5 Questions for 2024 with DCG’s Joe Kennerson

DCG Managing Director Joe Kennerson joins Zach and Vinny to dive into 5 key questions for bankers as we move our way through 2024. The trio tackles lingering deposit cost pressures, potential cost relief if the Fed eases, prospects for margin recovery, the need to talk about bond strategy, and whether falling rates will be everything the industry hopes for.

For more insights and ideas, visit DCG at DarlingConsulting.com or follow us on LinkedIn.

Transcript

On the Balance Sheet S3E2 - 5 Questions for 2024 with DCG’s Joe Kennerson

[Vinny, 00:05]

Welcome back to on the balance sheet season 3 Episode 2 and our producer Dana has mentioned to me that this is actually our 25th episode to date. So, really excited about that. Today is actually going to be quite unique episode, and I'm really excited about it, Zach. As you and I, as well as our colleague Managing Director Joe Kennerson, are going to kind of answer several questions which I think are really on a lot of bankers and and folks from credit unions, minds as to how this year may in fact play out and we might play a little bit of point counterpoint and be devils advocates as we go through these conversations. We have our own chance to quasi weigh in on what's going on in the marketplace, and maybe give a few predictions that hopefully age well, but maybe they won't so.

[Zach, 00:54]

Yeah, time will will certainly tell. And for the listeners, I think they're all aware last year we did this with our President, Matt Pieniazek - didn't do questions,  a little more themes. And we're just going back in the the January of 2023 podcasts that we had talking about some of those, you'll see some of those are still valuable today, I think. And he, he did a pretty good job talking about the funding costs escalator, becoming an elevator. Hopefully that's slowing down. Talking about liquidity is going to matter. That's this is before SBB, you know, by the way. Couple other things about inverted curves and some of the hidden risks in NI that I know have all played out. So, he did a great job. Joe, no pressure this year trying to follow in those footsteps, but I think it's gonna be a great episode; again, a little different than having a guest on, but hope the listeners, you know, have some good takeaways from this overall.

[Vinny, 01:39]

Yeah, Zach, that funding cost escalator. Looks like it's turned into kind of a moving walkway, if you will, at the top of a of a long, long ride up. But also, as we mentioned before, being joined by Joe Kennison. Joe has the benefit of just being off of a trip to Acquire or be Acquired, the conference that took place a couple weeks back now, and Joe has some terrific observations. Joe, thank you for joining us and very much look forward to kind of what was on other bankers’ minds at that conference.

[Joe, 00:02:10]

Well, thanks for having me, #1 and I I want to start by saying that I think you guys are doing a great job. It's been fun to listen to this, and I'm excited to be back. So yeah, a lot of I guess key themes from Acquire be Acquired out in Phoenix and hopefully to, you know, share a couple of those as we talk today.

[Vinny, 02:27]

Absolutely. So why don't we get kind of right into it. Zach, we've kind of thought through a handful of things that that are really emerging as we're several weeks into the quarter here. So, we're all you know, right in the thick of speaking with a number of financial institutions. And I'll tell you it's just about every conversation is starting kind of and ending really with the general theme as to, hey, look, when will deposit pricing pressure finally recede? When is it gonna end? So, Zach,  Weigh in.  What do you think? What are we looking at in terms of and what are you working with and speaking and what types of conversations you're having with your clients?

[Zach, 02:38]

Yeah, it's it's the start of every meeting. We're kind of talking about how we're still handling the consequences, we'll call it of the COVID surge and the Fed going up 525 basis points. So we're still kind of fighting that battle. And like you said, maybe it's more of a moving walkway now where things are slowing down, but I just came into the office from a meeting this morning locally. Every meeting this week, the other five I've had and all the other ones we've had this quarter, it's it's slowing, certainly, but there's still mix shifting. There's still some cost drift, some pressure and we're just trying to play as much defense as possible before, maybe the next rate cycle happens, whenever that is going to happen. And I think we'll talk more to that, but the sentiment I’m getting is it's slowing, but it's still there. We still get to look at It - still got to model those things out, play as much defense as we possibly can. I mean, Joe, what did you see out in in your speaking?

