Episode 19: Interest Rate Cuts: What Financial Institutions Should Expect

In this episode Virginia Heyburn is joined by Fabio Biasella, Director of Strategic Services, and Joe Dugan, Strategic Advisor, to dive into one of the most pressing topics in financial services – the anticipated interest rate cut. They discuss its impact across the balance sheet, covering everything from deposits and loans to operations and strategic planning for banks and credit unions. 

Transcript

Virginia Heyburn (00:01.458) 

Hello to everyone joining us today. Welcome back to another episode of FinTech Unleashed. My name is Virginia Haber. I'm the Director of Research, Insights, and Advocacy at EngageFI. And today I'm joined by two of my colleagues, Fabio Biasella, Director of Strategic Services, and Joe Dugan, Strategic Advisor from EngageFI. Collectively, Fabio and Joe have about 70 years of experience in the financial services industry. And that experience is really going to come in handy today. 

Because on today's episode, we're covering one of the most talked about and certainly most complex topics in the financial services industry today. And that's the anticipated interest rate cut. We're going to explore its impact on both sides of the balance sheet, how it will affect deposits, loans, operations, and the overall strategy for banks and credit unions. Obviously, we have a lot to cover, so let's dive right in. 

Virginia Heyburn (01:00.348) 

Fabio, Joe, it's great to have you both on the podcast today. Welcome. 

Joe Dugan (01:05.208) 

Thanks. 

Fabio Biasella (01:06.0) 

Thank you, Virginia. Good to see you both. 

Virginia Heyburn (01:08.784) 

Yes, yes, always good to work with you. This is a big conversation and with interest rates coming up very soon, banks and credit unions are going to have to navigate this changing environment, changing deposit costs, falling yields. It's bigger than a bread box. So what are banks and credit unions dealing with today in this longstanding high interest rate environment? Let's start with where we are right now. And Joe, if I could ask you to start, that would be great. 

Joe Dugan (01:35.822) 

Sure. Well, you know, the challenge of right now is we have higher interest rates, but we also have higher cost of funds as we're paying premiums on deposits. And what's the other challenge is we haven't as banks and credit unions had the opportunity to really reap the benefit of the higher interest rate because most loan portfolios haven't 

completely repriced at this point with three and four year term loans still not being affected by the term of the interest rate increase. 

Fabio Biasella (02:17.71) 

Yeah, that's exactly right, Joe. You're seeing loan portfolios slower to reprice. And depending on your mix, whether you're a bank that's heavy or in a commercial, you've definitely got, as you mentioned, what you're seeing. And then if you're a more retail shop or a community credit union, it's really driven by the amount of 30 -year mortgages you have on your balance sheet. 

We're seeing in the data lots of people who will not move now because they do not want to give up their historically low interest rate mortgage. I can't say that I don't know a few of those people personally. I may even be one of them. 

Joe Dugan (02:51.98) 

Yeah. 

Virginia Heyburn (02:55.847) 

Present company included, right? So given that, I mean, we're in an environment that's very challenging for financial institutions. Now the environment is going to shift. It will happen gradually. know, how are the challenges going to be different once interest rates come down just a little bit? Joe, over to you. 

Joe Dugan (03:16.398) 

I think, okay, yes, I think they're gonna be quite a bit different because for a few reasons, one being the pressure to retain and acquire deposits is going to shift significantly. And again, your compression is only going to increase. So how do you raise deposits in a cost effective way and not 

continue to compress your interest rate, your net interest income opportunity. And I think one other challenge that banks are going to face is in the lower interest rate environment, they shifted their premium money, their premium priced products from CDs to money market and high yield savings products. 

which allow them to more rapidly reprice a portfolio when the portfolio is only moving 15 or 20 basis points over that long -term low rate environment. However, because all these funds are now in liquid products, they will not have the benefit of a lag effect that they had when they used to use CDs in prior falling rate environments. 

So those monies that they've accumulated and desperately need are going to be at risk very quickly and they need to understand what the right approach is to retain the monies and also acquire new deposits. 

Virginia Heyburn (05:01.34) 

So what I think I'm hearing you say, Joe, is we've been around these houses before with interest rates starting to come down. But this cycle is different because of the very reason that you mentioned in that people are holding and businesses are holding deposits in more liquid accounts. 

