Fighting NIM Compression

Intro:Helping community bankers grow themselves, their team, and their profits. This is the Community Bank Podcast. Now, here are your hosts, Eric Bagwell and Tom Fitzgerald.

Eric Bagwell: Welcome to the community bank podcast. I’m Eric Bagwell, along with Tom Fitzgerald coming to you from Atlanta, Georgia. This is our fourth show and we’re excited that you’ve joined us again. Tom, are you doing okay?

Tom Fitzgerald: I’m doing good, Eric. And we are in July now. How about that? I know there’s a summer is moving along.

Eric Bagwell: Crazy times, but the summer moves on and getting closer to what we hope is a football season, but who knows that change just seems like it changes every day. We are excited that you guys have joined us. Like I said, this is our fourth show. Today we’re going to talk about the liability side of the balance sheet. We’ve got a couple of guys joining us for a conversation, today with Tom. Jeremy Lucas, is the director of Balance Sheet Strategies here at CenterState Bank. Jeremy actually works down the hall from Tom and I, so he was an easy guest to go pick off and bring in. So, we’re excited to have Jeremy. Jeremy, you doing okay?

Jeremy Lucas: Doing good. Thanks for having me.

Eric Bagwell: Good deal. And then we’ve got Todd Wacker. Todd is not with us in Person, but Todd is the Vice President and Senior Relationship Manager with the Federal Home Loan Bank of Atlanta and Todd, we appreciate you being on with us as well. You’re doing alright.?

Todd Wacker: Yes. I’m doing good. Happy to be here.

Eric Bagwell: Good deal! We do appreciate you being on. Tom. I’m going to turn it over to you, and we’re going to just kind of walk through what we’re seeing on the liability side of the balance sheet. Talk about funding and just some strategy on that side so…

Tom Fitzgerald: Okay. I would think most community bankers spend probably at least a majority of their time and up to 75% of their time looking at the asset side. So, as net interest margins come under pressure, the funding side certainly does have to get its share of attention. And we think that with the guys that we have today, they spend a hundred percent of their time on the balance sheet and on the funding side. So, it’s a case where we, you know, we can kind of draw on their expertise and some of their knowledge to sort of go through ways and techniques and just some good ole elbow grease, how we get the funding down to the cheapest levels possible because every basis point counts when you’re talking about net interest margins and Jeremy was with us today, he’s our Director of a balance sheet strategy for CenterState bank. And Jeremy, can you just talk through some of the things that you’ve been doing most recently in that regard?

Jeremy Lucas: Sure. Tom. It’s really important just to have an active liquidity management funding plan. It’s no secret over the last few months, banks are flushed with liquidity. You’ve had Government Stimulus Programs, you’d have P.P.P, you had a large corporation drawn down the credit facilities depositing those back into the banks. Not only that, you’ve had delayed tax payments, that’ll be going out in July. You’ve had the savings rate. I think the historical savings rates since 1960 is around 9%, in April that jumped to 32% and then may 23%. So, until you see some of those start to flow back out, banks are going to be flushed with liquidity, kind of compresses your margin a little bit. So, what do you do? Having an active strategy in place and active deposit strategy funding strategy is very important. You know, here at center state, you know, we kind of last year, when the fed started cutting rates in July, we kind of started taking a look at, all our deposits obviously.
And not just us, but we’ve talked with peers and a lot of special pricing, a lot of promo pricing; Just where can you lower costs and lowering product cost, product rates are obviously very important and easy to do, but there’s a lot of times things fall through the cracks. and so, we’ve kind of taken a look at that and just remain discipline on looking at all those rates. Other peer banks have mentioned the same thing as well they just, over time, I think the last time the fed cut was December 2008. So, you had a decade where there’s no fed guts, really didn’t have to worry about this as you mentioned, spending a lot of time on the liability side. And so, as the fed cut three times last year, and then again, you know, twice effectively to zero in March, we’ve just taken a fresh approach to that, and having somebody look at those monthly, looking at all your rates were can you just earn a few extra basis points?

Eric Bagwell: And I also remember we sat in on an A.L.C.O Committee Meeting, probably in the fall of last year. And one of the things that Jeremy was talking about were some of these old accounts; old promotional accounts that were still on the books, earning way above market on the interest rate. And so, like you said, talk about things falling through the crack. And that was just a case of you just sort of, compare it to like blocking and tackling. It’s not glamorous, it’s not sexy, but sometimes you just got to dig into the reports, go through almost line by line to say, okay, what are these accounts? Why are we paying it a 4% rate? It’s not a large balance, but obviously every little bit helps. So, you know, some of the stuff is, like I said, it’s not high tech high, high touch, it’s just a matter of getting in there and rolling up your sleeves and kind of just going through the reports. So, it can be as simple as that sometimes. I wanted to bring in Todd Wacker now from the Federal Home loan Bank. Todd, how are you doing?