[Joe, 03:58]

Yeah. No surprise. This was one of the topics out out in Phoenix. You you really couldn't go into a session without hearing somebody talk about deposits. The question of, do we think deposit pressure is going to subside? Yeah, it's it's going to, right?. The real question is when and and how do we get there? And that's largely going to be predicated upon the pathway from the Fed. I mean if the Fed stays higher for longer, then we're gonna feel some pressure in the near term, and the further we get from the last Fed hike, that's gonna come, right? And then the question becomes when when the Fed pivots, at what pace and at what magnitude? And at Aoba Frank Farone and I were, we're lucky enough to to speak out there, and and we we tackle this topic.

[Joe, 04:45]

And I guess I'll respond, you know, the same way I did out there and and share some data right, really kind of you know, tackle this thing from a data perspective, and and we're very fortunate here at DCG where we get to see so much of what's happening at the ground floor with the data, and we've got this neat system called Deposits360, and you know, we're collecting data from our clients. We've got almost 300 D360 clients. Not only do we collect a lot of data, but we get to track things like cannibalization. And we've got this, you know,  neat forecasting model with, you know, that our clients can can utilize. And so what we did out there is we simplified it and forecasted out two scenarios and extrapolated from there. So, we started with a you know, a higher for longer you know scenario and and kind of did some some rate paths there and then look to the futures market. Now, a month ago, the Fed funds futures market had the Fed cutting rates 150 basis points, which just walked back a little bit today. When we're recording this in the middle of February, I'm going to start on the non-maturity deposit side and then and then we can come back to CD's. So, in our higher-for- longer camp and, by the way, that's just the Fed not cutting rates, just keeping rates where they’re at; our solutions are Deposit 360 is projecting momentary deposit costs to go up another 11 basis points in the calendar year of 2024. Now 11 might not seem like that much, but that's an all-in number. That's that, that includes non-interest bearing checking. The starting point is like 105. So we are still seeing that pressure that's you know we just lived that in January.

[Joe, 06:12]

I will say that within that analysis, a bulk of that is a continued shift in mix, less checking, less savings, more in premium accounts. On top of that, we're forecasting non-maturity deposit balances to continue to go down, and it's just 18 straight months. You know in aggregate that they've gone down, and it's it's likely to to continue and that both of those factors are are going to continue to to drive pressure on on deposit costs at least in the, you know, in the next you know six months or so in the Fed Funds Futures scenario that that we modeled out, we projected non-maturity deposit costs to go down 10 basis points, but it's hard in the podcast to talk about that cause you gotta visualize the curve, the pathway, right? Cause that's a point in time to point in time. A lot of that is, you know, realized on the back end - meaning that the lag pressures are still kind of being played out. And so that all kind of amounts to the fact that, yeah, this we know that the first half of the year is still going to put some pressure on the non-maturity deposit costs.

[Zach, 07:10]

It makes perfect sense. And you, you listen to earnings calls. You read the transcripts of some of the bigger banks who report. You talk to our clients, certainly, in in some of the data we have. A lot of similarities, meaning it's another quarter or two probably. And obviously to your point, well if the Fed is here for four more years, it's going to keep going. But the Fed does start to change. That might be an inflection point. And I'm wondering, too, Vin if we just kind of go to question #2 on the page here, which was really you know how much deposit cost relief can we expect when the Fed does cut? Or maybe if the Fed does cut, I think Joe, you were kind of getting to that in your in your response there, which is when they cut, what are the variables you're looking at? And how much do we think and what are we projecting I guess in in, in the data you’re seeing?

[Joe, 07:54]

Yeah, that was another key theme in our presentation out in Phoenix. And the takeaway there is that deposit cost relief at a Fed easing cycle is probably further out than we'd like. And the concept is, is pretty simple. We lag on the way down like we lag on the way up. You see that in every cycle. And you know from a balance sheet perspective, liquidity levels are still pretty tight early in, in the Fed easing cycle. Also, it's like there’s some human nature built into that, I mean think about the last two years how hard banks and credit unions have fought to hold on to these depositors, there's going to be that that need to maybe lag on on the way down. So, again, putting data to it. We we've got all this for the listeners, if they're interested in in getting geeky about this, but we looked at deposit rate pass in different, you know, falling rate scenarios and we simply just showed like a down one, down two, down three rampant. And what's interesting in the down one, and this is as of 12/31, we're not really projecting much non-maturity deposit cost relief. A little bit, but not much.