Joe Dugan (05:19.776) 

Exactly. 

Fabio Biasella (05:21.07) 

were able to get yield for once in those accounts right 

Joe Dugan (05:25.4) 

Right, exactly. And the other reality is we have generations of both consumers, businesses, and bankers who have never been through a rising interest rate environment and now reversing to go back in a falling interest rate environment. Interest rates have been basically zero for 

most of the 21st century. 

Fabio Biasella (05:57.814) 

Yeah, an unusual period of time in which many of the executives that I've encountered, even myself in my own experience as a bank executive, dealing with kind of a progressively, perpetually lower interest rate environment. 

is going to be a sea change. Because while interest rates were fall, there's nothing that I've seen in any of the research that I've looked at, either anecdotally or directly, that says interest rates are going to fall back to the levels they were pre -pandemic or during the pandemic, certainly when they were truly anomalous. If anything, we look at the longitudinal data, the long -term data over 30 years when I first entered banking and Joe first entered banking, we're really returning those levels of interest rates. So yeah, they may be going 

down and that may take some of the pressure off on the margin for just a bit. But if they don't have the pricing discipline and now they have to have pricing discipline where the bulk of the monies are in liquid accounts rather than term CD products, they're going to feel the pain even much more quickly. So there's it's a bit of a different animal. So strategies on maybe figuring out how to start locking in some of these. 

balances as rates start to fall would be worthwhile. 

Virginia Heyburn (07:14.928) 

And let's talk more about that, but I want to get back to something that Joe brought up, and that is that there's an entirely new generation here that has never been through a rising rate environment, and now they are looking at a declining rate environment. Can you dig into that just a little bit more and share with us how that is going to impact financial institutions? 

Fabio Biasella (07:35.438) 

Sure, sure. least from my perspective, right? I think the thing that I've been most impressed by in looking at the deposit portfolios of clients is 

The generational wealth, the capital cycle that was generated by the baby womb generation, that's coming to an end. And I cannot stress enough that this was the wealthiest, most upwardly mobile generation in human history. And it created a lot of income and a lot of capital that kind of just flooded the system, basically for the last kind of 15 years at least. 

pushing down those rates, that's starting to unwind. Those folks, that generation now as they completely phase into retirement are gonna be looking to spend that capital. They will need to spend some of that capital in which to live and they're certainly going to move it out into other areas where they can have some yield. So you have this, the days of kind of just the capital washing in the industry, really everywhere, not just, I don't wanna just single out banks and credit unions, but it washed into all. 

the capital markets. They're pretty much done so it's going to be much more competitive on those prices and then you have another generation, the Zoomers and the Boomers and the younger Millennials, Zoomers and the younger Millennials, excuse me, now going in at first for the first time actually being able to capture some amount of yield. 

bank or credit union product and now they're gonna watch those yields start to fall and by the way they are now by far the most sophisticated shoppers they do know how to search for rate and they do know how to search for price and let's be honest in the world of digital account opening we've made it really easy for them 

Fabio Biasella (09:25.422) 

to move the money around and reduce the switching costs to that. So we have to really begin paying attention to how much of our funds are really historically sleepy. I think that number is going to be changing. It's been, was my experience, right? If you would look at your deposit portfolio, you know, it's not uncommon for 80 to 85%, 90 % of it to kind of just always be there in the various buckets. 

That may be less true now. Now, is it going to go from 80 to 85 to 50? I don't know. But it will be some figure substantively less because the consumers are just much more mobile. And they have so much more competitive opportunity to select from. So real challenge, real challenge connecting with our customers and our members. 

Virginia Heyburn (10:15.27) 

Yeah, and Joe, do you have anything to add to that? 

Joe Dugan (10:18.252) 

Well, I think, you know what Fabio touched on there and different generations. Absolutely. The younger generation, as we all well know, are very plugged into digital and they are not afraid to find a better solution, which for them is going to be a higher yield than they're getting elsewhere or where they currently are. And not only are switching costs lower, but friction is almost non -existent and 

that it used to be, inertia was banks and credit unions best friend. We made it so hard to switch in a manual environment that you really had to be wanting and persistent to move those funds in the past. Nowadays, those funds are out the door in three minutes or less and the bank or credit union don't even know it. So that's the pressure that's gonna be on deposits between the pricing 

with falling rates, the deposit pricing needed to be maintained and this movement outflow of money risk is real. 

