Special Episode - Managing Through Volatile Times with Matt Pieniazek, DCG President & CEO

In this special episode, Darling Consulting Group President & CEO Matt Pieniazek joins for a C-suite-focused “fireside chat” to share his insights and perspectives on managing earnings and balance sheet risks in this highly volatile and uncertain environment. Matt reflects on key realities, challenges, and opportunities, and also addresses some very relevant current strategies for managing an institution’s risks in general – and lending and deposit customers in particular.

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

Transcript

On the Balance Sheet:  S4 E4: Special Episode – Managing Through Volatile Times with Matt Pieniazek

 Transcript

[Vinny, 00:05]

Welcome to On the Balance Sheet, season 4, we have a special episode today on Wednesday, April 16th. Matt Penizak, the CEO and President of Darling Consulting Group, gave a fireside chat and was really focused on managing the balance sheet through all the volatility. For those who are interested, you can access, I guess Matt's face if you want, for lack of a better description, via our website. You can see kind of the real-time interaction he's having. But, Zach, what a very timely discussion, fireside chat with Matt, I think it's well worth all of our listeners' time.

[Zach, 00:38]

100%, Vin, I think part of this, too, is if you were available to on that Wednesday afternoon to listen to Matt, great. If not, some people digest information different ways and through different mediums, so we wanted to rebroadcast that through the podcast for those who prefer this type of medium. And a big thing, I think, and Matt gets into it, is this isn't a prescriptive type of chat or strategy session where like do these three transactions and you're going to be good. It's a lot of thought on different parts of the balance sheet, and he talks a lot about what-iffing and just trying to go through a lot of the things that could happen and trying to make sure that your balance sheet is resilient or your ALCOs are talking about the things to make your balance sheet resilient. And he touches everything: lending, the deposit side, spends a lot of time on both of those kinds of core pieces, a lot of time on investments as well, hedging derivatives are certainly a key piece. And Matt, as he always does, gets into liquidity. There's some things on the modeling side about what we should be doing, stress testing, and again, getting all back to no one knows what's going to happen. And to manage the balance sheet through volatility, there's a lot of thought that has to go into, you know, what if this happens? What if this happens? How do we think through those types of things? So, I think, again, it's about a 60-minute type of chat, but I think it's well worth the listen and the thought process. So hopefully everybody enjoys it.

[Vinny, 02:01]

Absolutely. A must listen, given all the sort of uncertainty in the marketplaces. So, without further ado, Matt Pieniazek.

[Matt, 02:15]