Todd Wacker: Oh yeah, I’m doing good, only a couple miles away, but I think we’ve got a safe social distance working here.

Eric Bagwell: That’s right. You’re sort of Midtown-ish and we’re kind of uptown. So…

Todd Wacker: Yeah.

Eric Bagwell: Separated only by a few miles of Aisle 75. Working at the Home Loan Bank, you’ve got a special kind of what I would call the “catbird seat”, so you can kind of see what a lot of banks are doing, from the funding side of the balance sheet. And could you just talk briefly about what are some of the real popular things that the banks are doing right now with the funding and the types of strategies they’re doing? Are they moving, taking advantage of the lower rates moving, getting some long-term deposits, or advances on the books? Just kind of speak to kind of what you’re seeing on a frequent basis right now.

Todd Wacker: Yeah. I mean, a couple of things, and, you noted at the beginning of this, I guess, Jeremy, about the unprecedented liquidity out there, and we are always monitoring that as well. This was, just the positive banks have grown by $2 trillion this year, since January, with that being, you know, 860 billion in April alone. So, it’s a very liquid time out there. What we did see though, as we transitioned into this, COVID, or COVID preparation for a recession, was banks in our other financial institution members, really storing up liquidity, both on a balance sheet and off balance sheet. And now, as the balances have gotten high, we’re, now dealing with the next phase for them deploying those assets or those funds back out against assets, and our conversations have changed because I think the short end, the cash piece has done real well. We actually offered, advanced pricing special during this time. It’s almost finished as of now, but, you know, we offered roughly, you know, five to $6 billion at discounted far into one month to six month space, just as a reaction to help the liquidity positions during this time.
So, since our conversations now it’s shifted a little bit, now we’re talking a little more strategy now. And one of the items that has come up more frequently is, restructuring current advances. So, our advanced borrowings offered a lot of flexibility and one of them is the ability to modify the terms. And now with the rate environment kind of where it is; just looking at one of my rate sheets from beginning of the year, we were pricing a five-year borrowing at 187 and now that’s down to 69 basis points. So, we’ve had different members come in and inquire into maybe some of their advances with, six months or a year, even two years remaining seeing what it looked like if they push this back out to the five-year point, take advantage of this flattening, the curve, really just lowering overall the entire curve. So that’s one place where we helped them add a little liability duration, but use the ease of the advanced product to do it.
Probably another one that we were talking about is along the same lines is , for starting advances. Again, the whole rate curve shifting down 100 – 150 basis points just in this year. It starts to make the opportunities look a little bit more attractive to push out. I mean, I know a long-term focus is tough to do, and there’s so much short term stress right now, but just one example again, if we just stick with that five-year space, like I said was about 59 basis points right now, and if you delayed the start on that two years, so two years (inaudible 09:22) starting three year, so there’d be a still a five year final ,looking at a rate of about 74 basis points. So, you’re paying, you know, you’re really paying the cash flows , that’s when the curve starts to move back up towards the last couple of years, but you’re not doing an exorbitant rate or the curve is pretty flat.
And in doing that kind of in this example, if you did this for a $10 million borrowing, if you just did the straight five-year bullet, you’d be looking at about $345,000.00 interest cost over the life. Whereas you do the two year [inaudible 09:56] starting three year, you’re looking at $222,000.00 in interest costs. So, you know, you’re, you’re picking up the interest cost savings with putting some, you know, you know, a little bit of duration on that same time not taking the funding down right no and liquidity is at such a high watermark. So those are kind of two, of those quick ones that come to mind. I don’t know if you guys want to talk more about, pay fixed swaps, tied to funding because that’s always a attractive product as well here.

Eric Bagwell: Well, let me ask you Todd, on something you’d mentioned a few minutes ago, and that was, we’ve got a lot of banks that are sitting on it, advances that are probably open, the rate is well above market at this point. Can you usually work them out of those into a lower cut where it makes economic sense for them, whatever the prepayment penalty is. Sometimes they don’t even look at it because they’re like us; they’re going to hit me with a penalty and it’s just going to take away the advantage of the low rate. Are there ways where they can mitigate that to where it does make sense?

