This report outlines key performance trends and strategic recommendations to help your bank capitalize on the improving banking environment.
Fourth Quarter 2024 – Q4 vs Q3 Trends*:
The banking industry outperformed on net interest margin (NIM) expansion, driven mainly by a decrease in deposit costs. Growth was balanced between loans and deposits in the mid-single digits, and proceeds from net securities sales were used to pay down higher-cost borrowings. Pre-provision net revenue (PPNR) growth stood out while credit costs remained in check.
- NIM expanded 5 bps from lower funding rates. Cost of funds dropped 13 bps, driven primarily by banks lowering deposit rates while earning asset yields peaked.
- Loan growth improved to mid-single digits. Loan balances increased 5.6% annualized, compared to 1.4% annualized last quarter. Most of the growth occurred in CRE balances.
- Core deposit growth strengthened. Core deposit growth approached 6% annualized and the mix shift continued out of CDs into non-maturity deposits. Money market deposit accounts and non-interest bearing DDA contributed to the overall growth.
- Borrowings declined significantly. Balanced loan and deposit growth enabled banks to focus on other areas of the balance sheet, including securities restructuring and deleveraging strategies.
- Pre-provision earnings growth accelerated. NIM expansion, along with an uptick in non-interest income, drove strong PPNR growth of 3.5% for the quarter.
- Credit trends remained positive. Non-performing loans, net charge-offs, and loan loss provisioning increased slightly for the quarter as credit continued a normalizing trend.
- Regulatory hot buttons. Areas of focus for regulatory exams include deposit stability, CRE concentrations, contingency funding plans, and capital stress testing.
Bank Strategies For First Quarter 2025 and Beyond:
The Fed was on hold with rate cuts in January and will likely stay on the sidelines as data continues to evolve regarding inflation and other economic factors. With limited rate cuts expected, yields should remain elevated and push toward a more normal, positively sloped yield curve. Given this backdrop, the following ALM strategies focus on fundamentals – conservative balance sheet positioning, NIM stability, and improving the Asset/Liability Committee (ALCO) process.
- Securities restructuring opportunities still exist. Strong retail demand for tax-exempt municipal bonds is providing an opportunity to sell lower-yielding positions at losses and reinvesting back into higher-yielding securities. Mortgage-backed securities provide the highest spreads to Treasuries however, prepayment risk will decrease balances if mortgage rates fall. Focusing on front-end cash-flowing issues with ‘out of the money’ weighted average coupons at discounts will provide some prepayment protection and higher income from prepayments.
- Strengthen the deposit culture. Create a deposit-centric sales strategy led by treasury management with direct production and calling goals. Establish deposit-focused individual lender incentive compensation plans and train lenders to fund their loan production with deposit growth goals.
- Build a more consistent NIM. A neutral balance sheet position means a more stable NIM, one that can hold up to changes in interest rates and shifts in the yield curve. Use wholesale funding to match new fixed-rate loan volume and lock in spread. Match non-maturity deposits with variable rate loans. Consider the impact of a deposit mix shift from CDs to non-maturity deposits.
- Establish a pricing plan for loans and deposits. Use a risk-adjusted return on capital (RAROC) approach to price growth from new and existing relationships. Set return on capital hurdle rates to ensure alignment with corporate profitability goals.
- Align ALM goals with expected returns. Work backwards from earnings goals to set ALM-related goals for NIM, pricing, growth, sensitivity, mix, etc.
- Use excess liquidity to pay down high-cost borrowings. Direct excess cash and proceeds from securities portfolio restructurings to pay off expensive borrowings.
- Utilize swaps to pick up additional spread. Today, a borrowing swap structure can cut 25 to 40 basis points off borrowing cost.
- Build an effective ALCO process. These often-overlooked agenda items can take your ALCO meetings to the next level:
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- Review status of action items from last ALCO meeting.
- Address the most significant issues up front.
- Add bullet points on more complicated reports/slides to clarify key takeaways.
- Identify new strategies. Assign ownership, set timeframe, and measure impact.
- Maintain a list of active strategies. Add reports that monitor progress.
- Communicate goals and strategies to stakeholders throughout the Company, including loan and deposit committees.
- Align goals and strategies with the Company’s long-term strategic plan.
- Design reports comparing actual to last period, to ALM forecast, and to budget.
- Empower the treasury/finance team to enforce ALCO strategies and daily decisioning around pricing, spreads, match-funding, swaps, and rate sensitivity.
- Conduct pre- and post-meeting debriefs through the treasury/finance team
The banking community has much to celebrate following better-than-expected results for the fourth quarter, buoying the outlook for 2025. However, concerns of a protracted Fed pause amid persistent inflation and a hot labor market may temper some of that optimism. Above, we lay out several fundamental ALCO strategies for your consideration and implementation regardless of the economic environment. We emphasize the last strategy to build an effective ALCO process. In our experience, without an effective ALCO, banks will likely fall short of realizing the full impact of their goals and strategies.
*Source: S&P Capital IQ, US Banks < $10B
Date: 2/27/2025