Well, good afternoon, everybody. I think for a few of you on the West Coast or for some of you on the West Coast, still late, good morning. I think we can all agree that assuming away the unexpected is probably not a good approach for managing your bank or credit union's business. Certainly when it comes to managing balance sheet risk, I think that's for sure, specifically kind of in particular interest rate risk, liquidity, and credit risk. There's a notable quote from a book entitled The Psychology of Money that says the following, "Things that never happened before happen all the time." And we believe that that's kind of deserving of being hung on the wall of your ALCO. So, not because you should be managing your institution with a chicken little sky is falling mindset, but rather to remind us that we should be wary of, very wary of, over-influencing our conversations and strategy discussions at ALCO with subjective opinions and/or biases such as that can't or won't happen either in general or particularly to my bank or credit union because we're different. And those are things we can hear more often than not, might be surprising. But the purpose of hanging that, figuratively speaking, is to remind us of the importance of asking ourselves that important critical question, what if? And while there's no rewind button, what if we could go back to 2021 and the COVID deposit surge, with that as a backdrop. What if we could go back to the 2022 sudden spike in interest rates? What if we could go back to 2023 and the March madness and the high-profile bank failures What if we could go back to last year, 2024, rate levels and the corresponding sustained historic inverted yield curve environment? What if we had been better at exploring what-ifs over these past five years? What could we have, and perhaps should have, considered? What questions should we have thought of? What questions should we have explored? How could we have looked at things through different lenses? And thus, how could we have changed that conversation over those past five years? Which begs the logical question, why didn't we? What got in the way? While we can't go back and plant a tree five years ago, we can certainly plant one today which brings me to today's fireside chat, if you will, because that's my intention. My comments over the next 30 minutes or so are not intended to be a prepared PowerPoint slide deck leaving you with five, six, ten things that you need to be doing. Because I think that candidly would be disingenuous because there's so many things that are different for each of our institutions, kind of balance sheet risk profile, our strategies or growth plans, and a lot of other variables. So, my comments over the next 30 minutes or so is to truly sound like a fireside chat. More like a stream of consciousness, set of observations, considerations, and food for thought, hopefully will start to make a difference in your ALCOs. So, let's kind of just go quickly back to recent events, not go back, we're in them. So, these recent events, and the ensuing uncertainty that exists on so many fronts, have and continue to result in volatility throughout the capital markets, in general, and the bond markets in particular. We know what we've been seeing and experiencing in volatility and interest rates. There's been a yo-yo effect and that certainly is not optimal for this wonderful banking industry at large that we are part of. So, this clearly, clearly should warrant all outcomes to frame their assessments of interest rate risk, liquidity and credit related conversations, and thus related balance sheet management strategy conversations by asking important what-if questions. And again, to be careful, careful not to assume away the unexpected. Can you think about it? I mean, I can make, and I'm sure you can too, make a very logical case for a variety of potential outcomes here. Tell me a scenario, and I can make a strong case for why that could or actually will happen. So that kind of sets the tone for one thing we've been very, very focused on and that is to be encouraging and engaging our client conversations with ALCOs to ask what if the outcome as a starting point from the current environment ended up being everything is OK. This was a lot of noise and rates remained at or near current levels for longer and the economy just continues to go along the way it has been. What if there's a mild recession, a short rate actually cycled gradually lower and they stabilized with some moderately sloped to the yield curve return? What if there's a surge in inflation? What if all these things that could happen result in a spike in interest rates and either inverted, you know, a more inverted curve or even more with a severe bond market sell-off and a slope to the curve at higher rate levels? What if there is a deep recession with rates once again heading down towards last cycle lows and likely accompanied by a very challenging credit environment? What would be the impact on my institution? And what if we knew for sure which of those would happen? What would we do if we knew for sure if each and every one of those were to occur? And that sets the tone for assessing, in effect, what the embedded accepted risks are in your institution, and then it begs the next question or reality. Now that I know that we don't know what's going to happen, what should we do? To what extent should we factor those known or estimated expected outcomes into making decisions in a world that has very meaningful current impact, but not knowing where we end up? How do we factor that into our thought process? I'll tell you, it forces, it forces very interesting conversations leading to establishing the most important decision criteria for your institutions. In effect, it puts you in a scenario where you openly talk about, discuss, debate, and establish the tiebreakers for your decisions, for your decisions affecting everything across that entire balance sheet. It will raise very real questions in this current environment regarding, as a starting point, your growth strategy and thus your risk tolerances and your capital allocation and what are or what is acceptable or appropriate related returns in this environment. And thinking about growth, let me kind of move into some commentary on lend for the moment. Let's think about this current environment. We continue to sit here with an environment with these handful of realities, cost of capital for your organizations, I don't care whether you're mutual, credit union, or a bank. The reality is the concept of cost of capital is real and it sets the tone. The cost of capital is high, it places a value on the use and allocation of that capital, the allocation. If you look at the cost of liquidity in this environment, it still remains high and at risk. We're one event away from another set of surprises as it relates to liquidity and liquidity management. Interest rate risk uncertainty is elevated and certainly credit risk is on the rise and highly uncertain and we're seeing signs of that. So, factor all those realities together, and what does it mean for pricing and our thought process on that? Should we remain steadfast with our loan pricing discipline and be willing to accept slower growth, but at our spreads that we think are appropriate for this environment, regardless of what competition is doing? Or the other extreme, do we target a faster, higher growth rate at tighter spreads, and do lenders care? Which one will we do? And how do we communicate, engage them into understanding and appreciating where our thought process and course of action is?  