There's no doubt that the COVID-19 pandemic has changed life as we know it in this country and around the world. Congress and the Federal Reserve have reacted with initiatives intended to soften the impact — including two rounds of stimulus packages aimed at helping small businesses with forgivable loans — and this has helped stabilize the stock market for now. Still, as we emerge from lockdown and begin opening up our economy, the full impact on community banks’ financial performance remains to be seen.
While “those who don’t learn from history are doomed to repeat it,” is often referenced, our nation lacks an exact parallel to COVID-19 to potentially “repeat.”
The financial industry did encounter a similar economic storm during the Great Recession of 2008, resulting in the failure of hundreds of financial institutions. One challenge, in particular, is resurfacing now: Banks are struggling with maintaining a healthy net interest margin (NIM).
Barry Adcock, Deluxe Banker’s Dashboard Sales Executive, was the CFO of NorthSide Bank in Georgia from 2004 to 2016, and he led his bank through that tumultuous time. In the thick of the recession, the bank's CEO let Barry and his team know that it wasn't a matter of "if" the bank would fail, it was a matter of "when."
"By the end of 2007, the Feds were slashing rates," Barry said. "It proved devastating to our net interest margin. By 2008, our credit quality began to deteriorate rapidly. In 2009, our NIM had plummeted and the regulators had come in and placed our bank under a consent order."
Dire as that looked, the bank survived, due to some quick thinking and smart tactics employed by Barry and his team. Keeping a sharp eye on the numbers and reacting quickly to downturns was enough to increase the bank's NIM. It kept the bank alive. Barry recently shared those winning strategies in Deluxe's webinar, "Rebuilding Your NIM with the Long Term In Mind."
There are many similarities between 2008 and 2020:
- Drastic rate cuts by the Federal Reserve Board
- Lower asset yields
- Reductions in cost of funds lagging
- Thinner margins resulting in lower earnings
Although the situations aren't exactly analogous, many of NorthSide’s strategies during that tumultuous time can be applied today to help banks stay ahead of NIM challenges.
11 strategies banks can immediately apply to increase NIM
NIM couldn’t be more important for a bank today. It accounts for 90% of a bank’s earnings and is a central measure of an institution’s financial viability.
The Fed’s rate cuts and the congressional stimulus packages are serving to infuse liquidity into the economic system to stabilize and stimulate the economy. The short-term impacts to banks will likely be lower asset yields and thinner NIMs, thus lower earnings. The good news is there will be opportunities in the coming weeks and months for banks to lower their cost of funds, allowing NIMs to slowly recover.
Focusing on two vital components for your bank — your funds and your people — is critical to boosting your NIM.
Here are some tips and tactics you can employ right now to ensure everyone makes it through this storm.
1. Focus on liquidity
During the Great Recession, the major issue was credit quality. This time around will be quite different. Job losses and the economic slowdown may accelerate liquidity issues. Funding has not yet become an issue due to high demand for the small business loans that are part of the stimulus package, as most of these loans are being funded by the Federal Reserve and borrowers are depositing the proceeds to cover future payroll needs. Many banks are also seeing an influx of deposits as their customers receive their stimulus checks. But how long will these funds stay on the balance sheet? How quickly will these funds flow out as states begin to open up the economy? What liquidity challenges lie ahead? These are some of the questions banks are facing.
Nothing will cause the failure of an institution faster than a lack of liquidity — the ability of a bank to meet the demands of its depositors. Uncertain economic times are fear-inducing for your customers, and these fears can ratchet up very quickly. A lack of trust in the government and in the financial system can lead customers to irrational decisions like withdrawing cash and storing it under their proverbial mattresses.
Another outgrowth of economic uncertainty is financial hardship for your borrowers, especially if they work in industries that are temporarily closed. A lack of revenue coming into their tills each day reduces their ability to make loan payments, thereby reducing cash in-flows at your institution. So just what can and should you be doing right now? Focus daily on ratios and trends that have to do with liquidity.
Work with your board to develop a target liquidity range that you’re comfortable with. Adcock recommends shooting for a number that's a bit higher than the recommended minimum of 10%, to provide a cushion. Identify a number that fits the risk profile of your institution and provides you the ability to execute on your long term strategy.
Getting this liquidity aspect right will put you in a great place to have a soft landing and recover more quickly when this economic storm subsides.
2. Monitor cash and cash equivalents
Determine the level of cash and cash equivalents you need on your balance sheet to achieve that target liquidity range. Once you know that number, monitor it as closely as possible every day, acquiring additional funds as needed or letting excess funds roll off when opportunities present themselves. Ups and downs will occur, but you should be concentrating on the trend. Your target may need to be readjusted over time as loan demand fluctuates or you experience early loan payoffs.
