growth or cover deposit outflows.

Consequently, wholesale funding usage is up to fill the gap. If deposits continue to contract/hold flat and loan growth is realized, this would apply additional pressure on liquidity as institutions would need to raise wholesale levels further.

Furthermore, given what occurred during March with SVB and others, liquidity is at the forefront of examiners’ minds, as evidenced by the July interagency guidance around stress testing and contingency planning.

So how does this impact planning for 2024?

Funding Expectations

Most start the budgeting discussion on the funding side of the balance sheet. What are fair rate projections (both for my deposit base and for the Fed)? How will my cost of funds change? As evidenced in DCG’s Deposits360°® database, costs continued to rise even as the Fed held rates steady recently.

Not only have deposit rates risen, industry data to this point also displays a combination of runoff and mix shifts within the deposit base as consumers search for a return on their balances. Many institutions have experienced a decline in non-maturities with a portion shifting to higher-costing CDs. If they were not able to retain the relationship within the CD portfolio, the balance was likely replaced with another form of liquidity (cash and or wholesale). Each of these examples has resulted in higher overall funding costs.

If rates remain higher for longer, does that mean non-maturity costs will continue to rise or do they settle in and hold steady? How does that impact your 2024 budget?

Whether the Fed Funds rate increases, falls, or holds steady, the Deposits360° model does not expect the pressure to dissipate. Depending on what your institution forecasts internally for base case market rates, it may be worth considering an additional budget iteration reflecting an alternative outlook as that could impact interest expense projections.

With further strain on liquidity expected on the horizon, institutions may be forced to increase offering rates meaningfully on MMDA and CD special products for retention purposes. There has been a gap between offering rates and wholesale rates historically. That window will close tighter and tighter as the curve inversion lives on.

Source: Darling Consulting Group Deposits360°®

What are expectations around balances? COVID surge balances are certainly down from their peak levels, but a portion remains embedded within the deposit base today. DCG’s analysis points to this running lower in 2024. Between inflation-related reasons, alternative investment opportunities, and competitive alternative offerings just a few clicks away, pressure has not and likely may not abate. Most are anticipating further declines within overall deposit bases. Some non-maturity balances may shift and be absorbed within the CD base (at higher costs), while others may leave entirely.

Source: Darling Consulting Group Deposits360°®

Lending Outlook

I have had discussions with several institutions who mentioned that lending has materially slowed. Perhaps there is limited inventory (residential) or commercial loan rates have reached levels where the math doesn’t work anymore. Some even remarked that they would be happy to simply “keep total loans flat” for next year.

Recognizing that deposit pressures continue into 2024, how does that impact forecasting for loan production? If you fund loan activity with wholesale balances, are you comfortable with the higher cost and pressure that puts on liquidity? Is the rate you receive on the loan adequately compensating the institution for its risks?

It is not uncommon to see loan activity funded with deposit promotions. In some cases, the cost of the incremental funding is just slightly below the corresponding loan origination rate. If the spreads on those deals were evaluated in isolation, they generally wouldn’t even cover overhead expenses. Effectively, those institutions are allocating valuable capital toward a transaction that isn’t accretive to earnings. Therefore, one cannot lose sight of the impact of loan growth aspirations on both liquidity and capital.

Another variable for consideration in projecting 2024 balances is the influence of expected prepayment. Unsurprisingly, higher interest rates have significantly reduced the incentive to refinance. While most ALM models incorporate some expectation for runoff over and above P&I payments, it may make sense to get a better feel for what actual activity occurred.

Lastly, but perhaps most important, is the outlook for credit moving into a very uncertain environment. It’s no secret that the industry has operated in a benign credit environment for the last several years. But is 2024 the year that changes? Some have already tightened credit standards. For others, it’s still business as usual. Whatever the case, management and lending teams must synchronize their “views of the world.”

Bond Portfolio Management

One area of the balance sheet with varied opinions on strategy for 2024 is the investment portfolio. The calcification from unrealized losses has some running for the exits in 2024. In fact, they’d rather stand pat and redeploy any cashflow they receive into loans or paying down borrowing positions. Worse case scenario, they do nothing and earn greater than 5% in cash.

Others are looking to flush those losses down the drain and reposition their portfolios via what is commonly referred to as the “loss trade.” In this scenario, managers seek to set the balance sheet up for future performance. (While this discussion is not intended to be an exhaustive analysis of the loss trade, we recommend that all facets of those transactions be fully vetted prior to execution.)

And lastly, there are some executive teams who are undeterred by the bloodbath in the bond markets and who continue to “average into” the significant sell off in market interest rates since early 2022. History would suggest that duration at this point in the cycle might not be the worse idea, but will this time be different?

In Summary

The opening quote by Robelli reminds me of an annual tradition on a local Boston Sports Talk radio show. Every year prior to the NFL Draft, the hosts put the names of prospects up on a dart board. They then throw darts to guess who the hometown Patriots will select. The Coach / General Manager Bill Belichick has a penchant for drafting unheralded players. Believe it or not, that dart board has a better track record of accurately predicting picks than most of the local pundits. But at least these radio hosts are smart enough to know what they don’t know!

Unfortunately, the budget for 2024 feels very similar. You could easily make a case for higher rates, lower rates, or the proverbial “higher for longer.” Will the Fed continue to increase rates? Will the Fed begin to cut rates? What is the shape of the yield curve? Should we anticipate further deposit contraction or is it almost over? How does that influence our loan projections? Will we see credit deteriorate?

Don’t run to the dart board just yet! Laying the groundwork now, asking the appropriate questions, and ensuring all have a clear understanding of the impact each decision can have on earnings is vital for success in 2024. Best of luck to all!


For more insights from Darling Consulting Group, click here.



Joe Bona is a Director at Darling Consulting Group. In his role, he assists banks and credit unions of all sizes throughout the country with asset/liability management. He works with management teams to develop institution-specific strategies to improve financial performance while effectively managing interest rate risk, liquidity, and capital through the ever-changing economic and regulatory environment.

Joe began his career at DCG in 2015 as a financial analyst. He earned a B.S. in business administration from Bryant University.


© 2023 Darling Consulting Group, Inc.


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