Also, what are the implications for funding this, for deposit strategy, investment strategy, the role of wholesale? I will tell you that we see commonly, not always, commonly, above average loan growth strategies being highly correlated with below average returns, think about that. Above average loan growth strategies being executed and produce below average returns. Why is that the case? It comes down to funding strategy and how one goes about that. And I'll address that a little bit in a few minutes. A couple other things, just kind of quickly, because I'm just thinking out loud here on a number of variables. Let's think about this environment and the uncertainty and a few things to ponder. First of all, since I've talked about growth, let's think about the headwinds to growth. Not just the economics of it, not just the fact that there's a lot of uncertainty, that we're seeing hesitation on the case of borrowers kind of slowing down and being reluctant to come into the market. Some banks are a little reluctant to do things in this market, kind of pulling back, concentrations are becoming an issue. The reality is those we are seeing a growing number of banks and credit unions whose pipelines have actually widened out here, but there's an interesting dynamic going on. They've widened out, not necessarily because they're expecting we're going to see those pipelines clear and produce more loan growth, but the throughput, things are hanging in those pipelines longer and longer and longer. And that creates a lot of a lot of uncertainty. One of the things it creates uncertainty on is your commitment strategy. How do you, how do you work? How do you create commitments on loans, fixed versus floating rate commitments? If this volatility in this market doesn't highlight the importance of rethinking your commitment strategy or addressing it or confirming it, then I don't know what will. We have been pushing for a long, long time Banks to really be rethinking that strategy. Don't get so hung up with the competition, you know, what they're doing, because, you know, competition will follow prudent behavior. And sit back and give borrowers, sound difference to your borrowers, present them with opportunities and alternatives. Present them with a floating rate opportunity, let it float, but also show them fixed rate opportunities. Different pricing points for floating rate commitments or for fixed rate, and a fixed rate for 30 days, fixed rate for 90 days, fixed rate for 6 months, whatever it is that your uncertainty or Mr. or Mrs. your borrower, we are willing to accommodate you across those fronts, which means you have to understand and appreciate and be able to determine the valuation of the value of those options, and they are very, very readily available. So, we need to really, really think through how we word, how we go about our commitments. The value of those options are far greater than you might might might believe. I talked about growth as maybe coming back to optionality and the value of options. One of the headwinds to growth is that we tend to forecast growth on some net basis. If you ask people their growth assumption, it's very rare where someone will tell you their gross loan production. They'll speak to a net number. We're looking to grow loans 3%, 5%, 2%, 4.36667 repeating, you get my point. The point is they talk about it from a net growth. We don't fully appreciate or need to better appreciate what does that net growth translate to in terms of growth production. And what I'll tell you is that prepayment assumptions is very meaningful on that. Prepayment reality is very meaningful on that. And I'll tell you an area that we have a tendency to underestimate. Banks and credit unions of all sizes have a tendency to underestimate prepayments. There's a whole issue of modifications, and modifications are gaining momentum in this environment, and we believe will continue to gain momentum. And modifications can have a very meaningful impact on prepayment assumptions. And very few organizations come even close to pulling in modifications into that kind of mechanics and estimates. But another thing, believe it or not, what you see may not be what is happening. We see when modifications are elevated, and pulled out, and talked about, it creates a lot of surprises in terms of assumptions about the level of modifications versus the degree to which they're actually occurring. So, modifications are a really important thing to just be thinking about in this environment. We have to be careful not to have a static view related to all this on prepayment risk or modifications. We're sitting here today with a spectrum of loans like we've never seen before. You've got seasoned 3 to 4% paper coming in for repricings and/or maturities, whether they reprice or mature are very two different realities. At the same time, we're facing with existing portfolio levels of newly minted, quote unquote, mid sevens or high sevens, depending on your market, loans in a world where rates are coming down. I would be taking a look at both of those bookends for sure and talking overtly about them. Those 3 and 4%, what is your contractual repricing risk? I always get a list of largest ones coming due in the next 12 months because we start to see 12 to 15 months out prepayment activity. Actually, 18 months, our data shows, starts to gain momentum. And that momentum is nonlinear, it accelerates as you get closer. Get out in front of those loans, rank order all your largest maturing and repricing loans coming through and sit back and say those that are repricing, contractually, what do my documents say reprices to? How do those repricing points relate to current market rate? If this thing matured and came to market today, how does the market compare to contractually pricing? Get out in front of those loans now, looking out over the next 12 months. And then on the higher levels, what are the ones that are at risk? What happens if the five-year drops another 25, 50 or even more? What are the expectations or likelihood? What could happen with modification pressure or refinancing risk? And the refinancing risk channel is going to be correlated to two things. Your stiffness of your the appropriateness of your prepayment