[Zach, 08:57]

So you're saying like 100 BPs from the Fed may not see any cost relief, it might take more than four cuts?

[Joe, 00:09:03]

Exactly. Exactly. And and it's again. It's the timing of that too, because it's likely that we could live times of negative betas. It's like, hey, the Feds, you know, cutting rates, but there's still that pressure that added.

[Joe, 09:17]

Pressure that where non-maturity deposit costs are going down so that that concept of negative data and you're thinking about that from from, you know, risk management standpoint is is likely, but even in the down two and down 3 scenarios another Fed cutting rates you know 200 under 300 basis points, those are going to be much different deposit and liquidity environments we we know that, but even if you look historically in in, in our forecasting models like there's it, there's that initial lack, there's that initial lag and so you you talk about this really from the the point of OK, what does that mean to to total margin and balance sheet strategy with obviously you know margin pressure is real. And then, you know, we even brought up the point that, yeah. You think about, you know, the five-year point of the curve, we're living a little bit of a selloff in the bond market, but the five year point still 70 BPs off its its highs in the fall. So, I can envision some loan pricing pressure, you know coming coming down the Pike. So, it's it's getting into the mindset from a strategy, you know, side of things of how can we get ahead of that deposit rate flag? How can we start having those conversations and preparing, you know, for that and so like the whole theme of building a Fed easing playbook strategically at ALCO and pricing meetings has been like a, you know, a big takeoff in, in our ALCO meetings this quarter just to try to be somewhat proactive and compartmentalize our depositor base and our and our product set to hopefully again get ahead of those those pricing lags.

[Vinnie, 10:42]

Joe, some of those data points that you just shared with us, I think are really, really important. It's almost like I want to repeat them for our listeners because it's, you know, we do have some a ton of data, as Joe alluded to, and Joe said it so eloquently. But a couple of main takeaways from what you just said was, look at, we still probably are going to experience 10, 11 basis points of additional non-maturity deposit cost increase off of a base which is already up over 1% right now. So, like that can be eye opening. You know, we're still, by the way, even if rates were to go back down, the models are projecting that you're still going to see some run off. We're still in the tail end, potentially, of that COVID surge. There's still some money that's kind of laying asleep, and it might wake up. Not a lot, but it’s still happening and, you know, the the other thing that you know in my meetings you hear and I've heard this over the years - I've been here for two decades and been through a couple of rate cycles, but you hear well, no, we we lag on the way up and we cut immediately on the way down. And I think there's a there's got to be some context placed around that because, generally speaking, no, they don't. And so this has significant ramifications, particularly on the budget side, as banks have really, the ink is now dry on most banks budgets. It should be by now. In many cases, the banks I'm speaking with, they didn't budget any funding cost relief for 2024 because of a couple of those facts. I think you know I hate to be redundant, but those are really, really Important takeaways for our listeners.

[Zach, 12:16]

You have, Vin, absolutely, and I think you look a lot of these models too and more folks are liability sensitive. So, you wonder too well, are they liability sensitive because they have an assumption they're going to cut deposits, right away, right. So, can they help quantify that? Cause to your point, I think all my meetings, everybody gets a good chuckle. We say the Fed cuts in May, let's make it up, which right now, I think, it's a coin flip, give or take. And that's been changing. Most people are like maybe you get a couple bips here or there off something, but nothing meaningful it, you know, it maybe it's to test the water on it, but they know it's going to be a couple cuts, couple quarters, probably, before they can really make any meaningful dent in there to Joe's 100 basis point kind of question. I think that's a really important take away as well.

[Vinny, 12:59]

No, absolutely. I mean part of it, too, is either this, this ideal that we always come down immediately, maybe that premium rate money market moves down a nudge, but everything else is still going there because the other part of that is the human element, I mean, folks have been arm wrestling to basically just maintain what they have and and we saw stabilization and deposits in Q4 on a relative basis. The outflow - it kind of slowed down. There's there's clearly evidence of that in the industry. But at the same time, you sit back and say, well, I've already been borrowing. A lot of these banks have just 10/15/20 percent of the non-maturities and they've been borrowing to fill that hole and it's like do they want to keep borrowing. So, it it's a really kind of an interesting time right now for a lot of these bankers.