Performance management platforms allow you to set an alert to notify you if that number falls below your target. As the crisis begins to abate, you can reduce that liquidity target. Excess liquidity sitting on your balance sheet will be a drag on your margin, but right now you need the security, safety and comfort level liquidity provides.
3. Focus on three trends: Total loans, total deposits and loans-to-deposits ratio
Follow these trends daily and be ready to react to them. Any time there is a negative shift in any of those numbers, you'll want to know the day it happened. Forecast your sources and uses of cash at least on a monthly basis. If liquidity starts to get tight and funds are more difficult to acquire, you might want to consider going to a weekly forecast. Regulators may require this, depending on how long the situation persists. The key here is to avoid any unwelcome surprises.
4. Consider cutting deposit rates
It's true that cutting deposit rates too much, too quickly can result in a loss of deposits. During the prolonged economic expansion, many banks had to pay higher rates for deposits, especially money market and time deposits, to meet the increased loan demand. As a result, these banks have large blocks of time deposits maturing and repricing lower each month. Access a CD maturity report to analyze and understand the maturity schedule of your time deposit portfolio
5. Evaluate your contingency funding plan
When's the last time you reviewed your contingency funding plan? Review and revise as necessary to fit the current economic environment. Work with your board and update those plans. Update your cashflow stress test scenarios to reflect this current environment. Test those contingency funding sources and make sure they’re in place and available. Also, review your collateral. Identify collateral available for pledging before it becomes necessary to do so.
6. Look for opportunities everywhere
Begin immediately looking for opportunities to lower your cost of funds, while balancing the need for liquidity and your asset/liability position; paying higher rates for longer terms will still likely lower your cost of funds but give you more protection against future rising rates, given the extremely low-rate environment we are operating under; and incent your depositors to move funds from money market accounts to time deposits to reduce the sensitivity to rising rates in the future.
7. Create open communication and transparency
Establish and maintain your lines of communication with funding sources, the board (or designated committee) and regulators, keeping everyone up to date on your situation. And, don't forget your staff. Morale can plummet quickly if your people think the bank is in trouble. Make sure they know you're doing all you can; be transparent about the situation and make sure everyone knows their role is vital. This is the time to have all hands on deck doing everything they can to boost your NIM.
8. Educate and train your staff
Educate staff at all levels, from the board room to the teller line, on the value of one basis point in NIM. Train them on the little things they can do every day to move this needle, including connecting with friends and acquaintances about moving their non-interest-bearing deposits to your bank. Also talk with them about what metrics are the most important to your institution and how what they do contributes to your success. And just as important, encourage and reward new ideas from your staff.
Also, train those who have responsibilities for negotiating on loan and deposit rates to become better negotiators, getting every basis point possible on loans and paying the least possible rate for deposits.
9. Evaluate your loan portfolio
Calculate the effect the rate cuts will have on your loan portfolio. The impact will depend on the pricing structure of your loan portfolio and the extent to which the yield is protected by rate floors when you made the loans. Also look at the maturity schedule of your loan portfolio. How can you reprice these loans as they come up for maturity and renewal to increase your net interest margin? If they don’t have rate floors, look for ways to insert those rate floors now.
Price loans appropriately. Make sure you are being paid for the risks you are taking. In this environment, you cannot afford to let your competition drive your pricing. Use a loan pricing tool like the one in Deluxe’s Banker's Dashboard. It will determine the pricing you need to drive your desired results. Once you get your model set up, your lenders will likely embrace it. It will give them information to become better negotiators when they’re sitting across the table from borrowers.
10. Begin reviewing your CD maturity schedule
Do you have a nice ladder spread out with relatively equal amounts of CDs maturing each month? Or do you have some large buckets all maturing at the same time? Twelve to tweny four months down the road, rates may be rising, and you’ll have to reprice those CDs again. Give your customers incentives to go for longer terms. Paying slightly higher rates for longer terms now will provide protection against a sharp increase in your cost of funds in the future. Ask yourself, “What do we need to accomplish?” Develop your pricing strategy based on that. Communicate that strategy often. Educate your staff.
11. Analyze changes to NIM
Are your efforts working? See if you’re gaining or losing basis points. Performance management tools have Margin Analysis capabilities that can calculate what the monthly impact of those changes will be. Drill down based on loan type to see where you may be gaining points and where you may be losing. That will help you determine where to adjust as needed.
The current situation is a defining moment for your bank and in your career. It’s not the crisis that will define you and your institution, it's how you respond. The economic situation will eventually settle in to a new normal. Those who adopt a growth mindset will be focused on capitalizing on every opportunity that’s out there. It's what we call Performance Banking. It means intentional actions driving results for community banks. It'll get you through this storm, and beyond.