New Year's Resolutions for Your Institution
As with the dawn of every new year, many people look in the mirror and decide there is an area of themselves they’d like to improve. The excesses of the holiday season generally lead to self-introspection and some specific action plan for the betterment of their health. Typically, you hear about changes to diet (no more sugar/carbs), folks finally joining gyms (or purchasing Pelotons), or maybe a less quantifiable goal such as spending more time with friends. Whatever the declaration, on January 1, people set out determined to make this year better than the last.
But what about your Institution? What are your resolutions for this approaching year? Are there areas for improvement and altering of prior strategy? The following is a short list of resolutions for your consideration in 2021.
From the Editor
Happy New Year and welcome to the first edition of the 2021 Bulletin! The turn of the calendar is a perfect time to recalibrate and set goals for your business. Accordingly, the theme of the January article is all about resolutions. What are your institution's “resolutions” for the current year? Could it finally be time to change up your “routine” and challenge long-held business practices?
Similarly, a change has occurred in this very space. Keith Reagan, the former editor of the monthly Bulletin, has taken a more active role in internal management and, therefore, is stepping away from the Bulletin. We thank Keith for his tremendous work and ability to produce valuable content over the past 12 years. In this case, my only resolution is to maintain the high standard he has established for this column.
Vin Clevenger, Managing Director
Start with a full diagnostic workup.
It has become commonplace for people to have blood tests administered to better understand their biological processes. The unearthing of different markers could provide clues on how to best manage their diet and reach their goals. Your balance sheet is no different. If you really think about it, the balance sheet has experienced myriad different stressors since the pandemic started. There are a lot more moving pieces on the balance sheet than ever before. Additionally, the interest rate environment has changed significantly in the past 12 months. A balance sheet which may have traditionally been liability sensitive might now appear as asset sensitive. But is this really the case? Are rising rates now your friend, whereas they used to be your worst enemy? While FOMC Chairman Powell has essentially indicated short rates are anchored, what occurs on the long end of the yield curve will ultimately determine profitability levels for many institutions. Does your current modeling project the influence of a steeper yield curve? What about if rates take as long to “lift off” as projected by the Fed in its recent Dot Plot? What if the pandemic-induced deposit “surge” is matched by a commensurate exodus of these same funds from the balance sheet? How would all those new term assets look if they were instead funded with market rate borrowings? Are these scenarios captured in your modeling and influencing balance sheet decision making?
Before formulating a plan to best manage the balance sheet for 2021, it's imperative to understand what the balance sheet will ultimately look like in a wide array of interest rate scenarios and to understand the impact of varying assumptions on those results.
Keep your hand out of the cookie jar.
Despite eating a relatively healthy dinner, I usually find myself locking eyes on the cookie jar. Although, I clearly understand any indulgence would eliminate all the sound dietary decisions from the day, I still find it difficult to resist the temptation of a decadent chocolate chip cookie. It is very similar to what balance sheet managers are dealing with in the current environment. Many are sitting on piles of cash and have resisted the urge to put the money to work via the investment markets. The challenges are many. Rates are historically low. Margins are under assault. Mortgage prepays are at unprecedented levels. Additional stimulus is on the way. What if rates stay “here” for the remainder of 2021? A hard reality is that the cash position is only “getting worse.” Is it finally time to indulge in one of those cookies and boost our income? No matter what the right approach for the balance sheet is, making decisions to reflexively boost income levels because of mounting earnings pressure can have consequences. Before pulling the trigger, have you analyzed the level of COVID-related deposit “surge”? What are the alternatives? What does the loan pipeline look like? If we purchase investments in the current environment, what could they look like in several years? Is it possible we could generate the same income return with half the total investment if rates move higher? What would the liquidity profile look like if the entire country was vaccinated tomorrow? For some institutions, purchasing investments in the current environment is unequivocally the right strategy; for others it can be a different story. Be sure to make informed decisions and not rash judgements predicated upon historically high cash balances. While the sugar high is enjoyable, the amount of exercise to “work it off” may not make it worth it.
