Quarterly Banking Trends & Strategies Report

First Quarter 2025 

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

Q1 25 vs Q4 24 Bank Trends*: 

For U.S. banks under $10 billion, loan demand softened while deposits grew at a solid pace, the combination of which resulted in banks holding excess liquidity in cash and securities and paying down borrowings. Net interest income growth slowed considerably, mostly due to the lack of loan growth coupled with a flat net interest margin (NIM). Credit remained resilient. Given the uncertainty around tariffs and the economy, banks were guarded about growth expectations later in the year.  

• Slight bump in NIM. The cost of funds dropped 23 bps, driven by banks continuing to lower deposit rates and shed higher-cost borrowings while earning asset yields declined at a slower pace. 
• Modest decline in loan balances. Loan balances came in slightly below last quarter, reflecting some early hesitation about the economy and fiscal policy.  
• Strong core deposit growth. Core deposits grew 5% annualized, continuing the solid growth trend from the prior quarter. The mix shift continued out of CDs and borrowings into lower-cost non-maturity deposits.  
• Decline in borrowed funds. Growth in deposits outpaced loans for the quarter, opening opportunities to address restructuring efforts in both wholesale funding and investment portfolios. 
• Slowdown in pre-provision net revenue growth. Top line revenue declined due to both weaker net interest income and fee income, partially offset by lower non-interest expense.  
• Credit trends remained positive. Key credit metrics, such as non-performing loans, loan loss provisioning, and reserves, were relatively stable for the quarter. Following an increase in Q4 24, net charge-offs returned to Q3 24 levels. 
• Regulatory hot buttons. Areas of focus for regulatory exams include credit, stress testing interest rate risk, liquidity/contingency funding plans, and capital stress testing. 

Bank Strategies For The First Quarter 2025 and Beyond:  

The economy remains in a precarious position as the Fed pauses rate cuts to fully digest the impact of tariffs and market uncertainty. Mixed signals surround the recent GDP contraction, fueling concerns that the economy is teetering on a recession. While the Fed is exhibiting some restraint, the market has a different view, at least for right now, predicting upwards of 3 to 4 rate cuts for the remainder of this year. This ongoing back and forth between the Fed and market expectations gives us good reason to maintain a more neutral rate sensitivity position and exhibit a high degree of discipline with ALM strategies.  

In our Strategies in the Spotlight segment, we focus on two approaches – match-funding to stabilize NIM and disciplined loan pricing to strengthen NIM.

Banks tend to lend long and fund short, leaving NIM exposed at the long end of the curve. To better neutralize interest rate risk in those exposed areas, we recommend a match-funding approach so that regardless of the interest rate cycle or shape of the curve, you can maintain a more stable NIM. Funding instruments, such as FHLB advances and brokered deposits, work well to give your bank plenty of optionality to match-fund fixed-rate loan activity at just about any term and with call and put features to structure your wholesale funding portfolio to mirror loan terms, cash flows, and prepayments. 

Some practical expedients as you evaluate adopting a match-funding strategy: 

• Build a methodical approach. Individually, match-fund larger fixed-rate loans with longer maturities. Portfolio match-fund smaller fixed-rate loans with shorter maturities. 
• Manage liquidity needs of a match-funding strategy through monthly wholesale funding maturities.  
• Determine risk appetite and set goals for wholesale funding, such as wholesale funding as a percentage of total funding and available funding capacity. 
• Align floating rate instruments. Just as important as match-funding fixed-rate loan instruments is aligning your floating-rate loan portfolio with managed rate/indexed deposits.  

Only about 20% of banks under $10 billion use a loan pricing model. Without one, how would you truly know if you’re pricing a loan profitably and being properly compensated for the risk? We recommend a risk-adjusted return on capital (RAROC) approach, which divides net income of a proposed loan (or relationship) by an allocation of capital adjusted for risk. This calculation, which is intended for implementation at the product level, is essentially the same as return on equity (ROE) used companywide. 

Consider the following as you delve into executing a loan pricing model: 

• Utilize the wholesale funding curve (or funds transfer price) to determine loan spread. 
• Add deposits to the analysis to benefit from a deposit spread or premium. 
• Include direct and allocated non-interest income and expenses.
• Build a capital allocation matrix to assign risk-adjusted capital to product groups.
• Set a target (or hurdle) rate of return. The target rate should align with companywide ROE goals. 
• Evaluate the profitability of the entire relationship, not just the proposed loan and new deposits. The relationship may influence decision-making around the current deal.  
• Use the model flexibility to achieve desired results, sometimes working in reverse from the target rate of return to solve for the required loan rate and fees.  
• Integrate model results into the loan committee approval process. 
• Build a model that fits your needs. A loan pricing model can be as simple as an Excel spreadsheet or built for full integration with a profitability system.  

The following summarizes other ALM strategies and opportunities to consider for 2025 and beyond: 

• Securities purchase opportunities in an uncertain economy. Interest rates seesawed in the quarter due to uncertainty about the effect tariffs will have on the economy. Tax-exempt municipal yields increased due to lower retail demand and increased supply providing opportunities for banks to invest in this sector for the first time in quite a while. Mortgage-backed spreads remained elevated due to prepayment risk in falling rate scenarios. Discount prices and prepayment stories should be considered when purchasing mortgage-backed bonds. 
• Grow deposits through a deposit-centric sales strategy. Deposit gatherers should have 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.  
• Set clear deposit pricing strategies. Deposit committees need to fully understand the impact of deposit pricing decisions on NIM. Forecasting changes in average loan yields a month or two out can help committees set guardrails for making deposit pricing decisions. 
• Evaluate derivatives on both sides of the balance sheet. Consider back-to-back commercial loan interest rate and borrowing swaps to reduce interest rate risk and improve NIM. Today, a borrowing swap can cut 25 to 40 basis points off borrowing costs.  
• Effective execution of ALM strategies. For an ALM strategy to work, setting timelines, targets, goals, and ownership is just as important as the strategy itself. 

It was another strong quarter for banks, exhibiting solid expense control as an offset to moderating revenue trends. Economic headwinds are expected to temper bank balance sheet growth throughout the remainder of the year. While there’s not much we can do about the economy, we can set strategies to address the uncertainty ahead. Our spotlight strategies above are designed to do just that. A match-funding approach provides NIM stability regardless of how interest rates move, and a loan pricing model can help banks gain important basis points on balance sheet growth.  

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

Date: 05/16/25