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  • Writer's pictureKeith Reagan



In the summer blockbuster Top Gun: Maverick, we catch up with Lt. Pete Mitchell (call sign: Maverick) as he breaks Mach 10 in an experimental aircraft.

It sure feels like that is how fast interest rates have been changing during 2022. The entire banking industry is night and day different than at the start of:

  • The year

  • The pandemic

  • The last rising rate environment

  • The last inflationary world

The vast majority of those reading this Bulletin have never experienced this amount of (or any) inflation in their professional lives. There is no playbook for the current environment.

Think back to the end of last year when you were finalizing the 2022 budget. Most assumed one, maybe two increases from the Fed late in the year. Oops.

Now it appears that Fed Funds could be 3.5%+ by the end of 2022.

Throughout the pandemic, the industry has gone through a transformation. Deposits grew so much so fast that the industry reached unprecedented loan/deposit ratios. The dramatic growth in liquidity and the expectation of gradual rate increases caused many to assume deposit rates would not be increasing in 2022. Oops.


From the Editor

There is nothing like an edge-of-your-seat summer blockbuster. Thirty-six

years after the original, Top Gun: Maverick has captivated audiences all over the country and people are flocking to cinemas in record numbers.

For me, the allure of watching the very best pilots in the world fly aircraft at inconceivable speeds is inspiring and wildly impressive. In a way, it reminds me of what the very best ALCO committees are facing in the current environment.

Unequivocally, the speed at which the economic environment is changing is breaking new “sound barriers,” and now is the time when ALCO committees must “earn their wings.”

In this month’s Bulletin, Keith Reagan refers to a “blockbuster” definition of a top-performing ALCO authored by George Darling back in 2007. George astutely noted that committees need to have clear objectives and base decisions on good information (not just data) with emphasis on future earnings.

Within this context, Keith addresses many of the pertinent balance sheet issues regarding the current environment and asks committees to really challenge themselves in this cycle. He reminds us that the old playbook for rising interest rates might not work this time around.

So as the second half of the year unfolds, buckle up that chin strap and get ready for one heck of a ride.

Vin Clevenger, Managing Director


So here we are. The Fed is aggressively increasing rates. The benefit of lagging deposit rates is quickly coming to an end, while high levels of industry liquidity and an inverted yield curve are holding loan rates/spreads down.

Margin pressure is forthcoming.

This is when top-performing ALCOs outpace their peers. But just how is “top-performing” defined? For that definition I will go back to an article written by George Darling (call sign: Legend) in 2007:

"Top-performing ALCOs are very focused on managing future net interest income and making decisions that will impact interest rate risk, capital, and liquidity on a go-forward basis. For most top-performing ALCOs:

  • ALCO meetings are considered important to all attendees

  • All key areas of the institution are represented

  • The agenda is focused on clear objectives with emphasis on the future, not the past

  • Decisions are made that influence strategies for: investments, loan products & pricing, deposit products and pricing, wholesale funding, hedging, capital management

  • Decisions are made at meetings and responsibilities are assigned

  • The ALCO package is clear and concise, filled with information and not just data

  • Committee members understand and have confidence in the accuracy of the reports Policies are designed and documented around business perspectives and not primarily for regulatory appeasement"

Source: George Darling, “Assessing Your ALCO Process,” 12/2007

George Darling

Thank you, George. A mentor, a friend, and a legend.

This is as true today as when George wrote it. Top-performing ALCOs know that the last rising rate cycle’s game plan cannot simply be duplicated this time around.

Deposit Pricing / Stability / Strategy

Every deposit base is different today than it was the last time rates were rising. Top ALCOs continuously ask questions about:

  • Where the growth came from – internal shift vs. external campaign?

  • Whether or not it is going to remain on the balance sheet (both qualitatively and quantitatively) The impact on liquidity and interest rate risk of deposit outflow or migration

  • The importance of proactive segmentation that highlights customer stability/profitability (i.e., bill pay, direct deposit, multiple relationships, loan relationships, etc.)

  • Whether rate is the driving force for the relationship or if it is other factors (service, location, insurance, etc.)

  • The betas assumed in the ALCO model. When was the last time they were changed? Are they reasonable? Will you change rates based on them or will you follow competition? If one or two large customers complain, will you raise rates for everyone? See the Bullet Point below on how expensive the Marginal Cost of Funds can be if all rates increase to satisfy a few rate-sensitive customers.

  • The variables that determine the stability (or lack thereof). Type of deposit, vintage, size, and the other variables above all matter. Does your model account for this?

Using the same gameplan, assumptions, and model in a vastly different world is not what high-performing institutions are doing. There is work to do on the funding side of the balance sheet.

Given what appears to be happening with rates, it is time to take strategic action.

Wholesale Funding

Industry-wide wholesale funding usage has declined given the massive increase in deposits. As rates rise, are you prepared to utilize them once again? How much capacity do you have? Is this factored into the deposit pricing strategy going forward?

Understanding how much deposit outflow you would be willing to accept and what that means to wholesale funding levels and overall liquidity is essential to effectively managing funding costs. Wholesale funding can be an effective tool that impacts liquidity, interest rate risk, and earnings.

Loan Pricing / Spreads

There are many ways to price a loan. Some utilize models, others price to the market or competition, whereas some lenders rely on “gut feel." None is inherently correct or incorrect. Regardless of the approach, it can be impactful to compare origination rates to an index over time and see the changing spread. Spreads are declining in the industry.

Look at your historical spreads and ask yourself if you are being paid fairly for the risks you are taking today, remembering that an inverted yield curve has always signaled a recession.

The following chart captures all DCG client CRE originations over the last year. The spread to Treasury a year ago was above 3%. Today it is closer to 1%.

Commercial RE Fixed 2021-2022

Apply this analysis to your institution’s portfolio and use as a basis for discussion at your next ALCO.


Investments are an important piece of the balance sheet, providing liquidity, earnings, and diversification – and are therefore an interest rate risk management tool. In the last rising rate environment, asset- sensitive institutions layered duration in the investment portfolio (that would not pre-pay) to protect themselves against falling rates. If you are asset-sensitive, are you looking at similar strategies right now? Adding asset duration while rates are rising may seem counterintuitive, but ALCO is not about predicting interest rates, it is about managing risk.

If you have exposure to falling rates, your investment portfolio can help.


Much like the investment portfolio, derivatives are a tool designed to help manage interest rate risk. Are they in your toolbox? If so, there are institutions executing strategies right now as insurance against their risk. If you are not currently using derivatives, I encourage you to learn more. If after learning more they are still not for you, you are still more educated on the subject, which cannot hurt.

We live in a very different world than not that long ago. Given that, you should be asking different questions and looking at things differently than before. Don’t be afraid to challenge yourself. Challenge your modeling assumptions.


Top-performing ALCOs do not look at the same reports quarter after quarter to satisfy requirements. They continuously challenge themselves and discuss how to improve earnings while managing within approved policy parameters.

If your ALCO is not like this, be the Maverick in the room and ask why!


Learn more about our Asset/Liability Management services.



Keith Reagan is an Executive Managing Director at Darling Consulting Group. He has more than 25 years of experience working directly with community institutions helping them to improve their overall performance through the proactive management of liquidity, interest rate risk and capital by developing strategies that best fit the risk/return dynamics of their balance sheets.


© 2022 Darling Consulting Group, Inc.


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