Speaker 1:
As a bank that focuses on business, we work with business leaders all day, every day. We have a front row seat to what's working and what has potential. The First Business Bank podcast is dedicated to sharing insights to help you work better, smarter, and faster to achieve your goals. Let's get into the show.
Ed Sloane:
Welcome to the First Business Bank podcast, I'm Ed Sloane Chief Financial Officer of First Business Bank. And I'll be your host for today's episode, which is about how hiring an investment consultant enhances your succession planning. The last couple years have been challenging for banks to manage their balance sheets and due to economic stimulus at unprecedented levels over the last couple years, banks have experienced deposit growth well beyond their capacity to grow loans. And therefore banks have relied on their investment portfolios to supplement loan growth and put excess liquidity to work. And this liquidity issue is further compounded by the low interest rate environment as banks search for higher yields. Today, we have two colleagues from First Business banks and Consulting Group, Bill Uelmen and Craig Thieben, who will introduce themselves and then will get the conversation started as they discuss their experiences in this challenging market. Bill, we'll start with you.
Bill Uelmen:
Thank you, Ed. My name is Bill Uelmen and I'm president of the Bank Consulting Group for First Business Bank. With this group, I have 30 plus years experience working with community banks on their balance sheet management, as well as their investment portfolio management.
Ed Sloane:
Very good. Thank you, Bill. Craig?
Craig Thieben:
I'm Craig Thieben, Operations manager of the Bank Consulting team. I have 24 years experience in treasury and investment portfolio accounting and operations with various financial institutions.
Ed Sloane:
Very good. Thank you, Craig. And Bill, maybe we start some questions with you. Maybe your thoughts on the high level of liquidity that's currently in the banking system.
Bill Uelmen:
Sure. As you mentioned, we've had record liquidity in banking in the last 18 months to two years. There's been tremendous amount of stimulus money put in by the Federal Government. Vast majority of this has gone on to the banks' balance sheets essentially as deposits and cash, and really has continued to come in. We still have PPP loans being forgiven, and cash continuing to grow on the banks' balance sheets. And on top of that, the economy's still very strong. So we're seeing businesses being profitable, consumers and people maintaining their employment, very low unemployment in many areas, sub 3%, low 2%, in a lot of areas in Wisconsin. And so really more money is being deposited into the balance sheet.
Bill Uelmen:
And that brings a concern, of course, this big surge of money that came into the bank. So banks are concerned about this money essentially running off at some point. But in our opinion, with the going back to the great recession and the lessons we learned from there, it was really the same type of scenario. A lot of stimulus money was put into the system, went onto banks' balance sheets. And that money stayed on the banks as form of cash much longer than anyone thought. So we really think that that banks will continue to have cash, high cash per balances essentially, through 2022 and into 2023, as we start to get past a lot of the economic issues from the shutdown of COVID.
Bill Uelmen:
And one of the concerns that many banks have, and we have of course, is that when this money does leave, will we have enough liquidity and sources to be able to replace that money? So with this, with the banks increasing their investment portfolios and just changes overall into structure, there still is a lot of liquidity in the wholesale market, FHLB advances, and brokerage CDs, to replace any of that surge money that would start to run off. But it makes sense for banks to run different scenarios, to make sure if their deposit balances are going to run off, that they have the liquidity sources available to them, if that scenario would happen.
Ed Sloane:
Yeah. So you mentioned surge deposits, surge money, that's sitting on balance sheet right now. How have you seen banks handling these, these excess deposits?
Bill Uelmen:
Yeah, as you mentioned earlier, really loan demand has not kept up with the pace of deposit growth. So it's been a real challenge for banks with their balance sheets. So we've seen a combination of banks, either keeping money in cash, or growing their investment portfolio. So larger banks, some of the primary largest banks in the country have tended to keep more cash on their balance sheet, because primary reason is that the mark to market on their investment portfolio changes their regulatory capital. So it's a concern to have that mark to market. Smaller banks don't have that regulatory capital impact in a rising rate environment. They have tended to really invest into investment securities into the portfolio. And the challenge has been we're in a very low rate environment, very high demand for all types of securities, good quality investments. So, it's been a challenge really for a lot of banks to find appropriate investments for their portfolio.