Todd Wacker: Right. So, there’s no magic to this. The simple thought of it is, it’s taken what the underwater market is on the, current advance. So, let’s just, I’ll make the numbers easy on myself. So, let’s say it’s 5% underwater and it has two years to go. And we’re going to take that 5% mark now and spread it over let’s say five years and we’d add, so whatever my five-year rate is today, you take that 5% divided by 5, this is back of the envelope numbers these are all, there’s some nuances to it, but it’s back to the envelope, but we’re going to take that five-year rate and now add 1%, and so effectively we give me 1% per year.
So now we go from the 69 basis points to the 1.69, but what we’re doing we’re taking that, loss or mark to mark. It’s not mark-to-mark, the loss position now and spreading it for the two years out to five years, but effectively lowering your interest rate costs, for the next two years versus what you’d be paying on the existing advanced, so kind of accomplishes two things, one it adds some duration further out the liability side and it provides you with some cost savings today. Probably a third thing is it adds that duration but I’ll have to take out additional advance.

Eric Bagwell: Sounds good. And I think that’s something that all bankers probably should at least explore to see because I really think, this lower for longer rate period I think is going to be around for a while. And if they can shave, like I said, just if it can be just basis points that help the net interest margin and that’s probably going to the long run its going to benefit.

Todd Wacker: Yeah. Right. And it’s very easy for us to take a look at it on a quick level and then put some tighter numbers on it. So, we are to encourage our membership base to reach out to the relationship managers and just ask them and we’re happy to run it. It’s not a time-consuming process for us. And if savings is key, which I think we looked out through the next couple of quarters, I think any savings on them is going to help. So that might be worth putting on some restructures.

Eric Bagwell: Yeah. Well, that’s good information Todd. Now, I want to kind of switch back to Jeremy and kind of go over the sort of the state of the banks today is they’re a wash and liquidity from triple P loan proceeds from stimulus checks that are still sitting in accounts and allot of uncertainty is how much of that liquidity is going to hang around for a long term and what do you do with it? And so, have you developed some strategies or some thoughts on what we do with this liquidity right now and how long do we expect at that levels are going to remain that way?

Jeremy Lucas: Sure. We thought, with P.P.P, I guess that it got extended to 24 weeks versus eight weeks. And so we thought we might see some initially trickled out and even in, during the eight week period, we, we didn’t, obviously we just completed a merger with SouthState and say the same boat with liquidity So, we are flush with liquidity but all banks are, and maybe that goes out now in late fourth quarter, early, next year versus now. But no, I think we’re saying the same thing. We’re just fighting that NIM compression. There’s so much liquidity on the balance sheet. Record high levels whereas Todd mentioned, funding costs are at record lows, in loan to deposit ratio is at a 29 year low, rates low , one year broker CD rates, one year advanced rates, I think around 25, 30 basis points, I think you can get up to three or four years still under 50 basis points so you don’t need that, but we’re taking a look at that and do you run off core deposits? Do you invest, do you buy bonds? Do you buy securities? You know, looking at public funds as well, some of those are costly, have to be collateralized. So, looking at all those different strategies, not knowing when it’s going to run off, obviously but thinking it’s going to be here for a little while, at least to the end of the year.

Eric Bagwell: I want to change it up a little bit and talk about the competition from digital banking. We had an episode, I guess our last episode that was all about, Fintech and digital certainly when you’re dealing with that kind of platform, it can be challenging. Do you monitor a lot of the digital bank and what the rates are? and I don’t say compete with them or try to compete with them, but how do you sort of keep them on the radar and how do you manage that competition?

Jeremy Lucas: Yeah, that’s a great question. We’re never going to be able to compete on rate with those guys. I was actually able to hear the Treasurer, Goldman Sachs speak at a conference last year, talking about their markets platform. And I think to the end of last year, they had about 55 billion of deposits. It generated a billion and a half a month just in deposits through the Markus platform and she mentioned they’re not the highest rate, but they’re the ease of use and just the ability to open up other products through them. So, we’re not going to compete with the rate chasers , We’re more, especially in these times of uncertainty, the customers want stability, they want a strong bank to talk to, so we’re not going to compete with the rate chasers and some of those, you just have to let go, so I think that’s important to realize kind of, knowing your customer base.
And another thing she mentioned was, kind of going back to your earlier question, is her number one goal this year was to optimize funding, to minimize interest expense. They just said Goldman’s more cost conscious than ever when borrowing, looking at tenures, looking at the A.L.M side and when the largest banks in the world talking about this, it’s definitely important all the way down to the community banks. And it’s an easy way to kind of, the people probably don’t spend enough time on

