How important is Net Interest Margin (NIM) to your institution? Community financial institutions are heavily dependent on net interest income (NII). With the majority of earnings coming from NIM, implementing a disciplined approach around “NII management” will make the difference between underperforming and outperforming institutions. To request a comparison of how your institution ranks vs national and in-state peers, click here.

As financial institutions across the nation are dealing with challenges from COVID-19, anticipating next steps to protecting or to improving profitability will become increasingly difficult. Why: Margins are under pressure!  Cash positions are growing with record deposit inflows; loan pricing has become ultra-competitive; and many institutions are seeing accelerated cash flows from investment portfolios. In times of uncertainty, it can be challenging to develop and execute a strategy to defend profitability.   

In addition to profit management, it is important to remember that stress testing your institution’s balance sheet is no longer an academic exercise! Beyond the risk-management applications, stressing the resiliency of capital and durability of liquidity should give your institution the confidence necessary to execute on strategies to improve performance and to stay ahead of your peers. It is of heightened importance to maintain focus on the four major balance sheet positions we discuss below.

Capital Assessment/Position

Capital serves as the cornerstone for all balance sheets, supporting growth, absorbing losses, and providing resources for seizing opportunities. Most importantly, capital serves as a last line of defense, protecting against risk of the known and the unknown. As we navigate this period of uncertainty over the next 12 to 24 months, capital will be tested. Rapid changes occurring within the economy are not entirely cyclical in nature; rather, structural shifts will develop as consumer behavior evolves and business operations adjust to a ‘next normal’. Knowing the ‘breaking points’ for your capital base in terms of growth, credit deterioration, and a combination of these factors will serve your institution well for the Board and regulators.

Liquidity Assessment/Position

At Taylor Advisors, we have a saying, “Asset quality deterioration leads to capital erosion which leads to liquidity evaporation”. With institutions reporting record deposit growth and cash balances swelling, understanding how access to a variety of funding sources can change given asset quality deterioration or capital pressure is critical to evaluating the adequacy of your comprehensive liquidity position. Furthermore, stress testing your profile for a variety of scenarios (including falling below “well capitalized”) should help to give further confidence to execute strategies to protect the margin.

Interest Rate Risk Assessment/Position

In today’s ultra-low rate environment, pressure on earning asset yields is compounded by funding costs already nearing historically low levels. Excess cash is expensive and significant asset-sensitivity represents an opportunity cost as the Fed and the market forecast a low rate environment for the foreseeable future. Focus on adjusting your asset mix, not only to improve your earnings today, but to sustain it with higher, stable earning asset yields over time. Additionally, revisit critical model assumptions including loan reinvestment rate floors to ensure that your assumptions are reflective of actual pricing and rates down deposit beta assumptions as they may be too high for certain deposit categories.

Investment Assessment/Position

Strategies for investment portfolios and cash usually make a meaningful contribution to your institution’s overall interest income. Below are some key considerations to help guide the investment process in today’s challenging environment:

• Cost of carrying excess cash just increased – Most institutions are now earning just 0.10% or less on their overnight funds. There are alternatives available in the market to increase income on short-term liquidity.  Cash is not always KING!
• Consider pre-investing – Many institutions have been very busy with PPP loans, and investments have taken a back seat. However, we anticipate this program having a short-term impact on liquidity and resources.  Currently, spreads are still attractive in select sectors of the market.  

Taylor Advisors’ Take:  

Looking beyond 2020, liquidity and capital are taking center stage in most ALCO discussions. Moving away from regulatory appeasement and towards pro-active planning and decision-making will be of paramount importance. This can start with upgrading your tools and policies, improving your ability to interpret and communicate the results, and helping implement actionable strategies.

Truly understanding your balance sheet positions is critical before implementing balance sheet management strategies. Why? You must know where you are to know where you want to go. Start by studying your latest Q3 data! Dissect your NIM and understand why your earning asset yields are above or below peer. Balance sheet management is about driving unique strategies and tailored risk management practices to outperform…anything less will lead to sub-optimal results. 

