Pub. 15 2020-2021 Issue 4

NEBRASKA BANKERS ASSOCIATION 23 Since 1857, Cline Williams has devoted attention to the unique needs of the banking and nancial services industries. Since then, we have provided our clients with the resources they need in the areas that are most important to them – from lending and collections, to regulatory compliance, to mergers and acquisitions, and so much more. We’re more than a law rm. We’re a partner for your bank. | | | | | Dale Sheller is Senior Vice President in the Financial Strategies Group at The Baker Group. He joined the firm in 2015 after spending six years as a bank examiner with the Federal Deposit Insurance Corporation. Sheller holds a bachelor’s degree in finance and a master’s degree in business administration from Oklahoma State University. He works with clients on interest rate risk management, liquidity risk management, and regulatory issues. Contact: 800-937-2257, dsheller@GoBaker.com . we made sure our balance sheets were well positioned to take advantage of rising interest rates. That strategy allowed net interest margins to expand slowly but surely for several years as the Fed engaged in its most recent tightening cycle. But that was then and this is now. The Fed has put rates back at zero, and it is highly unlikely we will see an increase in rates in the next few years, if not longer. At the start of 2020, most banks were well positioned for a rise in interest rates, not a freefall back to zero. Interest rate risk has already taken its initial hit on margins and there is likely more to come. Institutions who were able to extend as- set yields before rates hit zero will fare better in the near term, but a prolonged low interest rate environment will eventually take its toll on all. Fighting Margin Compression The quickest way for institutions to fight margin compres - sion is through lowering their deposits rates and overall cost of funds. Most bankers have aggressively cut deposit rates as banks have already unwound about half the increase to their costs of funds experienced during the previous Fed tightening cycle. Most of the room left to cut will be on CD rates, which saw the biggest increase in the last few years. If you are worried about deposit runoff should you continue to lower rates, con - sider replacing those deposits with cheap wholesale funding. Yields on earning assets have fallen since year-end 2019 for two reasons: lower interest rates and excess liquidity on the balance sheet. As of June 30, 2020, the average community bank was holding approximately eight percent of total assets in interest-bearing balances, with most of those dollars likely held at the Federal Reserve earning ten basis points. Most of that excess liquidity came in so fast that some bankers haven’t had sufficient time to strategize on where to deploy it. Staying Fully Deployed Holding on to too much cash and waiting for rates to go up is not the conservative play. Margins can’t afford it. If quality loan demand is available, make the loan; if not, you need to earn more than ten basis points. Take a long look at your liquidity position and decide how much you are able to deploy into the investment portfolio. No one loves today’s bonds yields, but don’t compare them to where they were a year ago. Instead, compare them to the alternative, which is holding them in low earning cash. There are only somany levers we can pull to fight margin compression, and we need to start as soon as possible. 