Pub. 15 2020-21 Issue 6

WWW.NEBANKERS.ORG 22 B EFORE THE COVID-19 PANDEMIC TOOK HOLD ON THE WORLD and the United States, many community bank - ers watched the slow fall of their on-balance sheet liquidity. Throughout the last decade of economic expansion, many community banks’ loan demand consistently outpaced deposit growth. At the beginning of 2020, bankers’ expectations for the year were for more of the same: a com- bination of steady loan growth and an expanding net interest margin. The pandemic completely changed those expectations. The First Wave The first liquidity wave in the banking system started gaining momentum in early March as the pandemic sparked fear and panic in the financial markets. The Federal Reserve lowered its benchmark rate by 50bps in early March, only to outdo themselves a couple of weeks later during an emergency meeting with a 100bps cut. Two key things happened in March that started the liquidity wave. First, dollars flowed into the banking system seeking the safety of the FDIC deposit insur- ance. Second, larger corporations boosted their cash positions and overall balance sheets by drawing on their credit lines. The wave grew larger in early April as billions in stimulus checks were sent out and the personal savings rate reached an all-time high. Furthermore, the Paycheck Protection Program (PPP) loan program rolled out as part of the CARES Act, which added more liquidity as the initial $349 billion in PPP funds were lent out in under two weeks. While many businesses spent their PPP loan funds over the next two to three months, billions of the loan proceeds sat idle in business operating accounts. The Impending Second Wave Where do liquidity levels in the banking system liquid- ity go from here? Will upcoming loan demand gobble them up, or will there be plenty left over? Outside of additional second draw PPP loans, loan demand remains lower than pre-pandemic levels. Recent PPP loan forgiveness has reduced overall loan portfolios. The additional $2 trillion stimulus package currently moving through Congress includes larger direct stimulus payments, which should further add to overall liquidity levels. Balance Sheet Considerations When will loan demand return to a more normal level as seen before the pandemic? One guess is as good as any, but we know that stockpiling cash or short-term liquidity isn’t a conservative long-term solution during a historically low-rate environment. Net interest margins compressed significantly over the last year. We need to take a hard look at our short-term liquidity position and ask ourselves if our cash position is too high. Are we waiting too long for loan demand to come back or for deposits to surge out of the bank? It is challenging to predict your liquidity position outside of a few months given all the external factors that can influence it in today’s environment. Riding the Liquidity Waves Dale Sheller, Senior Vice President, Financial Strategies Group, The Baker Group