In the midst of that, however, we are hearing how credit unions have stepped up to help, whether through helping the Federal government distribute some of the $3 trillion it has injected into the economy (and the ever-changing rules that came with that!) or by offering their own assistance to their members. And you had to do that while figuring out how best to work remotely yet serve members and keep your own employees safe. The work that has been done thus far is nothing short of amazing.

As credit unions know, there is a cost, however: we’re hearing from many clients who have revised their budgets for 2020 to reflect a substantial drop in net income. Several are even forecasting very lean earnings for 2021. All are looking for ways to enhance earnings, and there is also a focus on reducing expense.

One area that is often a target for tightening during these times is compensation and benefit expense. It does, after all, represent one of largest expense categories on the P&L. At a time when you have asked so much more from your team – and by most accounts they have delivered - we caution you to carefully consider those decisions and review some of the ways we’ve helped clients adjust their budgets while valuing their people.

Here are some of the ways that IZALE has helped clients this year:

• Client A, a $1 billion FCU, has used BOLI for several years to offset the cost of all employee benefits. With deposits up, loan demand tempered, and traditional yields down significantly, they allocated additional money to BOLI and immediately (with no market risk) boosted earnings by over $140,000.
• Client B, a multi-billion FCU, had an established 457(f) for several executives. We helped them evaluate the merits of continuing that plan vs. using a split-dollar loan structure, deciding the latter met their objectives. The client recaptured more than $5 million of prior expense while offering more net cash flow to executives.
• Client C, a multi-billion state CU, needed a program for senior executives. They have a rational process for first quantifying how much of a benefit they want to offer. The board, with input from the CEO, evaluated 457(f), split-dollar loan, and Restricted Executive Bonus Arrangements (or REBA), and decided that a combination 457(f) + REBA most met their objectives.

While there is no one best way for every institution to value their people or improve earnings, we believe you should evaluate all options and choose the one (or ones) that check the most boxes for the institution and executives (not vendor). Our examples above describe ways we’ve assisted larger institutions, but we helped clients in all asset sizes implement programs appropriate for their budget. IZALE has never charged for evaluating plans, and we welcome the opportunity to share what we’ve learned from helping to design (or redesign) over 1,100 executive benefit plans over the past 20 years.

arrive at this moment with the overleveraged corporate sector about to face the prospect that new-issue bond markets may seize up, as they did last week, and that even seemingly sound companies will find credit expensive or difficult to obtain. Credit spreads have a long way to expand. BBB bonds could easily reach a spread of 400 basis points over Treasurys while high yield would follow suit with BB bonds at 750 basis points over and single B bonds at 1,100 basis points over. The risk is that it could be worse. As for stocks, technical analysis suggests that there should be support around 2,600 on the S&P 500, but in a recession scenario a level closer to 2,000 could be the ultimate outcome.

The only silver lining is that you should have some gains in the bond portfolio. But now what? Unless you have a robust loan pipeline, where do you go with maturing bonds or to invest the cash from loan payments?
 
Bank-Owned Life Insurance or BOLI is used by over 4,000 financial institutions with over $180 BILLION of capital invested in it. What makes BOLI so attractive?
 

• Guaranteed minimum crediting rates of 1% - 4%. You are reading that correctly.
• Current yields (after cost of insurance) of 2.75% - 3.5%, depending on purchase size and insured demographics. Tax-effect that, and it compares with some new loan rates.
• No mark-to-market risk. With general account or hybrid account BOLI, a change in market rates has zero impact on the balance sheet value.
• There are even products with an “index” crediting rate that could deliver far more yield than traditional BOLI.

 
Call or email us today. Let’s talk about the vital role that BOLI can play on your balance sheet and let us help you with the next BOLI purchase.