penalties and your propensity to invoke them. It's a time to sit back and say, these things that are coming in that could be up for modification, that could materialize or prepayment or maturity, which ones are we willing and going to go to the mat for, to fight? Which ones are areas that we just assume have them go someplace else? And where in that middle do we play and why and how and how do we determine that? How do we negotiate in that middle? These are conversations that are worthy, in our opinion, of ALCO. It's important to revisit your prepayment philosophy and the rules of engagement, get that on the table now. The spectrum of the conversations we have out there are mind-boggling, and so revisit your prepayment documentation. It's surprising to us how often we see prepayment documentation being multiple documentations. A lot of banks or credit unions don't have a standard, they got a variety of ones that may be used. Or prepayment documentation gives free outs, it says we'll only invoke them if or we won't invoke them if. Give some thought to do we need that? Is that restrictive? Do we need to have that kind of commitment in there? And even if you're going to give away and not invoke them, why not have that be something that comes from you out of benevolence rather than something that you've already given away because of contractual for which you will get no incremental value if you decide not to invoke those penalties. And keep in mind too, the value of prepayment options are very much influenced by rate levels and curve slope and everything. Today today, in fact, you know as of this morning, the value of a prepayment option, give you a perspective. If you had the exact same loan, one that had a yield maintenance penalty and one that had no prepayment penalty, the coupon on the loan that has no prepayment penalty should be 80 basis points higher. That's the value of that option. 5-4-3-2-1s, which are common are not linear, but it probably captures 40% of the value. If we had time, and again, I'd dive into tactics that you can have your loan officers utilize to your benefit, even if you acquiesce a prepayment penalty. Educate the borrower as to the value that you're providing them by doing so. You're going to sound different, and different is good. Look, we understand and appreciate that this rate volatility has created significant challenges for pricing strategy and negotiation. We've experienced this for quite a long time now in ALCO. It's not an easy thing, it's challenging. And again, as I said, what we have found banks starting to get and credit unions get some mileage is rethinking that commitment strategy and providing your customers and your prospects choices on how they want to set those up. Give them a choice to pay a fee for a fixed rate commitment, to accept the fixed rate commitment for 30, 60, 90, whatever time period that they choose, because there's uncertainty with how these loans may cycle through or close or, you know, construction and all that, so just think about that. It can be very, very powerful. So, I mean, I can go on and on the loan side, let me just kind of quickly on the mortgage side. If we're coming into the season, as we know, if we were to some reason get a further rally here, an extreme rally, and all of a sudden mortgage rates drop below sub six, we're going to see things start to happen. I would just make sure that you have a plan in place. If we see pickup in activity, are we going to hold? Are we going to sell? What are the differences? Are there certain types that will hold versus sell? Get that on the table now. Also, I've been sitting back and saying, are we this visible? Values have been down, and some markets inventory has been up where we would like it, are we as visible as we need to be? Get in front of the gatekeepers here. So those are just some quick things and if people have any questions on the loan side, throw them in the chat box and we'll come back after. So let me shift gears real quick to talking about growth, let's shift to the funding side. Deposit growth is a very real challenge. While the spectrum of what any one bank or credit union's experience is is is a broad base, as we all can know and envision, the industry on average is growing little more than interest, the cost of interest so in effect, retaining our interest. That's a that’s a challenging environment. And another reality is the bulk of our deposit cost benefit is behind us, it's behind us. It is waning materially over the next three months. All the decisions we have made to date, we're already enjoying the bulk of those benefits. Non-maturity deposit rates, the higher negotiated rates, the premium rates we have, we've all brought those down. CD rates, there's been a strong tendency to shorten up maturity ladders, three, six months. There is a tsunami effect of CD maturities that continue to come through here, which means all the bulk of the benefit is in our pocket and it's going to start to run out for most of us in the next 90 days or so. So that means we're sitting here with the following reality, there seems to be this 4%, what we call floor effect, that's influencing mindset and price. There is a convergence of almost everything out there. I don't care whether you look at the, at the wholesale CD markets, if you look at money market funds, you look at brokerage accounts, you look at where bank CD pricing is, you look at where premium negotiated rates are on money markets and premium savings. We're all in a very narrow, probably most converged band that we've seen in a long, long time. And it's all kind of with a, most of it with a 4% hand. There's a reluctance, a reluctance to do too much testing of elasticity in here by breaking through that floor. We see banks and credit unions that have been successful with that. We've also seen banks and credit unions that once they get too far afield from four, they start to see their retainers factor or runoff. The retainers factor goes down on CDs and their runoff on others starts to become a little bit more problematic. It's a very interesting time for some very interesting and, candidly, kind of fun conversations in ALCO about strategy here. What's the best way to target and go after elasticity? Do I need to do it everywhere? Are there things I can do in selected markets? There's some very interesting things that one can do here to manage those tiebreakers, which starts with you need to establish that tiebreaker within your organization. Is it NIM or is it balances? Everybody talks about, I don't want to pay up, I am not going to pay up for volatile deposits, and I get that, we get that. But there is a very clear reluctance out there to let deposits go. There is, where one event, one event, one story, one thing that could create uncertainty and fear, uncertainty and doubt within our deposit bases that could become problematic. There's reluctance to want to watch deposits go. So