Change up your routine.
Although experts contend that diet is really the key driver for losing weight, you can certainly augment your results with a solid workout regimen. For many, that means hitting the treadmill or a stationary exercise bike for 30 minutes. But does that really provide any benefit? Most bodies adapt very quickly to a “routine” and, consequently, the expected results are much different than the reality. 2021 will continue to challenge long-held tenets in lending. It will require agility and hard work. Status quo may no longer yield the desired results. Lending in this environment most likely means we will continue to see intense competition and lower rates at longer terms than ever before. Often, you will hear lenders mention specific rate levels at which they “draw a line in the sand.” The same could be applied to maturity/amortizations. But does a legacy strategy still yield optimal results in the current environment? While loan rates are at unprecedented levels, your funding costs should be reaching historical lows as well. Ironically, if you look at loan origination rates pre-pandemic versus today, you could make the argument that since funding costs have fallen dramatically, spreads have actually widened! Also, if we are saying no to the loans, what are we implicitly saying yes to? Cash? Investments? One discussion that is alive and well is the decision to hold or sell mortgage production. On one side of the coin, gains on the sale of conforming product are averaging in the 3% range. In fact, those with significant mortgage volumes during 2020 may have had record earnings. But how long will it last? What if the early January sell off in the bond market is just the beginning to a more prolonged increase in interest rates and refinance activity evaporates? What may happen if that treadmill we have been running on is powered off? Consequently, some institutions are contemplating the viability of holding residential mortgage production today while the activity is still strong. Lastly, what role may derivatives play in executing balance sheet strategy? Is your management team and board aware of potential opportunities for your balance sheet? Is now the time to reposition your balance sheet for future business cycles? For some, considering derivatives is akin to leaving the comforts of a stationary bike and venturing into a CrossFit class.
But maybe 2021 is the opportune time to change up your approach and long-held beliefs to achieve the best results.
Spend more time with your friends (particularly the new ones).
There is plenty of data that demonstrates a strong correlation between mental health and physical well-being. Given the challenges associated with the past year, everyone looks forward to spending quality time with their family and friends. While it is hard to quantify the benefits of these interactions, it is a critical component of a wholistic approach to improving your health.
There is no better time to make sure the communities you serve understand that their local lender is there to assist them though a very difficult operating environment.
While the pandemic may have restricted human interaction with customers, it has simultaneously presented a golden opportunity to grow your customer base.
Specifically, the Paycheck Protection Program has introduced customers to the personal experience of working with a small community institution. These folks were largely disregarded at the outset of the pandemic. In many cases, they had no idea of the value proposition a community institution could provide.
And with the second iteration of the PPP now underway, the industry has another chance to pry away market share from the larger banks.
It makes sense to dedicate resources to make sure we treat our new friends like our old ones.
Don’t give into the temptation.
The hardest thing about making a resolution is “sticking with it.” Like most diets, the first five pounds come off easy, and the early returns are satisfying enough to keep you engaged. However, it's when you start to see a plateau that it becomes awfully easy to just give up and go back to your old habits.
Make 2021 the year your institution takes a hard look at its balance sheet and investigates new solutions to the challenges presented. Ultimately, at some point all bad habits must be addressed, and the “reset” the pandemic has offered is the perfect opportunity to position your institution for years to come.
Good luck to all in the New Year!
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ABOUT THE AUTHOR
Vin Clevenger is a Managing Director at DCG. In this position, he currently advises financial institutions on balance sheet management strategies. He takes a practical approach to the demands that the economic and regulatory environment place on his clients. Since joining the firm in 2003, he has worked in a number of capacities within DCG assisting clients in all aspects of ALM including process reviews, model validations, policy reviews, capital management, and contingency liquidity planning.
© 2021 Darling Consulting Group, Inc.