I have two lifelong passions – saltwater fishing and sports! My friends and colleagues know that in the summer I can be found on the Atlantic Ocean fishing with the family, running outdoors, or catching my boys playing ice hockey at our local rinks. And while this summer has brought more precipitation than usual to New England, the fishing and sports have not disappointed. This, coupled with getting back to “in person” meetings with executive and board teams throughout the country, has made for a productive and enjoyable summer season thus far.
The teams I work with across our country know I get great pleasure in working fishing and hockey stories into our dynamic discussions around key issues bankers are challenged with. It is also a great way to keep ALCO members and directors engaged! As such, I am excited to share three “summer stories” with parallels to banking and highlight themes that should be top of mind for this last half of 2021 and beyond.
From the Editor
After a recent visit by some clients to our home office in Newburyport, Massachusetts, I was reminded of how fortunate we are to live and work in a community with such a deep and storied coastal heritage. The charm of our little seaside town, its rich maritime history, and federalist period architecture had our friends from the Midwest soaking in an experience totally unfamiliar to their part of the country.
In this month’s Bulletin, Keri Crooks shares with us some of the parallels of her
summertime passions and current issues within the industry. In many respects, Keri Crooks is the embodiment of a quintessential New Englander. She is a former college athlete who was brought up in a fishing family and is married to a commercial lobsterman.
She draws comparisons between the current inflation debate and the surging price of a lobster roll, the resistance training of her son’s hockey training and the “drag” lenders are dealing with in today’s market, and lastly, the utilization of technology to yield better results. (If lobstermen are using data and technology to their advantage, then why aren’t bankers?)
We hope you enjoy some “summer reading” courtesy of Keri and can incorporate a few of her thoughts into improving your business.
Vin Clevenger, Managing Director
$40 Lobster Roll, Anyone?
Would you believe the iconic sandwich of summer has reached an unprecedented $40 (depending on the venue)? I had a meeting with an ALCO team last week, and the head of Trust and Wealth Management immediately asked, “Keri, what in the world is going on with lobster prices?” He had several clients in his office recently asking why this summer delight is so elevated in price this year. “Inflation!” he responded.
Given that my husband is a commercial fisherman, we have benefitted from this post-pandemic bump in seafood prices.
But in reality, the reason for the price increases is threefold: 1) seafood imports from Canada normally flood US markets, but due to COVID this has not happened, 2) restaurant demand and summer tourism have resumed, and 3) more Americans have learned to cook at home and found that seafood is actually not that difficult to cook after all.
Coming out of this recession, demand has increased as people are spending, and supply is more limited than in prior years bringing inflation/higher prices to something as basic as lobster. It is important to mention that this is MUCH different than the great recession of 2008 when lobstermen could not even sell their catch, and no one knows how long this “bump” in prices and demand will last. These trends are strikingly familiar to many other food products, construction materials, and consumer goods thus far in 2021. I point this out because inflation is not just happening in the auto industry or hotels or airfare, which are frequently referred to as the drivers; inflation is happening at the “ground level” on most domestic goods. There are many smart economists on opposing ends of today’s Great Transitory Inflation debate. The ongoing dialogue of why “this time is different” and when the FOMC might remove accommodation and ultimately hike interest rates can be perplexing (if not exhausting) for all of us.
And unfortunately, even the smartest bankers, business owners, and examiners can all too often get bogged down in debates around inflation and what may or may not result in higher interest rates.
Ironically, if you examine the revenue stream derived from a financial institution’s balance sheet and core operations, the greatest long-term risks are to a sustained current rate environment or falling rates – not rising rates in the wake of unrelenting inflation and a continuously improving economy.
The earnings pressure is the result of investment and loan portfolios continuously generating cashflow from contractual and unexpected payments, which are being replaced at currently lower rates. Recent feedback highlights that the competition for loans remains fierce, the further flattening of the yield curve is painful, and minimal relief remains available from lower funding costs (which are approaching zero). Additionally, the dominant concern is for next year – 2022 – with less one-time fee income from the PPP loan programs and mortgage banking activity.
At DCG, we often find ourselves reminding industry participants there is no crystal ball. It will be important to manage to your risk position (not biases, hopes, or daily consensus) given that the road ahead for the stock and the bond markets will continue to be choppy as the great inflation debate continues, tapering discussions commence at the FOMC, labor and wage pressures persist, and global COVID concerns percolate.
Parachute training for stronger endurance
I received a video last week of my 7- and 10-year-old boys at an elite hockey camp with a parachute attached to their back and their respective 200-pound coach holding on to the roping of the chute. What a sight to see as these featherweight kids are at the end of an intense 6-hour day of training but still manage to perform under pressure with a smile.