Bill Uelmen:
And then of course, the Fed, through their asset purchase program, has been purchasing a large majority of the new issuance of mortgage back securities, as well as treasuries. So, it's been a challenge for banks to manage their own investment portfolio, because there's a lot of complex investments essentially in the market right now. High prepayments on mortgage back securities, large premiums being paid on these securities, which essentially lowers your book yield, complex structures, callables, and step-ups. So it's really causing banks, if they're managing their own investment portfolio, to spend a significant amount of their time, really on the investment portfolio, trying to identify these risks, and really the larger part of the balance sheet being the investment portfolio.
Ed Sloane:
Yeah, interesting. And that's a lot of activity and transactions hitting the bank's investment portfolios in a relatively short period of time. So, maybe we shift here just a little bit, and I would ask Craig to weigh in on this. So, how has all this affected the accounting and operations? What have you experienced with the additional investment activity?
Craig Thieben:
Well, obviously with more trade activity each trade has its own documentation. So there's more documentation that you have to prepare. There's settlement coordination with the increased activity. You might have multiple brokers that you settle trades with and potentially more than one safe-keeping agent. So you have to coordinate all that activity to make sure everything gets settled in an appropriate and timely manner. Then there's more cash and bond system activity. So you have to make sure you get all the activity up to the bond system, so everything's captured appropriately, and just more cash activity. And lastly, there's regulatory compliance. You have to make sure all your ducks are in a row. You got to make sure all the documentation's right. And potentially for a community bank, maybe they were doing one to two transactions a month, and now it could be up to five to ten. And it's more activity, and there's a balancing act there.
Ed Sloane:
Yeah. So, just staying on this topic for a moment, Craig, how are you? How are banks handling the increased operational responsibilities and strain on their own internal resources, especially in the finance and treasury functions?
Craig Thieben:
Well, the first thing they do is a lot of times they have to spread out this additional work within the finance department, potentially bringing other people in, just to fill the gap. Other things that they have to do is prioritize these time sensitive activities, such as trade settlement, and then their other responsibilities would be pushed down. And obviously they have to get done at some point. So, potentially working more hours. And, like Bill said earlier, there might be new types of transactions, or new types of securities they're buying that they might be unfamiliar with. So, the documentation on those takes longer to learn. And a lot of times, the other thing they're doing is they're engaging in experienced consultants, such as First Business Bank Consulting to take some of these responsibilities and leverage that expertise to help them out.
Ed Sloane:
So Bill, we've been talking a little bit about increased activity. And I mentioned earlier in my comments about low yield, we've been in a low interest rate environment for a period of time. Now, are you seeing banks stretching for yield? Perhaps it's a bit of a balancing act between risk and reward. Your thoughts?
Bill Uelmen:
Yeah, I have. And of course we look at a lot of different peer reports, try to identify what other banks are doing. And yeah, I have seen banks looking for additional yield, and stretching. Maybe extending maturities or selling call options in callable securities, or step-ups with longer final maturities and shorter calls, or buying some longer mortgage back securities with higher premiums, with the anticipation of higher rates, those prepayments would slow and yields would come back in line. So, it's been really a challenge for banks really to manage that, because there is a lot of optionality in there. And the bottom line, when I look at this, duration isn't a bad thing. So longer duration securities, I think help some of the portfolio yield. But you do have the risk and return, like you mentioned, of that market value changing when interest rates go up, and potentially that structure falling apart, and your cashflow is going way out onto the curve.
Bill Uelmen:
So that short term view of that additional yield isn't always what a bank wants to look for in the investment portfolio. And one of the things that we really like to make sure with our clients, to make sure if you are looking at some of these longer duration securities and structures, one is to make sure their structure stays in place with changes and interest rates. And then two, have an exit plan, right? Some of these securities may fall out of their structure, and there's a time you want to get out of those securities. And most banks generally will look at their portfolio as a buy and hold type structure. And it's really in this scenario, because the portfolio's grown so much and so fast and all the different offers that are being put into the portfolio, your strategy gets deluded, and you need to re-conform and re-look at the portfolio from time to time.
Ed Sloane:
Very, very good. And maybe this is a question for both of you, and probably the crux of the podcast here. How can First Business Banks Consulting Group assist banks with the increased activity and complexity we've discussed here today?