[Joe, 13:48]

The other interesting piece on top of that said, you know, just spending time talking about non-maturity deposits, which is the bulk of it, you think about the the time deposit book and you look back at last year, obviously CD books, you know, grew tremendously. What we found in the data is that almost half of the CD growth was cannibalization shifted from non-maturity deposits into CD's. And that and that's what took a big bite out of out of margins, too. You look at it today and bankers are kind of in a pickle, right now where the bulk of CD's are coming due in the first half of this year. And so, in the average coupon for at least for what we see is is under 4%. So that is built into budgets. We know that those costs are going to go higher. The pickle is that the feds signal the pivot, the markets, anticipating it. Wholesale rates have come down a little bit at the time of this recording. You know when you're, you know, wholesale rates are around 5%, you know the. And so, the pickle is that like, Oh yeah, how do I start moving my CD pricing down when I know I've got, you know, a lot of maturities coming due, the first renewals are the most important and it's like oh, so just thinking about the overall CD strategy, I think reconfiguring that with this in mind. I'm hearing from more and more clients that, you know, this I don’t think it’s big surprise. But this year it's more about retention than growth. And so how do we reshape our offerings, our product offerings to align with that? In other words, do I wanna? Well, here's a question, where do I think I would have to be priced - ask your team this, where would I have to be priced on CD's just to hold the line, not to grow, just to hold the line, start there. And for most people it should - It shouldn't start with a 5. And and also. if like its retention is a strategy, how does, you know, how do you think about that? In other words, just having one CD special, is that the best way to go? I don't know if I'd want to, I'm going to reward depositors that are. You'd have a a good banking relationship with me. Do I want to pay close to wholesale market rates on single source CD relationships, you know, so how do you kind of think about that dynamic when you're starting to try to posture for for rates to go down?

[Vinny, 15:55]

Yeah, Joe, part of that D 360 tool that you alluded to earlier before is that there is we give the benefit, also, of surveying the folks that use it and, you know, one of the survey questions was what are you anticipating for deposit growth in 2024 and to your point where the overwhelming sort of take away is, say we're trying to maintain our deposits? Retain them, if you will. I think the answer that we got overwhelmingly was zero to 2% is the expected growth for deposits and, you know, I also think that's kind of interesting because I I had a recent conversation with the head of retail of a several billion dollar bank, and we were going through a bunch of analytics and trends and trying to determine what the right number was for their forecast. And she came to me, and she said, “Vin, I got to tell you, all signs are pointing towards that we're going to shrink.”  And I go, “Well, yeah, that's, that’s pretty obvious,” and she goes, “I've never given my board a budget with a negative number,” and she goes, “So what? What do you, what do you think I should do?” It's like, well, you can lie, or you can tell them the truth. So it is, it is obvious. And and that's a great point you make where you should start this conversation, which is a very important conversation as we go through this year. What rate do we need to be at to keep this money iIn here? It's really, that's one of the things we're spending a lot of time on in these ALCO meetings and using data to inform those decisions. I think, actually Zach, I think that discussion is a perfect segue for our third question of the day, which is when do we think margins may potentially recover in 2024?

[Zach, 17:38]

It's a tough question because there's so many variables that Joe laid out that you that you laid out. But I tell you, a lot of things. I'm I'm looking at and these are all depending on where rates go, certainly. But I think second-half of this year you're going to see some, some better lift on that. And that's not just because the Fed could be cutting right. I think a big, big, big piece of this and I'll throw the asterisk out there. Obviously, if there's a massive geopolitical event and a recession and huge credit issue like those are things that we have to deal with. But I'm just saying if if things are still reasonably OK on that front, you know a lot of loan cash flow. Folks, a lot of bond cash flow, in some cases coming back to us, they're going to be able to reset a lot higher, and it just takes some time and we're, what, 2 years from the start of the hiking cycle? A lot of folks they knew in the past. Hey, when rates start hiking, we don't want to go too long. Sometimes a lot of people did some swaps for two years or borrowing for two years, three years. And those things are all starting to come back. You know, too, I think you're going to see some lift. I'm hearing from the bigger banks. I'm hearing from some of our clients on that front. And then get the deposit piece where obviously, if that can help, then that's only going to add some more benefit there. But that's as Joe said, that's super dependent on the short-term Fed funds rate and how there's, I don't know if you agree or disagree.