Virginia Heyburn (11:22.13) 

Thank 

Fabio Biasella (11:26.914) 

Yeah, that's a great, great point, Joe. Great description as opposed to the word sleepy. I appreciate that. 

So it really says strategically, A portfolio management is really going to matter. You've got to know from a balance perspective, your higher balance depositor, households, and customers. You've got to be monitoring them probably daily. And then in anticipation of any strategic rate changes you might be making, I think that's worthwhile to at least have an idea. 

Hey, we're about to lower our standard rates for this particular product. It's going to affect these key 500 customers or members. Let's get out ahead of this. Those types of tactics, I think actually are going to be of paramount importance, almost kind of one -on -one. 

tactical initiatives for those clients or members that we're about to affect the most. Because you're right, don't think it's gonna, it can move just like that and you may not know it. 

Virginia Heyburn (12:30.098) 

me ask you, we have been talking about the impact of the lower interest rate environment on the deposit side of the house for both banks and credit unions. Can we draw a distinction? So Fabio, I know you spend a lot of time with both, as do you Joe, but what's different about the credit union world, Fabio, that you believe is going to really stand out in the next months? 

Fabio Biasella (12:54.69) 

Yeah, a couple of things there. Let me get on my soapbox moment for the wonderful world of retail amongst credit unions, Historically, credit unions have lagged changing in their deposit prices, maybe for some of the reason that Joe mentioned earlier, where they were using so much more term product. We have that phenomena still today, but because the switching costs are so easy, I think that they need to have much better discipline. 

deposit pricing discipline going forward right now and moving those rates much more quickly than they have historically or they're going to feel the crimp on the margin side for longer than they should. So that would be soapbox moment number one. 

And then again, because they're so reliant on the CDs, they're going to have to determine going forward what they're going to do. Are they going to continue to offer special rates? Are they going to shuttle more into the liquid accounts? How willing will they be to match rates in the market that they're in? And what kind of mechanism 

do they have available for their frontline staff to do that. One of the interesting topics that I'm seeing, it just started to flow across my desk the last couple of weeks is developing tools which allow your frontline staff or your managers to be able to adjust pricing within parameters. 

But in concert with the member or the customer, you will, trading term for rate or rate for term, depending on the needs of the particular individual. So I thought that was an interesting approach. But those are the big ones, pricing discipline, and then really being able to monitor that CD portfolio much more carefully than I think they have historically. Not just calling up in anticipation, but calling with a plan about what to do. 

Virginia Heyburn (14:49.285) 

and all those things true on the bank side and what's different. 

Joe Dugan (14:49.464) 

Good. 

Joe Dugan (14:53.442) 

Well, I'd say all those things are true on the bank side. And one other thing, just backing up a little bit to our previous question for credit unions, the other interesting part is many are acquiring commercial portfolios by acquiring small community banks currently. And these generational shifts, banks 

already don't have the more seasoned bankers sitting around their Elko table anymore, who maybe been through both a rise and a fall and a rise and fall. They've been mostly in a flat environment until this recent rising environment. They had to scramble around that. Now they'll have to scramble and learn in this falling rate environment. And the credit union has an extra complexity 

because they don't have the experience either as far as rising and falling over such a short period of time, but they're also relatively new to the balance sheet management subtleties that are different on the commercial portfolio from the consumer portfolio. So. 

Fabio Biasella (16:11.81) 

absolutely, we're acquiring a whole new skill set. 

Joe Dugan (16:15.094) 

Yeah, so that pricing management that Fabio mentioned is really going to be very critical and very challenging for both banks and credit unions. 

Virginia Heyburn (16:29.626) 

Interest rate risk management is back in vogue, is it not? 

Joe Dugan (16:32.942) 

Exactly. 

Virginia Heyburn (16:35.302) 

Let's turn to the loan side of the business. It certainly seems obvious that lower interest rates are not going to ignite loan growth in the near term at least. Because just with a refinance, it's going to get a long time to get to a place where you're doing better refinancing your house, your car, commercial property versus a few years ago. And that's not even speaking of generating new loan growth. 