therefore, we have to create clarity on our strategy. Are we on the offense or are we on the defense? And a lot of that comes down to your, to your loan growth. One of the things that, and then your overall funding strategy. What I mentioned earlier about high loan growth is not necessarily correlated with above average earnings growth and it becomes back to how we fund it. Banks that are able to fund the delta of loan versus deposit growth, just kind of normalized deposit growth through security cash flow, home run. Those that are willing to use wholesale funding, not the same, but okay. Those that are force feeding that delta by growing deposit growth have a tendency to sit back and say, if I'm on the offensive for deposit strategy, I'm going to have to pay up for elements of that, especially the sooner I want to do that. And I'm going to have to take a long effect there so that at the margin, my average cost at the margin is not what I'm paying the marginal customer is to take a long effect. The cannibalization effect is real and that crushes, crushes in so many cases, the incremental benefit of that loan growth, begging the question about the appropriateness of allocation of capital to such a strategy. So, it's critical to bring that funding piece into this overall conversation. I mentioned the tsunami of CD maturities. 2025, I think, is going to have to be a year that we address that maturity. We can't go through in time with having this cycling through of this level of maturities every 90 days, every six months. It has risk from interest rate risk and certainly on liquidity. And unfortunately, the best time to try to do that without paying an inordinate premium is when we've got slope in the curve and that's going to make it challenging. So that's something that we're constantly on the watch for and talking with and setting up the tone for conversation. There's going to be, hopefully there'll be the appropriate time sometime this year to start to institute that kind of a strategy, try and lengthen that out without unnecessarily paying up for that. Then also begs the question, you know, what if the Fed is on hold for longer than we think? What are we going to do on the deposit side? Are we going to test the elasticity if the Fed doesn't help create that? So, if we hang here, we got this 4% threshold. Our models are showing that we need another, 25 is not going to do it, we need another 50 before we think that things are going to change mature. Let's go back to when we were at 5% and rates were 550 to 575 on accounts. And we were all wrestling with that 5% threshold, we were afraid to go below the 5. Once the market cleared and we got below 5 and there were very little fives out there, the pace with which we could come down the 4% ladder accelerated. Because if I'm at 490 versus 510, that sounds a lot different than if I'm at 450 versus 470. And so that mindset and psychology is real and alive and how do I take advantage of that is important. And the same thing, we've squeezed the bulk of that out and now we're wrestling with that same thing, F4. We think it's going to take another 50 before we start to clear fours and have very little pressure and then that'll open up the ability to do more things now. But it's a very interesting conversation to be had on the front of our tiebreakers as it relates to NIM, net interest margin, versus dollar balance behavior. Very, very interesting conversation. Then also think too, what if we go into a recession? I think a number of institutions we hear chatter out there, well, hey, you know what? It looks like rates could be coming down further, it looks like the economy could hit a roadblock here. Yeah, maybe that's not so good on my credit, maybe that holds. But hey, we should get a flight to quality, will that happen again? If we were to, God forbid, have a down environment, are we so sure that what has happened in the past will happen again? Is the alertness, is the antenna up? Will the kind of monies that have come into the banking system of the past repeat itself, and what if it doesn't? What are we going to do? How should we be thinking about this? So that's just one of the things I just want to kind of highlight a little bit more you know on that. So let me shift gears really quickly then maybe on investment comments here, because obviously I could sit back and take each and one of these areas and talk for hours on it. But on the investment side, I think one of the first things to set the tone here is establish the context for conversation and looking at our loan versus deposit growth and to what extent our ongoing security cash flow will kind of fund or not fund that. But I do want to comment, it's kind of interesting, when 1% bond yields were prevalent, everybody was all in, we all know why. At 6%, nobody wanted them, you know what's interesting? I think we kind of survived this AFS tangible capital noise, at the end of the day what do we find out? Yeah, it's accounting, it's mathematics, it's there, it's like it didn't change. Our loans were underwater, but somehow, we ignored that. But because we can see the securities, all of a sudden that matters, but our loan losses, unrealized losses are irrelevant, so I think we survived that noise. And so, we're sitting here today, and one of the conversations we're having with an awful lot of institutions that have been, depending on their profile, is the role and value pre-investment strategy. Cash flow coming in, if I'm either one of two things, how does it compare to what I might need for loan funding? And to what extent, given where we are with the curve, does it make sense to maybe buy investments today ahead of, by either using cash or short-term bonds, to pre-invest some of those monies today? Those institutions that have notable exposure to a sustained low-rate environment, this is a very real issue for consideration. And we want to remind you, if you're going to go into the bond market today, we are not against, have not been against for the right institutions, adding duration in here. And if you're going to do it, add call protection, give up current yield for call protection, it's really valuable. Especially if you think about a role for investment portfolios often forgotten. When rates are high at the top of rate cycles, the probabilities by definition get greater that we could be closer to the next down cycle. And in the down cycle, they're highly correlated, highly correlated with a bad economic environment or a weakening environment, and therefore the potential for hitting a wall that creates credit-related issues and concerns, drives up credit-related costs, drives the need for additional reserves and things of that nature, and it allows me to have assets out there that I can monetize, if appropriate, to generate gains, to help slow the pace or offset the pace with which credit issues are seeping into my earnings and therefore slowing the