Second Quarter 2025 

This report outlines key bank performance trends and strategic recommendations to help your bank capitalize on the current economic environment. 

Q2 25 vs Q1 25 Bank Trends*: 

Bank fundamentals were solid and investor sentiment positive for the quarter, building momentum for the industry as we enter the second half of 2025. Despite continued economic challenges, more banks beat EPS growth estimates than in the prior quarter. Loan growth accelerated while core deposits and wholesale funding growth moderated. New loan volume was funded primarily through excess balance sheet liquidity. Strong top-line revenue growth fell mainly to the bottom line as expenses grew at half the pace of revenues and credit costs showed little change.            

Chart showing Q2 vs Q1 2025 balance sheet changes for U.S. banks under $10B in assets. Categories include Assets, Loans, Cash, Reserves, Securities, Deposits, and Borrowings. Values range from -$22B to +$24B and -10% to +6% change. Source: S&P Capital IQ.

  • Rebound in loan growth as deposit growth slows. Following last quarter’s decline in loan balances, the second quarter ended on a more positive note as loans grew by mid-single digits on an annualized basis. Core deposit balances declined slightly and a build-up of excess liquidity in the first quarter filled most of the funding gap.   
  • Solid NIM expansion. After a flattish first quarter, NIM expanded 17 basis points, reflecting an increase in earning asset yields driven by positive asset repricing. Cost of funds remained unchanged, indicating limited opportunity to lower funding rates.    
  • Double-digit pre-provision net revenue growth. Top-line revenue growth was the primary driver of positive operating leverage with solid contributions from net interest income and fee income. 
  • Stable credit. Overall, credit remained strong for the quarter as NPAs, NCOs, and provisioning showed only modest increases. Reserve levels were unchanged at 1.30% to total loans.  
  • Regulatory considerations. Regulators continue to focus on credit, including credit stress testing processes, liquidity and contingency planning, interest rate exposure under multiple +/- rate scenarios, and capital stress testing.                 

Line graph showing trends in NIM, Earning Asset Yield, Cost of Funds, and Fed Funds rate for U.S. banks under $10B assets from Q1 2024 to Q2 2025. NIM rises, Yield and Fed Funds decline, Cost of Funds stabilizes.

Bank Strategies For The Second Quarter 2025 and Beyond:  

The Fed continues to exhibit patience in its approach to lowering interest rates as they await further clarity around fiscal policy along with changes in employment and inflation data. The market is currently predicting two to three rate cuts this year with expectations of the first 25 bps cut at the September 17 FOMC meeting and an ending target rate forecast to be 3% by the end of 2026. We continue the drumbeat of managing to a neutral interest rate risk position as the Fed makes some critical policy decisions in the coming months.  

In our Strategies in the Spotlight segment, we turn our attention to the investment portfolio with recommendations to improve positioning and yield: 

  • The probability of multiple rate cuts before the end of 2025 will steepen the yield curve, allowing investments to roll down the curve over the next few years. Investment strategies should include adding duration to the portfolio with securities without significant prepayments such as Agency CMBS, lower-coupon collateral, and “prepayment story” Agency CMOs/MBS, and longer duration tax-exempt municipal securities.   
  • Consider restructuring the investment portfolio by selling lower- yielding holdings and mortgage-backed securities that will prepay fast in downrate scenarios and reinvest into the aforementioned longer duration securities adding future income and total return to the portfolio. Quarterly analysis of earnings above projected capital needed for dividends, debt service, and loan growth can be a guideline of the loss to realize in the bond swap transaction.  
  • Pre-investing the next six-to-twelve-month maturities with excess cash or short-term borrowings also should be considered to add positions at today’s levels using the cash flows from the portfolio to replenish cash or to pay off borrowings. 

The following summarizes other ALM strategies and best practices for the second half of 2025 and beyond: 

  • Implement a disciplined approach to loan pricing. We recommend a risk-adjusted return on capital (RAROC) methodology. Loan pricing models come in many forms ranging from simple Excel spreadsheets to those that integrate with the bank’s relationship profitability system. It’s important to find the type of model that works best for your bank today and begin the process of improving your NIM through more disciplined loan pricing. 
  • Adopt a match-funding strategy to improve NIM stability. Building a methodical approach to match wholesale funding to fixed-rate loan activity and locking in a profitable spread can greatly reduce long-term interest risk. Equally important is matching floating rate loans with managed-rate deposits to maintain short-term NIM stability.              
  • Build a deposit-centric culture. Design direct production and calling goals for all bankers. Establish deposit-focused individual lender incentive compensation plans and train lenders to self-fund their loan production.  
  • Establish a comprehensive approach to deposit pricing. It starts with a deposit committee whose members are cross-functional, including treasury managers from each market, finance and senior management, each having a clear understanding of the Bank’s long-term strategic plan, ALM strategies, and NIM expectations. A committee that is well-represented across several disciplines and meets on a regular basis allows for a more collaborative and holistic approach to pricing and strategy development.  
  • Evaluate derivative opportunities on both sides of the balance sheet. The swap curve is a forward-looking projection of rates that can be used to reduce wholesale borrowing costs by executing a pay fixed receive float swap and borrowing short term. The short-term borrowing and floating leg of the swap offset leaving a fixed rate borrowing on the balance sheet. Additional derivative strategies including swapping floating rate loans to fixed rate, adding floors and caps can also protect against falling rates.  
  • Execution of ALM strategies. At each ALM meeting, committee members should identify actionable strategies and set timelines, targets, goals and ownership. The execution of a strategy is just as important as the strategy itself.  

The banking industry posted strong second quarter performance, marked by solid loan growth, expanding NIM’s, positive operating leverage and stable credit. Given these excellent results, we decided to shift our focus this quarter to the investment portfolio with recommendations to improve positioning and yield with smart purchases and bond swap transactions. In the other ALM strategies and recommendations section we continue to drive home the importance of match funding, disciplined pricing and derivatives. 

*Source: S&P Capital IQ, US Banks < $10B 

Date: 08/26/25