[Vinny, 18:50]

No. In fact, the way I think about it is the absorption of your funding costs are overall, you know, liability costs you you probably have fully absorbed that cost. By and large, as we enter the third quarter of the year, Joe talked about that sort of tsunami of CD promotions that are all coming through and some of them are at 3, some are at 350, some are at 4. But it seems like the Fed stays still here. They're going to reprice up to some degree. But at that point, then there's sort of a de minimis, you know, amount of CD maturities for most institutions, as we look through the data in the final quarter of the year, second quarter, and you know this is all pretty intuitive, a lot of banks and credit unions were targeting maturities in the beginning of this year, thinking the Fed by now would be on its way back down. And I, clearly we're not there yet. Who knows - it could happen, it may not, but it seems like at least that variable in terms of your overall funding costs, you're probably reaching its apex as we get into the third quarter of the year this year. Now then the question becomes on the asset side of the balance sheet, can you get the loans on the balance sheet, and can you get investments with yields that are greater than existing portfolios? I think that's not a question that has an easy answer or solution for a lot of organizations. Joe mentioned earlier about the two-year point on the curve or the five-year point on the curve where a lot of assets can be tied to, they've now come back down. And so, I get this question all the time in my travels of late. Hey, Vin, should our loan pricing come back down? And I, I almost kind of laugh internally because it feels like, yeah, it in theory it, it should come down, but you never got it up to where it should have been to begin with. So, you're coming down off of a level that was too low to begin with. So, it just really kind of depends. You know, another variable for certain institutions is the degree of prepayment they're gonna’ get. We're clearly seeing prepayments slow, so we have models which suggest here comes cash flow off a Legacy 3 or 4/450 asset that's going to be repriced? Just by virtue of getting some early prepayment on it that that's just not happening. There's no real incentive for any of us to kind of go back to our bank and say, hey, I don't like my 2% mortgage -  give me a 6% mortgage. So, these models, you know Zach, you hit the nail on the head. These models are clearly there's a lot of different variables. You got to be very careful with. And I think 3 of the biggest variables are how are we going to price when rates go back down, how much of our core deposits are we going to hold? Are they going to keep sort of sliding over the other side of the balance sheet? How many assets? Can we actually get on our balance sheet? What are prepayments look like any one of those variables can play a huge, huge part in kind of what this year ultimately looks like. I'm a glass half full type of guy. As you know. I'm hoping that we get better margins at least into the final quarter of the year. I'm looking at a lot of our models and our models show lift. They show the levels of income improving and that it's interesting when bankers look at that and they say well that's that's a good sign. It is a good sign, but let's not forget you're just kind of working your way back to income levels that you had a couple of years ago. You're still not there per se, so a lot going on. I'll put it down that I'm hoping that we get better margins in the final quarter of the year, but there's so many things that influence that.

[Zach, 22:27]

No, 100%, and I think just just to take a step back for our listeners, it's well, the NI trajectory could be higher. What Vin was saying is, is there's there's three wildcards, at least with prepayments, in less cash flow being able to recast higher. There's the - what Joe mentioned in the first question, the non-maturity deposit cost drift or the mix shifting. The migration that's still happening that could dampen some of that. And then there's the can we cut rates fast enough. According to the model, so I think there's a couple of variables there that we'll we'll look back next year and see how influential those were, you know? Certainly. But I think those are huge, and I think your point on the CD book, once you get through the the first two quarters here, you're gonna see a lot of of CD's that went from, well before this, they're going from 3s up into the 45 50 range. Well, CDs today, they're not ten months are going to mature in December and they're going to go from 5, hopefully down to 475-450 that that was Joe's pointing on the CD side to start chipping away. There, the latter half of this year looks empty because all the CDs come and do in the first half gonna get pushed out there, and that's when you'll get some relief. If you're disciplined and you've done the work on that front.