erosion of capital. That has been an extremely valuable strategy for many, many banks and credit unions over prior cycles. So those are some things on the investment side. There's a lot of dynamics that go into it, if there's some thoughts or perspectives on this or curiosities, let us know, and I'd be delighted to visit a little bit more specifically on that. You know, you think about investments, it kind of conjures up also capital markets and derivatives. And I just want to sit back and say, we have observed and seen a growth rate in the number of banks and credit unions that are looking at and utilizing derivatives than probably any other time in modern banking history. It is becoming more and more apparent that I cannot manage my balance sheet risks by being dependent on influencing customer behaviors. Number one, they're diametrically opposed, more often than not, what's good for them at a moment in time is the opposite for me. So how do I give them what they need and want at a time when doing so may actually create risk for me? I can try and influence their behaviors, but it's going to be difficult to do it quickly in any kind of meaningful volumes. The role of derivatives can be extremely useful to augment customer behaviors. And keep in mind, markets don't wait. It is so important to have the arrows in your quiver and have readiness strategies. Get set up now, get educated. How they use, why they would use it? Why does it relate? How would it relate to us? How could we structure that? Are there accounting things we need to be related to? How do we just let's let's go through and let's go make believe testing environment. What if we can identify this would be, this looks like this would be a good strategy, what if we execute it? Don't execute it but make believe you did and monitor walk through that, get ready. I'll give you an example, readiness. You look at the volatility that just happened over the last couple of weeks. You probably wouldn't believe me if I told you the number of banks and credit unions that we know because of readiness strategy, were prepared to act when these markets went wacky the last couple of weeks. If they weren't prepared, they would have learned the lesson of markets don't wait for me to be ready. And if we're going to talk about derivatives, I'm just going to give you kind of a put this in your back pocket and keep this in your mind. If you thought Monday morning quarterbacks on your investment strategy were alive and well, you ain't seen nothing yet when it comes to derivatives. You've got to make sure that up front, everybody, including yourself, senior management, and your board understand that derivatives are insurance policies. And just like you have life insurance policies and property and casualty policies, I don't think any of you, any of you want to collect them, so the point is I don't want to collect. And you're going to find, if you're not careful, if you don't educate and get everyone to realize, if I do a derivative, I hope I don't collect over time on it. Because if I do, if I do, there's something else that I'm hedging is going to offset that. There are exceptions, and I'll tell you, and I can get into details. If I go back over last year, last year and a half, when this yield curve was so, so, so, so inverted and rates seemed to be just hanging there, there were wonderful opportunities for banks and credit unions to execute, execute interest rate swaps where they receive variable and pay fixed, which gave them tremendous insurance against rising rates and gave them a tremendous amount of current value. In that weird environment, they didn't necessarily want to collect, but they didn't mind not collecting on the insurance policy more than what they already had. They were getting paid out of the gate, which is highly, highly unusual when you're trying to protect against rising rates. So just think about that, in the current environment now, with rates down, one of the things that we're seeing, if you really have significant exposure to rising rates, we are finding that, we have been finding, especially with the bond market rally at rates were low, that banks and credit unions jumped on out of the money interest rate caps. They were dirt cheap, dirt cheap, buying significant sensitivity dampening effect for very little, very little upfront money with tremendous amount of insurance. And even the mirroring of a combination of some very short-term swaps at a positive carry to pay for the cap insurance has just been a very notable beneficial strategy for a lot of institutions, so I can go on and on there. So let me kind of maybe come back and take some literal macro effect commentary on a few things here, let me make a couple of comments on liquidity. If we haven't learned anything, I think there's a couple of things I want to make sure that I hope you learn about liquidity, so there's a couple of points. First of all, it is so critical that you take control of and tell your liquidity story. In fact, I'll say your story on every one of your risk areas, but particularly here on liquidity. There are a number of things that have come to reality that necessitate that. If you're not careful, somebody else will try and dictate your story for you, and that's that’s suboptimal. First of all, the concept of one-day liquidity has become alive and well with the March Madness bank failures. Putting it in the context of uninsured deposits has added to that. And the importance of understanding the level of your uninsured deposits as relates to your true ability to unequivocally get same-day liquidity. There's only two guaranteed sources, guaranteed. Cash in your pocket and the Federal Reserve. What we've learned over the last plus year is while the Federal Home Loan Bank is there, we love them, they've made such a difference in supporting our industries here, the reality is is that their ability to guarantee you one day liquidity doesn't exist. They may desire to, but that's different than guarantee and you need to be prepared to explain the difference between guarantee and the FHLB desire. We have been looking at metrics that it take away the Federal Home Loan Bank for day one and see how that compares to uninsured deposits and other volatile sources. And then bring in how much of that potential risk or volatility are we relying on access to the Federal Home Loan Bank. I think you'll find that that creates a very interesting conversation. Because of all this, there's there’s some movement afoot for banks and credit unions to be told, quote-unquote, suggested, mandated, that they need to elevate their level of cash balances or unencumbered securities. If left unattended, you're going to have a hard time responding to something if you don't have a policy in place. If you have a policy in place that addresses that, the burden shifts to the other party as to why they don't think that's appropriate. And here's an