How are banks and credit union executives looking at this in terms of lending as they look out over the next couple of years? What are they thinking? Fabio? 

Fabio Biasella (17:11.352) 

Well, I'll start on the consumer side. On the consumer side, what we're seeing trend -wise is because ostensibly the refinance market on the mortgage side is frozen in place, locked in place, you'll just have kind of the natural attrition that will take place there as folks sell homes and move along. So there'll be a bit of a purchase market. That purchase market will be sustained amongst the younger households. There is a sufficient size of a generation to come and try to purchase these homes, although supply 

are somewhat limited and those consumers have their own debt challenges, leaving that aside, strategically what you're seeing is debt management. On the consumer side, it's going to be about consumer loan debt management, managing credit card balances, debt consolidation loans, those types of personal financial lending are going to increase in importance and then you can obviously do that in any number of ways, direct lending, can do that through credit card balance transfer programs. 

things of that nature. And then home equity lending on the real estate side. Given the fact that we're locked in on the mortgage side, you're starting to see home equity loan demand, home equity loan of credit demand in particular, pick up. And that's a good example of, think that's something that... 

I see as a trend, really seeing it emerge on home equity products more and more now. Most banks only offer home equity lines of credit now, most commercial banks. But the ability to break off pieces of that line of credit into fixed term loans, and then as the consumer repays the term loan, it returns the available balance of the overall line. 

Those types of products, I think, are going to pick up in interest to consumers who are pretty much locked in on the front and still need a credit facility on the back end, on the real estate side, to get access to lower interest rates as they manage that or redo the home that they're now going to stay in because they have a 3 % mortgage for the next 15 years or so. 

Fabio Biasella (19:20.588) 

That's what I'm seeing on the consumer side in particular, move much towards consumer debt management of existing balances as much as the acquisition of new debt per se through home equity. 

Virginia Heyburn (19:33.882) 

And Joe, apart from maybe some initial exuberance around CRE lenders looking at possibly lower default rates, what's the impact on the bank side? 

Joe Dugan (19:44.814) 

Yeah, no, I think it's still the commercial loan loss risks the commercial loan loss portfolio. There's certainly the exuberance I'd say is rather modest on the CRE side because the larger problem is the property managers who are on the hook for the loan, the vacancy rates are climbing in these commercial properties ever since the pandemic and 

everyone working in the remote environment. The effort to try to bring people back to work has mostly failed. So this remote environments around for a long time, landlords aren't getting the rent and the lease opportunities that they're used to a lot of vacancy that ultimately leads to loss on the portfolio for the bankers. I think the other interesting piece of that that maybe less talked about is 

not necessarily the interest rate, but the same kind of problem of the building cost itself for the banks and the credit unions. So their headquarters too are empty and they're tied into 15 year leases on these buildings that they have to continue to pay. So their expenses are being 

suffering the same way as their business clients revenue stream is suffering because of these vacancies in their own building. 

Virginia Heyburn (21:25.615) 

So I think what I'm hearing you say, Joe, is that this lower interest rate environment as we move through this cycle, it's really revealing that there are some issues in the operations of financial institutions that we've probably been carrying with us as an industry for a long time, but we just haven't felt them in the way that we're now going to feel them, which means that we have to address them. So my question to you is, what is this interest rate environment going to reveal about lingering deficiencies in how 

banks and credit unions have set themselves up to operate. 

Joe Dugan (21:59.256) 

They have to change the model and they have to change it starting with how they approach their customer from a sales point of view and how they manage their channels from an optimization point of view for the customer to bank with them. Too long, for way too long, we have allowed these challenges or these channels rather to continue to proliferate. They're not being replaced. 

And we still, particularly on the bank side, have the burden of underperforming branches that are very difficult to close because of the CRA regulation. Credit unions have some of the same challenges just because they've been following the same model and they're hesitant to close branches frequently from a PR point of view. 

but they do have the luxury of being able to do it without the regulatory scrutiny that banks face. So the question is, if you can't close the branches, the branches aren't going away, the activity is shifting to digital. And we'd have everything centralized from a servicing point of view. What do you do? You need to change the model. 

sales needs to get out of the verticals, work holistically, and you'd have to maybe revisit the centralization model that is popular today. 