[Vinny, 23:34]

Yeah, the the reroll in the latter half of the year of this current roll that's coming through If if you will. I know one of our other things that, you know, it's interesting the you look at the bond portfolio and that market sentiment, some of the media attention that's been given to the bond portfolio and specifically, you know, some of the unrealized losses in those portfolios seems like there's been sort of a a negative connotation in that regard around investments. But I wanna turn it over to you, Joe, cause I I think you you made a comment to me before, and I really want you to answer this question, which is why we shouldn't be sleeping on the bond portfolio.

[Joe, 24:12]

Yeah, I've. I've talked about this with with some clients and some webinars and you always get a little shaky when you get to this topic because it's it's it's probably an unpopular take, which is to don't sleep on the on the bond strategy for for this year. And the argument is clear, it's crystal clear, and thinking about like, why would I even be talking about a bond strategy, you know, because we're reeling still from the unrealized losses you know and and there's this thought of like, oh, I'm looking to change my asset mix, you know, not add to to investment. Or how the heck am I gonna leverage or buy bonds? And, you know, with the curve that's this inverted, or I'm gonna have to utilize capital leverage my, you know? And so, I'm looking to preserve capital. So, the argument is is really strong against it. And and I think we all get that. I think there's also an argument to to have a a good conversation with your team at ALCO about this because at the end of the day, you know, when you're in an environment like this with a sustained inverted yield curve, you got to turn over every stone. OK. And by the way, I think your audience knows this, but we're coming at this from a completely independent perspective. We don't we don't sell bonds. It's just, you know, we're at the level of just let's just talk about it and just figure out if it's a a worthwhile strategy. And so, then I position it by, OK, what's the argument for considering this and having having this discussion? #1. The cycle - and you're not trying to be speculative, but as banks and credit unions, we generally, I think we buy bonds probably different than most entities like we we probably look at our investment book for like liquidity first then interest rate risk, yeah. And then and then earnings. And in that vein, we tend to buy bonds when we have a lot of liquidity, which is when rates are really low, right? That's that's fine, that's fine. This is generally the point of the cycle. we look back, I got, man, I wish I would have, you know, patted patted the the book a little bit, right. And so, I think that all is also aluding to the fact that nobody's buying. You know, in some products you you got wider spreads. I've seen some leverage strategies the two-year funding that had 100 basis points of spread. You know that that changes on on the day. Of course, can think of it also as potentially a strategy to protect against rates going down, although you gonna give a ton of spread up if you if you do that. So the point I think here is that it's worth having this conversation, looking at it, talking about it in most instances, and I'll go, it's probably gonna get, you know, no, it's not gonna be the, but that's the, that's the that's the healthy exercise and discussion worth going through. And if decisions you know no then OK good that that was a that was a worthwhile exercise in in in our opinion.

[Zach 26:45]

I think it's a great point because there hasn't been as much conversation on it the last year because of some of the the whiplash we'll call it or the the fatigue from unrealized loss as liquidity is tight. I'm growing loans. Why would I use that liquidity or capital to fund bond purchases, but I think, you know, one of the things is that, whether or not you're just buying bonds to maintain liquidity minimums, you're pre-investing, or even leverage strategies. Those all have have merit to at least model out and look at. It may not be for you to make the leverage work. You may have to put on, you know, a little bit of length on the funding side to get the spread you want. You may have to use swaps, different conversation, for our listeners, but that's a tool that most of our groups want to have in the toolkit and, to your point, if you want to do it to protect against falling rates, if you're truly asset sensitive, there may be no spread. It may be a negative spread to cash, which, I had a conversation with a group this week on it saying it's it's an almost an impossible sell, but some people see the merit. You know, if you have a lot of capital, you have a lot of liquidity. It might make a lot of sense to do stuff like that. And I'm not saying this is for everybody. But your point, Joe, right, is you going to have these conversations? It's been a sleepy portfolio for a little while after the the bingeing of 2020 and 2021, and we, you gotta reinvigorate that conversation because the - there's some reasonable things you could do there, even if it's just doing some pre-investment to get some of these yields, cause who knows If they're gonna be here down the road.