important takeaway, cash in your pocket being as a protector against liquidity stress is a false narrative, it's a false narrative. To some degree, available collateral, unencumbered, not available, unencumbered security collateral is also a false narrative on two fronts. Do I want to be dependent on selling assets to generate liquidity if I need it? if I need it, I got a problem. And I want to be forced to take losses if I have losses to solve a problem? Or might that create problems? And we know the answer to that. Also, it's not same day. I can't sell a security and get access today, so it's not same-day liquidity, it's not, unless it's pledged someplace. And when you really think about the true narrative that has come out of what we've learned over the last couple of years, it's something candid we've been talking about forever. Liquidity is the ability to raise cash quickly when I need it without having to take losses and at a reasonable cost. Reasonable is market. I don't want to be dependent on selling anything, but I want to be set up where I can monetize without having to take losses. At the end of the day, we are having a convergence of operating and liquidity, operating and contingency liquidity, which is very real. We need to rethink how we talk about and measure and explain liquidity, and it's all about collateral. I can have collateral, but if it's not in place to be used, it's no better today than if I didn't have it. And so, rethinking your levels of of collateral at the Federal Home Loan Bank with loans and securities. Looking at what your capacity is there very often, banks or credit unions, if you add up your loans and securities, they exceed what the Federal Home Loan Bank would even let you lend. And if you went to them suddenly, they're going to say, what's wrong? As you would do on a line of credit that never drew and suddenly the borrower shows up. You need to be disciplined there and looking at managing collateral, including at the Federal Home Loan Bank. And we need to get off the stigmatism. and there's things in the field that are going to kind of help that. So also, this kind of dovetails, eventually, down into policies. And a word of caution, if you need to look to your policies for guidance, do you want policies at a time, if you're looking at your policies for guidance, there's probably a challenge that's afoot. And if you experience a challenge or a scenario, do you want your policies to be a straitjacket and constrain your ability to do things? Or do you want to be appropriately flexible? If your policies have if-then statements, lose them, lose them. Don't have policies that if something happens that you don't even know what environment that happens in and you're going to say that I'm going to do the following, but I don't even know what it means when it happens. Give yourself latitude to address the situation, minimize, lose, forced reactions. Give a list of considerations and make sure you address that. So, I mean, I could go on and on there, but I just want to, just really important from my perspective to just share some of those perspectives on liquidity. Risk assessment, you know, I think one of the things that we kind of learned, I think a lot of bank and credit union leadership teams and boards probably lost confidence in a degree of confidence or certainly developed concerns about the accuracy of the risk assessments. Because most models were wrong, and they're wrong because of assumptions that were not reflected in models and realities that materialize. And I'll address that in a second real quickly, but one thing I tell you today is we're sitting here today and it's very rare where we don't see this. Momentum on net interest income is very rare. With rates stabilizing, even come down a little bit here, the momentum on asset yields is tremendous, we all know that. You've got peeling off the securities with 1% handles that are coming in and either defeating borrowing costs that are deep into the fours or being able to redeploy in cash or, God forbid, fund loans. We've got a lot of a lot of cash flow coming in. Loan portfolios, we've got 3, 4% handles repricing up now into the sixes. We've got tremendous momentum there, but those base case models tend to keep everything else constant. And while some of this is losing momentum, we've seen over a long period of time when rates were constant, the cost of funds continue to go up because of the lag effect there. So, you need to just make sure that we understand how much of that benefit is coming from the asset side and under the assumption that we're not going to have to do anything on the deposit side. Because of that tremendous upward trend in base case and the static mentality typically in in these models is it tends to dilute the impact on current earnings from rising rates scenarios. And so most models are showing from most institutions that a rising rate environment, they give up some of their flat rate benefit, but we don't go south of where we are with current earnings. Now that's not all, but that's a lot, so very common. And I would encourage you to revisit your assumptions in those models on the deposit side because those are the very assumptions that got in the way last time around. And so, I encourage you to sit back and ask yourself and think through the importance of dynamic versus static assumptions. Let's just go back quickly to the deposit side, which is where the source of the major uncertainty and surprises that materialized in 2022 and 23’ continued into 24’. Is the concept of nonlinear betas, they don't change in a linear fashion, they don't. And as rate degrees change, they accelerate. The concept of life cycle betas, if I'm looking at up 100, up 100 is different if I'm starting from a level where rates haven't changed versus starting from a level where rates have already gone up 200 or 100 or 300, and where the starting point matters. And most models don't capture that reality. The issue of decay or average lives, they're also not linear and they're highly correlated, they can be highly correlated with beta and decay. So, if I sit back and I say that I have high beta, I may see slower decay. How does that factor in? And the other thing is I may not lose deposits, it doesn't show up in decay per se, it may stay with me with mixed changes. All these things all add up to being a significant, significant variable at play in this last cycle of the accuracy of risk assessments. And so, I beg you to ask the question, is that a one-time event? Is that something weird about what happened over these last four years? And so, this won't recur? Or is what we experienced then just a reminder of the reality that always has and continues to exist? We just went through a long, long decade where rates didn't move much. And when they did, they only went up 225 basis points, it's been a long time. And your deposit base looks a lot different today than it did