The video showed a slow and steady struggle across the sheet of ice but also got me thinking about lending teams across the country – commercial and consumer divisions alike. These kids have the best facility, top-notch equipment with recently sharpened skates, and the best coaching, yet they are “dragging” a resistance parachute with a lot of weight attached to it…no matter how fast they skate or how elite they are, the ice being gained is modest at best.
Being involved in discussions with hundreds of high-performing financial institutions, the “dragging” feeling is similar for commercial and consumer lending staff alike. They have the best tools, top-notch expertise, flexibility of structure, term, etc. at their disposal to originate and grow their loan business. But on a net basis, they are facing strong resistance from the headwinds of existing loans paying off early or refinancing. The volume of loans being originated on a monthly, quarterly, and annual basis can be quite substantial and diverse by product type, but many are still witnessing modest net new loan growth for the total portfolio. The struggle is even more fatiguing for institutions with sizeable PPP loans that continue to undergo forgiveness and have yet to see line utilization increase.
While every pocket of the country differs and each group’s credit and risk tolerances vary, it is important to understand how much of your balance sheet will cashflow through planned amortization and maturities, but also with continued loan prepayment activity.
The following DCG calculation depicts a sample institution over the 12 months:
In this example, the institution needs to grow the bond portfolio by $75MM at an average yield of 1.50% (this is in addition to the $200MM of bonds needed to be reinvested from the existing portfolio) and add $165MM of loan growth while also averaging a loan rate of 3.50%. These are the hurdles to just “maintain” current interest income within their investment and loan portfolios.
It should be noted that this is $165MM of loan originations on top of the $850MM of loans projected to cashflow that need to be offset.
The growth targets can be sizeable (5-9% in this example) to just “maintain” revenue and “endure” this lower rate environment, never mind utilize any other incoming liquidity (e.g., deposits or PPP cashflows).
If the institution opts to shorten the average duration on the bonds being purchased, yields decline commensurately and require even more volume to offset the revenue loss. Similarly, if an institution decides to lower rates on loans universally or materially, the volume hurdles increase.
It is critical to understand your loan portfolio’s prepayment activity and have access to cashflow analysis and the resulting asset growth hurdles at your ALCO and team’s visibility. Your lenders (and entire ALM team) need to understand the realities of what it will take to stay revenue neutral. Although for some institutions “neutral” may not be a reasonable goal within the loan portfolio given their forecasts and resources, it might be time to reduce the “drag” on our lenders and think differently about lending strategy.
Which of the following views looks more advantageous and profitable?
Lobster fishing in the Atlantic Ocean without technology:
Lobster fishing in the same location but with technology:
Investing in technology and providing business solutions don’t need to be mutually exclusive. My early morning ocean view from our boat looks considerably different than the software and live maps of the ocean’s bottom where the lobsters prefer valleys and crevices.
They do not live above the waterline, yet so many in the business STILL, TODAY, rely on following other fishermen or looking at visible structures when setting their traps to catch their product.
Technology is readily available and provides a solution by mapping the depths and underwater structures for improved performance and charts brought to life in no time. The software provides a profitable solution to avoid running blindly a critical part of your business…this is not just an investment in technology.
The same is true for DCG’s suite of 360° solutions, which similarly convert what many institutions view as a software expense into a valuable investment with visible outputs related to loans, deposits, and liquidity planning. There are numerous examples of value-added returns emanating from improved customer loan retention strategies, loan prepayments, and more informed deposit product and pricing strategies.
A recent example is from our Deposits360°® solution whereby the cross-institution analysis aggregates and succinctly displays current and historical deposit results for financial institutions. There has been a significant spike or surge in deposits since the onset of the pandemic…somewhere north of 30% for annualized growth, and the broader industry is now managing “a balance sheet inside of a balance sheet.”
This increase in deposits and liquidity are accompanied by a variety of uncertainties that continue to raise important questions about the dependability of these elevated levels and, most recently, strategy discussions on future appetite for deposit outflows, comfort levels with utilizing wholesale funding, and ability to lag on increasing deposit rates coming out of this cycle.
Your institution’s outlook on the stability and future strategy related to these deposits has significant implications for lending appetite, cash and bond strategy, loan pricing, deposits strategy, and use of wholesale funding.
Just like the lobsterman with the best technology, investing in technology that converts empirical data into actionable strategy is of critical importance to ALM.
The season will soon change, but these summer stories and key industry challenges will not fade. High-performing businesses are constantly managing to their changing balance sheets. They diligently understand the headwinds to their core operations and prepare strategies accordingly. Technology that can make lots of data easily understood, while giving you the full landscape, can only serve to improve current and future profitability.
ABOUT THE AUTHOR
Keri Crooks is a Managing Director at Darling Consulting Group. She consults directly with ALCO groups and boards of directors at banks and credit unions in the area of asset liability management with the goal of enhancing high performing institutions.
© 2021 Darling Consulting Group, Inc.