[Vinny, 28:03]

Yeah, Zach, one of the things, if you're not careful, is you're going to wake up one day and you, you know, would have taken all your bond cash flow here and used it to fund loan growth. Cause it seems so expensive to go out and raise retail deposits. And then you look at how much liquidity you now have. And, again, for our listeners who may not be initiated, I mean, kind of our view is that you take the collateral which you have, take collateral on your balance sheet and use it to, you know, pledge against borrowings in some cases, and you get to a place where you're actually not at a a minimal level of collateral because you're redirecting cash flow in the loan growth and some of the conversations I've had with folks I said look at, I understand your budget, I understand your funding plan for the year, but Like you're you're getting to a point where you're going to have to add a minimal, at a minimum, replenish your your cash flows. And so, I've seen that conversation that's taking place a handful of times here of late, and banks have said, well, geez, that - you know what? We kind of lost sight of that. So, it is important. I candidly I I like that because now, you know, they're sort of sprinkling in some investments, Joe you talked about, and your main reason for having this conversation is the point in the cycle which would suggest just to be overt about it, that this would be the time to buy bonds kind of when the Fed is done, they're tightening. That's basically the time to buy bonds before rates start to move back down. That's historically - that would be the precedent. So really, really important conversation, but that probably leads us to our fifth and final really pressing question that most institutions are most concerned about and kind of hoping that it will be the panacea for them and their interest rate risk and their models and their net interest income projections. Will falling rates be the solution to the industries recent challenges?  Zach, I know you have a hot take.

[Zach, 29:59]

I'll give you the best, the best consulting answer. Which is - it depends, right? And I I think I mean Joe talked about it at length earlier. How fast do rates fall? How much do rates fall is the key, but I'm thinking of going to a straw man. If it's just the feds, right? And it's 75 bips here this year, a couple more cuts next year, and it's slow then it might be OK, right? It might be a pretty good solution because you that that might get the funding costs that might tip that, you know into our favor, maybe the asset side doesn't come down as much. You get that Goldilocks steep curve, but I keep coming back to are we gonna start trading the margin pressure for credit pressure, and I hope it's a it's a Goldilocks. It's a soft landing. Everything's great. It's the mid-90s; couple cuts, some Greenspan. Then we're off to the races again.

[Zach, 30:53]

I don't know. I'm a risk manager. You're the, you're the glass half full guy. I'm the glass half empty guy, and I just keep coming back to, I'm not sure if it's a solution. It might be for for for a period of time, but if this, that is a very high correlation, right? With rates falling in credit issues or recessions, right, you can go back inverted yield curves look back over time with like Campbell Harvey's work. Who who's? I think it's eight out of eight, when the three month Treasury has inverted with the 10 year you know your recessions. If you look at the two verse 10, it's like 11 for 13 or something like that. So it's a very high correlation that falling rates, especially meaningful falling rates might help the margins a bit, but it's not good on the credit side. You know, I'm not sure if we want to talk about credit today, but I'm not seeing a lot of this point, but you certainly see one-off the commercial real estate office space multi fam, the unsecured loan side certainly is a a challenge. You're seeing delinquencies at their highest in over a decade in some of those areas. So, those are the things that it's a, it's a panacea for the near the near term, possibly, but over the long term it, worries me a lot lower yield curve.

[Vinny, 31:59]