Virginia Heyburn (23:35.258) 

Mm 

Fabio Biasella (23:36.563) 

all sorts of implications like that. Spot on, Joe. 

Virginia Heyburn (23:39.61) 

Right, Fabio, and I know you're passionate about this topic. What go -forward strategies would you propose to make what Joe has described actually work? 

Fabio Biasella (23:50.466) 

Well, I think we build on what he's saying, right? The realities of siloed business units and siloed channels, right, that are not really mutually supportive. They exist next to one another. All of that has to be rethought, right? So that you can handle the burden of the realities of you may have a branch that you're going to need to keep for whatever reason. 

you're going have to staff it with far more people than it's required simply to maintain the proper safety protocols, let's say. 

Okay, so you've got that reality. How do we get more out of that particular location, both in terms of scalability of the amount of transactions or the amount of interactions or the amount of channels that they can support and the amount of a customer and or member engagement that really can take place? That's the real fundamental challenge. You have to rearrange kind of the internal operating model. 

I'm going to put it loosely away from just pure transaction management. I'm not saying that that's going to go away because we got to manage the transaction safely and soundly. 

Joe Dugan (24:55.59) 

Thank 

Fabio Biasella (24:57.282) 

But that has to exist almost at a fundamental level. And then on top of that, in order to drive performance, you have to have this whole new engagement model where the branch expertise supports the digital channels in particular, as a good example. And then for any given process that's more back office, how can you use the digital, a digital strategy, almost an internal digital strategy? 

to scale that business. So pick a process, right? I'm trans internally, if I'm transfer handling a million GL transactions a month through my accounting resources, my finance resource, how do we handle five million, 10 million a month with the same number of resources, maybe different tools that are more optimized. 

comes to mind. And then the same story on the front side. How can we take the expertise that's resident inside the financial advisors that we often have inside our shops who are very good at providing the software in relationship development, which is what I did historically as a private banker. 

how do we make that capability present inside our digital channels, for example, so that we can reap better engagement through those digital channels? Because the numbers I'm seeing on digital channel account opening abandonment, for example, they're untenable. mean, you're seeing 75%, 80 % attrition over a 12 to 15 month period on accounts that are coming in over your digital channels. 

really kind of laying bare the fact that we've been in this environment, largely driven by the interest rate cycle we were in, the beneficiaries of, kind of let hide all of these realities. So we have a huge opportunity, and it is nothing but an opportunity to rethink the business going franchise and the support structures and the engagement structures. So yeah, I get carried away, but it's going to be one of the best kind of 

Fabio Biasella (27:02.828) 

The success we see in that area from client to client will determine the forward, that institution's forward ability to thrive. 

Virginia Heyburn (27:10.49) 

Right, and I think, Joe, maybe it was you. You were sharing some statistics with me on just how underutilized branch expertise is. 

Joe Dugan (27:19.682) 

Right. So in the simplest, most basic fashion, the challenge for banks and credit unions are that as transaction volume has continued to drop and we have morphed branches into primarily being transaction takers. As they have dropped, you have a bunch of branches that require four FTEs to keep it open from safety and soundness. 

point of view, dual control, two people there during lunches, et cetera. And the activity level for transactions has a need for about one and a half FTEs. So you have two and a half FTEs that are barely being utilized because of dual control to keep the branch open. We need to shift our mindset to what does 

this office in this market provide us as an opportunity with the demographics that surround this office? And how do we staff this office to take advantage of that opportunity? 

Virginia Heyburn (28:33.458) 

So let me stay with you on that since you use the word opportunity and it's always nice to leave our listeners with a positive outlook, a reason for optimism. Given the challenges, given the fact that there are strategies that financial institutions can pursue to become far more efficient and operate more effectively, what makes you optimistic about the path that banks and credit unions will take? 

to transform their operations. 

Joe Dugan (29:05.208) 

what makes me optimistic that they'll do that or. 

Virginia Heyburn (29:07.322) 

Yes, because in the end it has to be done. 