Eric Bagwell: What do you see right now as sort of your biggest challenge Is it that liquidity question and how that’s going to flow in the next several months? or …

Jeremy Lucas: I think so, especially with liquidity being so easy to move right now through the online platforms, projecting that liquidity out a certain amount of time, whether it’s, 30 days, 90 days, it’s just, where does that go? Obviously, it’s not quite as important right now because we’re not going to have that liquidity crunch, but I think just getting a better handle on where that goes, and then just looking at opportunities not maturity deposits are probably not as much opportunity. There are a lot of banks, CenterState, SouthState had a very low cost of deposits, cost of funds among the best in the industry. There’s a lot of opportunities for CD repricing coming up. At our bank we have a significant amount maturing this year and across the industry. So I think that’s kind of the next opportunity as those CDs, reprice lower. But like you said, the challenge of managing it, kind of going forward, not knowing when all the uncertainty is going to play out.

Eric Bagwell: And it looks like you might be getting more liquidity when that forgiveness of those P.P.P loans proceeds start to flow back to the banks. And that could, like you said, they extended it to 24 weeks, I think. So, they went from an 8 week to 24 weeks. So, there’ll be a period of a longer period where those forgiveness proceeds will come back. But it seems like that’s just going to throw another chunk of cash onto the pile that bankers will have to figure out and at least that money, they know they’ve got control of. It’s not a deposit, it’s their funds. And so they can, probably utilize it to pay down other, maybe more expensive funding or move it into the lending market or back into investment. So, yeah.

Jeremy Lucas: Yeah, that’s a great point. I think it’s a great time to kind of review all of that. I think a lot of it went into DDAs for us, but how long has this elevated liquidity going to be here? How much excess liquidity do you want on the balance sheet? And then for some of the small bankers as well, it’s like, now’s the time to kind of get everything in place, get your policies, procedures, your borrowing capacity in place for when you do need it in the future.

Tom Fitzgerald: Well, I want to thank you Jeremy and also Todd. I want to thank you from the Home Loan Bank that I think for all the bankers out there listening, certainly, most of them having a relationship with the Home loan Bank. And I think they really need to kind of revisit if they’ve got advances on the books and kind of wondering can I change that into a more economical advance to reflect current funding? So again, utilize the resources of Todd and his colleagues at the Home loan Bank and Todd, we certainly appreciate you being with us today. And a lot of the insights that you’re able to provide us.

Todd Wacker: Yeah, thank you for letting me be a part of this.

Tom Fitzgerald: And Jeremy too your insights from actually running a large balance sheet and the funding side and a lot of your knowledge and expertise, I’m sure the bankers out there, appreciate hearing from you and what you’re doing to try to minimize funding costs and, and to keep net interest margins where they are, without, shrinking any more than they already are. So again, thank you for all your insights today.

Jeremy Lucas: Yeah, and we have a great relationship with Todd in the Home Loan Bank and always reach out to those guys just to take advantage of what the industry is doing and not just in a vacuum. So..

Tom Fitzgerald: Yeah. It’s a great resource from the Home Loan Bank. I used to be an employee years ago, we won’t go into that right now, but it was a great organization to work for and so it’s a great organization that brings a lot of resources to community banks, all across the Southeast. So take advantage of that and utilize that, as we work through these challenges in the coming months. Anyway, Eric, what do we have going for a future episodes?

Eric Bagwell: Tom, we’ve got, coming up at the end of this month, we’ve got some more shows that we’re going to actually record here in the next couple of weeks. We’re going to talk about marketing. We’ve got a lady coming on that’s going to do that. She is here in the Atlanta area and got some pretty cool information on what banks need to be doing as far as marketing to their communities. We’re going to talk about kind of the looming credit shock that’s coming that people think is coming in later this year, we’ve got someone that’s going to join us to talk about that later in July, but we’re excited that folks are listening to this podcast.
We hope it’s helpful and that it’s helping you guys in your bank. We’ve had, I think over 700 listeners. So please, if you enjoyed this, go out and give us a five-star rating, we’ve got quite a few of those. Tell other folks about it, We appreciate you tuning in and we look forward to talking with you next time. Thanks!

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