Margin Tailwinds Are Slowing: What Can ALCOs Do Now?
- Zach Zoia
- 2 days ago
- 5 min read
For many financial institutions, margin expansion has provided meaningful earnings lift over the past several quarters. But the forces behind that improvement are changing.
Funding cost relief, which drove much of the spread expansion in 2025, is fading. Asset repricing is still providing support, but that tailwind will not last indefinitely in the current rate environment.
The question for management teams and ALCOs is increasingly clear: What will drive earnings when today’s margin tailwinds run their course?
The Funding Cost Tailwind Is Fading
In 2025, the average balance sheet spread across DCG clients increased by roughly 30-32 basis points. Approximately 75% of that improvement came from funding cost relief, with asset yields accounting for the remainder.
2026 is shaping up differently.
At the beginning of the year, DCG projections indicated approximately 18 to 20 basis points of spread expansion, with roughly 80% expected to come from asset yields and just 20% from funding costs.
That reversal is currently underway, and matters.
Funding costs appear to be plateauing for many institutions and could even move higher in some areas, especially if the Fed hikes. Deposit mix continues to shift, while CD pricing has increased in most markets, given the yield curve sell-off that began late first quarter.
Institutions that built budgets around additional rate cuts and continued declines in deposit costs are finding that the expected funding benefit will not materialize to the extent anticipated.
The rest of the balance sheet will increasingly need to do more of the work.
Asset Repricing Is Driving Margin…for Now
The good news is that asset-side tailwinds have not disappeared.
Loans and other assets originated during the lower-rate environment of 2020, 2021, and 2022 continue to cycle through the balance sheet. As those cash flows mature or reprice into today’s higher-rate environment, they can generate additional yield and support net interest margin and net interest income.
But that benefit is slowing, too.
DCG’s models suggest many institutions still have several quarters of positive momentum ahead. Beyond that, however, net interest income begins to plateau at many organizations, which creates an important strategic inflection point.
If maintaining a relatively flat balance sheet no longer produces meaningful incremental earnings, institutions need to determine where the next source of profitable growth will come from and what risks they are willing to take to achieve it.
Loan Pricing Discipline Becomes Even More Important
The changing rate environment also raises another issue: Are loan spreads keeping pace with market rates and funding costs?
Recent Loans360°® data suggests that, on average, institutions are not seeing the full increase in benchmark rates flow through to loan pricing.
Depending on the benchmark used (the five-year Treasury, five-year Federal Home Loan Bank advance rate, five-year SOFR, or another reference rate), market rates have increased approximately 100 basis points since February. Yet average pricing on commercial real estate loans, as one example, has generally lagged, increasing by less than 25bp on average thus far.
That gap creates the potential for spread compression, and a jumping off point for additional strategic conversation.
Competition for high-quality loans remains intense, but volume alone does not necessarily translate into profitable growth. Institutions should evaluate new loan pricing relative to marginal funding costs, market rates, credit risk, capital usage, and the value of embedded options such as prepayment penalties or make-whole provisions.
The objective should not simply be to add assets. It should be to add assets that appropriately compensate the institution for the risks it is taking.
Growth vs. Margin: An Age-Old ALCO Discussion
As existing margin tailwinds slow, management teams face a more difficult tradeoff.
Should the institution maintain its current balance sheet, accept the possibility of an earnings plateau, and protect existing spreads?
Or should it deploy capital and pursue growth to generate additional net interest income?
There is no universal answer.
What matters is understanding the economics and the risks of each decision.
Growing into unfamiliar asset classes simply because traditional loan demand is limited can introduce risks that may not be fully reflected in the initial yield. At the same time, positioning too conservatively could leave an institution with limited earnings growth once the benefit from legacy asset repricing has run its course.
That makes the conversation bigger than simply “growth versus no growth.” ALCOs should evaluate where growth makes economic sense, what returns are required to justify it, and how each decision changes the institution’s risk profile.
Prepare Now for the Next Margin Environment
DCG’s modeling suggests many financial institutions may continue to experience positive margin momentum through the remainder of 2026. The more significant challenge could emerge as institutions move into 2027 and the benefit from legacy asset repricing begins to diminish.
Preparing for that environment takes time.
New strategies may require policy changes, board education, operational preparation, and greater familiarity with asset classes or funding alternatives before an institution is ready to transact. Waiting until earnings have already plateaued can limit the options available.
That makes the current environment an important planning window.
ALCOs should be asking:
How much margin expansion remains embedded in our balance sheet?
What assumptions are driving our net interest income forecast, and how sensitive are they?
Are we pricing new assets appropriately relative to marginal funding costs and market rates?
Where can we generate profitable growth without taking risks we do not fully understand?
What will drive earnings when today’s asset-repricing tailwind fades?
Do we have the policies, expertise, and balance sheet flexibility to act when opportunities emerge?
The goal is not to predict exactly where rates or markets will move next. It is to create a balance sheet that remains flexible enough to respond.
There is no shortage of volatility or risk in the current environment. Institutions that educate their teams, prepare their boards, evaluate their options, and maintain a nimble balance sheet will be better equipped to adjust their position or change their earnings trajectory as conditions evolve.
Margin expansion may not end overnight. But the forces supporting it are already changing.
Institutions that recognize that transition early can make more deliberate decisions today about pricing, growth, liquidity, and balance sheet strategy and be better prepared for the environment that comes next.
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 an MBA from Babson College.
© 2026 Darling Consulting Group, Inc.