back in the late single digit 2000s, 8’, 9’, the last time we had anything, anything nearly even close to where we are today. So how do you address that prospectively? How do you get the data and the information if you believe that what I just talked about is truly reality? And I can argue, not argue, I'll just say it because it's fact, is that there are loan related assumptions that are really important as well. I already mentioned the prepayments as well as loan pricing betas. How do you factor in loan pricing betas? Loan pricing you know is also nonlinear and a lot of variables at play. And then once you do that, then the importance of sensitivity analysis, I just want to highlight this. I can't tell you, I'll give you a perfect example. I'll go back to 2002s and 3‘. In fact, 2001 and 2’, even before rates went up. We looked at and saw that 20 to 25% of all industry non-maturity deposit growth that happened because of the COVID surge represented above trend line. And so, we sat back and said, well, okay, well, what if this is different money? Do I really want to extrapolate prior behavior patterns on this new stuff? What happens if half of it went away? What happens if it all went away? What happens if rates start to rise more than we expect or sooner than we expect? And what if at the same time we started to have decay on those excess balances? What happened if we were forced to pay up on monies to try and hold it off? So, what if our betas accelerated? At the same time, we had contraction in balances. And as you can imagine, the picture wasn't very pretty. And that highlights the risk of only talking about things in the context of sensitivity or stress testing. Because one of the challenges with stress testing, if you're not careful, is perceived or can be perceived. Ah, that's just something we do, but that can't possibly happen to me, we're different. I think we all realize, no, we weren't very different on this. And so, bringing those things and elevating them, and like I said earlier, out of the beginning, ask yourself what happens if, and how do you factor that into the thought process? Because, if I could hit a rewind button, there are a lot of things that could have been done. Some institutions did it, and a lot of them did not. So, let's just keep that in mind. Credit, I'm not going to spend too much time, I do want to say a couple of real quick things on the credit side. Again, I think it's it’s fair to ask ourselves what if. I gave the scenarios earlier, but what if we go down and it's not credit? Do we really have a handle on on what could happen? Do we really feel comfortable about our knowledge of the buffer that we have in our reserves and capital to handle that? How bad could it be? Or how bad would it have to get before we have an issue? And then be careful, be careful with only doing your stress testing on credit and your analytics by extrapolating your own bank or credit union history into the future. Because a standalone approach that just looks at your past experience, it’s just a very dangerous approach. Because models rely on data, if you're only using your data, it's only a function of what you have seen before. And what you saw in the past may not be what you're going to see now or in the future for a number of reasons, including your loan base probably looks a lot different today than it did the last time we had this thing happen. So, what could happen? And what if it did happen and the government doesn't step in to dampen what happened with COVID? And what if, what if we end up seeing the experiences back in the Great Recession? What would have happened? And just make sure you're looking at what if, you took on characteristics that others took, either in your region on average or or national on average. What if those were superimposed on you versus just what your experience is? So just getting clarity is really, really important. And again, keep in mind that what I just said, that models rely on basically what they see before, it's only as good as the data you give them. So, you have to be very careful about leaving your leaving your risk management models, including deposits and lending, and prepayments, to their own devices. Judgment is really important and is required. And I would just encourage you to think about the larger credits that if things were to happen in your organization can move the needle, move the needle in terms of your performance. Just dive into those things to develop some understanding there on a positive note. On average, as an industry, we are better positioned today, I think, regarding liquidity and net interest income and momentum than we've been in a while. I mentioned base case scenarios are definitely there. Margins are clearly widening; it's going to be very surprising. There ought to have to be some bad boogie to have to happen if for this industry, as a whole, to not see notable new momentum in the coming year. Now understanding I can tell you, the preparedness in the context of what I started with in terms of understanding and appreciating what can happen depending on what if occurs, what scenarios. The understanding and the preparedness of that is a broad spectrum. And the reality is, some banks and credit unions are a lot better and much better prepared and informed than others and just think about that. Ask yourself, where do you feel you are on that spectrum? And does it matter? So, I encourage you to challenge yourselves at ALCO and include leadership from the entire organization. Don’t let, do not let it become a finance thing, please don't let it become a finance thing because it's not. It's one of the most important committees, it should be, in your entire organization. It's the old adage, all roads lead to Rome, all roads lead to ALCO. Get the right people on the bus in there, facilitate the conversation that is deserving of their time and input. Don't assume away the unexpected. Change the conversation, look at yourself through different lenses and don't underestimate, please, the value of data that you have, in helping to change that conversation. If you look at data and analytics, it doesn't necessarily provide you answers all the time. It provides you with information that leaves the questions. If you don't get the information, you're not going to have the perspective to ask the kinds of questions that are being deserved to being asked. It's those questions that change, that force one, that contribute to changing the conversation and a willingness to look at oneself through different lenses. So, I threw out there a lot intentionally. I intentionally did not want to say, hey, look, do these three things and life's going to be wonderful because I think that would be disingenuous, and there's too much of a tendency for that kind of thing to happen. Each and every one of you is different and deservedly so.

[Dana, 54:53]

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