Yeah. The credit component, we always talk about how managing interest rate risk is so important. You know it's 80 to 90% of a institutions bottom line is the spread business, and it's clearly the beating heartbeat of an organization. However, ultimately that wouldn't necessarily submarine you - what submarines - just the credit side. And you know, I was at a at an institution whose headquarters was in an office building located in an area where there's a ton of volume, major highways, and I went into that parking lot. This is a big building and a nice building. There's 12 cars in the whole parking lot; It was like a ghost town. And actually, the main entrance I went up through pops me up on the floor, and then I just walked through, I don't know, 30,000 feet of empty office space, and then finally got into where I had to go. That's not a great omen. You know, I sat back and I said, geez, that that's just not good. And so, you're right. I think there are some things that can work their way through and, hopefully, it doesn't happen instantaneously. Hopefully it's a gradual thing from a credit perspective. I have banks that have some of that on their balance sheet. It doesn't seem like a lot of that paper is held kind of in the small bank space, it seems maybe it's more regional bank and some other non-bank entities. But there's a lot of uncertainty. We lived through it before. Hopefully it's not as brutal as it could be because that causes a real issue. Zach, you and I actually, consecutively, we're product managers for our capital planning tool, and that tool really came into existence in the wake of the last recession, and so we've seen it, we've seen it, and it takes time. So, I would certainly encourage banks to, if nothing else, make sure they've got some capital planning in place. My guess is if we get some credit and you're right, non-accruals past dues, they're up, FDIC statistics are demonstrating that. But when there's really been nothing for a long time and then there's some credit issues, it seems like there's a ton of credit issues. Yeah, I I would definitely be on top of that. It's interesting cuz always here, well, geez, it's just a couple idiosyncratic things. And I had a, I had a CEO at a bank who, in a meeting was talking to the one of the lenders, and they said, well, it's just a one-off. It's just a one-off thing. And he said, is it still going to be a one-off thing in September of this year? What are you going to call it then if there's still an issue? So, it's you just don't know it's it's like how did I go broke and it it's well, a little bit at first and and then all at once and that's kind of how it feels like in the credit space. So that is something. I did say I was the glass half full guy, too, didn't I? Yeah.

[Zach, 34:54]

It's yeah, yeah.

[Vinny, 34:55]

It’s on the record so, but a lot, lot going on, and and I think you're right structurally falling rates, you know, will will will be helpful, but let's not forget what generally companies that you just got to kind of keep your eyes on that.

[Joe, 35:09]

Yeah. I think outside of the the credit piece, too, and thinking about falling rates and what's asset sensitivity, what's liability sensitivity these days, but some thoughts to think about for institutions that do have like shorter-term loan books that are like oh, now with how these loans are coming due today. Yeah, I think there's some things to think about and have in your arsenal and and discussion-wise like so the just the concept of discipline and and loan pricing. Easy for us to say, but discipline with options, and so I had to shop the other day talking about really tough for them to get good prepayment penalties and some of their commercial deal and just working the the menu similar to what I talked about on the CD side and having different pricing options for different embedded floors or or prepayments and just thinking ahead of protecting against - maybe not the Fed soft landing down two or three, but like the hard land and that downside protection, I think it also weighs on the importance of being able to to execute on hedging strategies, getting in, you know, getting your shop in order. And because we know that whenever it was, late summer. And everybody thought rates were higher for longer, it's like man when's the best time to buy protection. I think rates are going to stay up for a while and the window shuts quickly. So having your, we have some clients that that bought some floors, for example, and and with the accounting, you know, the whole thing that that goes around that and how you want to position the funding side of the balance sheet. So, there's some healthy discussions to have, even if as you start to eye you're falling rates down the road.

[Vinny, 36:34]

Joe, great point. I mean having the ability to kind of leverage hedging, if you will (probably shouldn't use leverage because it kind of scares folks off), but utilize, you know, hedging, if your balance sheet calls for it, is is critically important, there's no doubt about that. But I think that's a good place to end this. And I really enjoyed this conversation, and we thank our listeners. Hopefully you folks did as well, and obviously thank Joe and Joe, it is a pleasure to be joined by you and and to hear your insights. Because oftentimes, like Zach and I, our our paths don't really cross. You know, we're we do get on a call once a week as a consulting team and talk, but It's great for you to join us. Thank you so much.

[Joe, 37:133]

I appreciate it. Thanks for having me. You guys are doing a great job.

[Zach, 37:15]

Thanks Joe, and hopefully for our listeners. Thanks again for all the support. We hope you at least got a couple of takeaways from this or at least maybe some different topics for conversation to kind of bring into your ALCOs, because that's that's what's all about at this point. Thank you.

[Vinny, 37:26]

So that's a wrap. Thanks for listening to On the Balance Sheet and hope you'll check in with us next time.

[Dana, 37:34]

On the Balance Sheet is a podcast produced by Darling Consulting Group, DCG. All views and opinions expressed by the hosts and guests are solely their own and may not represent those of DCG. All third parties are independent entities and are not affiliated with DCG. This podcast is intended for informational and educational purposes only and is not considered as advice.

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