I’m looking forward to the return of a number of fourth-quarter traditions in 2024: sweatshirts, football, leaves, crisp air and an interest rate environment that supports the community banking model. I’m not saying they are, we will finally see the interest rate curve assume a positive slope. And that’s when the fun should really kick in. But (there’s always a “but” in these columns) be warned: Multiple rate cuts, and a normal yield curve, will probably have less upside this time around for community banks, at least initially. In a “bull steepener,” which is what we’re likely to experience, short rates fall, and longer rates fall less or longer rates rise. Either way, since most community banks’ portfolio’s effective durations are longer than normal, the price appreciation of your current bonds may not be what you’re hoping for. (To put some numbers on it, a typical bank’s duration is now about 4.3 years, versus about 2.5 years back in 2020 according to Stifel.) Things Looking Up In spite of the buzzkill of the previous section, a community bank’s universe just performs better when short rates are below long ones. Regardless of which part of the balance sheet you’re responsible for, it’s easier to price in relative risk/reward. For well over a year, the highest-yielding bank-suitable bonds have been CMO (collateralized mortgage obligation) monthly floaters. That’s fun for a while, but that’s not how financial instruments are supposed to work longer-term. Lower risk (i.e., lower duration) is supposed to produce lower yields. I also suspect that “betas” for community bank deposits will be friendly into 2025. Interest rate models weren’t built for 2022-23, in which overnight rates spiked 525 basis points (5.25%) in just 16 months. The initial bulge in net interest margins (NIMs) started to shrink early in 2023, and are now about where they were before the tightening cycle began. From conversations I’ve had with community bankers, anecdotally and otherwise, cost of funds should begin to retreat. Deposit managers have demonstrated their ability to manage NIMs through plenty of rate cycles, and rate shocks, and I see no reason to doubt their capabilities now. The big picture is the industry has held up remarkably well through a generation-high interest rate environment, that resulted from Fed tightening activity, and inflation, that most of today’s community bankers have never managed through. I’m looking forward to the return of a number of fourth-quarter traditions in 2024: sweatshirts, football, leaves, crisp air and an interest rate environment that supports the community banking model. 12 NEBRASKA INDEPENDENT BANKER
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