Joe Dugan (29:11.926) 

Yeah, well, I think what makes what what makes me optimistic is just that they're running out of options. We've tried to delay this reality for as long as possible. And we've tried. But the competition is getting more and more difficult, particularly in the neo bank space. And we all know these younger generations are very fluid. 

and fluent in the digital universe. So what makes me optimistic is we're running out of options. Much like, know, for years and years when we got to digital, it was only consumer facing. Now, because of the pandemic, we found out, or small businesses learned, had to learn how to use digital and found out 

Hey, this is great. This is easy. I like it too. When's my bank or credit union going to give me a digital offer? So, but we resisted until we had something like a epidemic drive that change. So I don't think we're quite at the epidemic level yet as far as operational structure, but the pressure is only building to push this change. 

And that's what makes me most optimistic. Although there's some pessimism still kind of folded in there. Our past history is not really a positive precedent for change, but we're going to be forced into it shortly. 

Fabio Biasella (30:49.462) 

No, no, Joe, sunshine and rainbows. No, no, no, not at all. 

Fabio Biasella (31:03.85) 

And from my perspective, if we build on the sunshine and rainbows theory, consumer preference will drive the change. But also the fact that we're local. When I look at any bit of research historically through the years, even with the advent of the new more digital native individual or consumer or business customer, strong preference for physical proximity to their banker. 

is expressed time and time again. And it's relatively stable. It doesn't change that much, particularly amongst small businesses. They will be proximate to their relationship manager. The question is, how can we effectively replicate that model to more and more businesses? 

becomes an interesting question to solve, an interesting problem to solve. And the same story is true on the consumer side. A younger individual may not be going to the branches in the same number on a monthly basis that an older consumer indicates that they would be, but they still go. And when they go, they go for advice and engagement and open accounts. 

So those things can't be undersold. have to, think strategically a big implication is how do we push the fact that we have a local presence along with a strong, properly tuned digital experience. So that's what I'm optimistic about because the neo banks can't do that. And all it takes is one problem with the neo bank and no way to get to a human being to make consumers and or small businesses realize maybe. 

Gotta have a human being somewhere in the loop. That's close at hand or closer 

Virginia Heyburn (32:51.588) 

It's high tech, high touch, right? It's both, both and. 

Joe Dugan (32:51.927) 

And it's. 

Joe Dugan (32:56.494) 

I think the other thing, Fabio, you brought up an interesting stat that I've been watching for years. That customer preference. And number one was always for 20 years, branch near where I live or work until two years ago. And then it became convenient digital application. Do I have mobile app? And branch location has dropped to number two. 

Fabio Biasella (33:12.546) 

Yep. Yeah. 

Joe Dugan (33:26.38) 

So that's also a harbinger of those needs to shift the model. Financial education advice locally delivered is great, but is your branch staff to offer that education advice that the people need when they're coming in the door or the staff to deal with transactions? 

Fabio Biasella (33:50.606) 

Exactly. Great point. Right. So the way I put it to clients when I'm challenging them in the C -suite now is historically the old fundamental was we add digital channels and it supports the branch effort. The branch is where the sales had taken place historically. We're now in an environment where that's almost inverted. Okay. Where the branch... 

is supporting the digital effort much more clearly, much more plainly than I think we're willing to admit yet, or we will be admitted shortly. And it builds on your point, Joe. Can you then project your expertise on relationship development into that digital channel from the branch? Right? 

Virginia Heyburn (34:33.296) 

We'll have to leave it there today. We can talk all day. I know the three of us could. But the industry environment is giving us a new reality. We have a new generation of customers and members. We have a new generation of competition. This is a new environment. And we also have a new generation of technologies that allow us to pursue the kinds of efficiencies that we have been talking about here today. So thank you, Fabio. Thank you, Joe. This has been great. 

Fabio Biasella (35:00.174) 

Thank you. That was wonderful. 

Joe Dugan (35:00.312) 

Thank you. 

Virginia Heyburn (35:02.63) 

Yes, was definitely terrific. And to all of our listeners, thank you for joining us for today's episode. To stay informed on when we're going to be dropping the next episode, follow EngageFI on LinkedIn. I look forward to seeing you on the next episode of Fintech Unleashed. Have a great rest of your day, everyone.