Bill Uelmen:
Sure. Maybe I'll start with that, and then, Craig, you can add some comments as well. But what we try to do is we really try to serve as an employee of the bank. So, we're sitting right next to the CFO or the president, and we're having discussions about the investment portfolio, about their balance sheet, to make sure the structure and the type of investment that we're buying really fits into the overall risk that the bank is looking for, essentially, from the balance sheet standpoint. And then we continue to research trade opportunities and prepare all the pre-purchase analysis, and things that Craig had mentioned earlier to make sure all the documentation is in place. And it's really a way to expand the expertise of the bank as a form of an education process.
Bill Uelmen:
So many banks will have a structure where maybe the president or the CFO will be the primary person to buy investments. And there really isn't a structure in place. So we try to help get that education and help the bank with that. And then of course, just identifying any individual issues to sell or replace in the portfolio. The market is very fast moving. So the really best structured securities you're looking for trade very, very quickly. So if you're not in the market on a daily basis, and really all day long, you're going to miss out on opportunities without having a consultant or someone who is actually managing the investment portfolio on a day to day basis.
Craig Thieben:
And then on the operations side, like we had previously talked about, we provide documentation, the whole trade packet, including the pre and post purchase analysis. On the operational side, we can provide efficiency. We have in-house transaction reports and in-house monthly bond system analytic reports, that we create and provide monthly. And on the regulatory side, we have to provide documentation to auditors, regulators, any questions they might have, or any things that you need to have provided to them. We can do that as well.
Ed Sloane:
Very good. Well, it sounds like the increased liquidity is going to be around for a period of time and continue to challenge banks to manage their own portfolios. So how can First Business Bank help in the long run to ease some of the strain?
Bill Uelmen:
One of the first things we do with a bank, especially a smaller community bank, is set up an investment committee. And that's something that's typically missing within the community bank structure. You know, as I mentioned earlier, maybe the president or CFO has that investment experience and talks to the broker dealers, but it really doesn't get communicated to the rest of the staff. So it's a way to set up this committee, meet on a regular basis, review transactions that were done, review the economic and current markets, go through the current portfolio analytics, and then come up with an investment strategy. I mean, that's one of the most important things, that results from the investment committee, is having this strategy that you're going to follow for the next three months, based upon your balance sheet structure and how you're positioned. Because again, typically a president and CFO should be doing other things than trying to manage the investment portfolio. And if they have to invest securities, they're not necessarily always focused with that individual strategy.
Bill Uelmen:
And another thing with investment committee, it does a really nice job with the succession planning. So one of the topics of this discussion today is that it brings others into the bank. So we'll bring in typically in an investment committee, what we will have with the president CFO, we'll bring probably someone from the deposit side, someone from the lending side, and have a discussion about the portfolio. And it allows them to understand more about the investments in the portfolio, and current offers, and current markets. So it's a great succession planning structure essentially, put into place. And then investment execution, I think is one of the biggest things, is working with a money manager you get preferred pricing, right? Because we're trading, we have a book of over $2.3 billion right now in fixed income securities. We work with over a dozen broker dealers. So we have various different markets, from municipals and mortgages and agencies, et cetera. We get money manager pricing, which is going to be slightly better than what a bank would be able to buy directly from a broker dealer.
Ed Sloane:
Craig, your thoughts?
Craig Thieben:
Yeah. And, like Bill had said before, even on the operations and accounting side, we're looking to be just an employee of the bank. So we're going to provide transactions if needed. We're going to provide all the documentation on the trades. We're going to provide portfolio analysis reports, transaction reports, all those different things that typically would fall into the finance department, we can take that off the plate and provide on a seamless basis from month to month.
Ed Sloane:
Very, very good. Well, Bill and Craig, this has been some great information and recommendations from your group. It sounds like First Business has a great solution. Any other comments for the audience?
Bill Uelmen:
Yeah, for my side, I guess I'll say it really is our passion to help community banks. I've been doing this for over 30 years, going back to the early nineties to date myself a little bit. But again, we really enjoy doing it and we enjoy being part of that bank. And as I said, as an employee, trying to help, assist the bank, roll their balance sheet and identify their risks and really control some of those risks within their investment portfolio and balance sheet. And so again, how we can help is give us a call or email at your convenience, and we'd love to discuss anything about the balance sheet. Phone calls are free and emails are free. Just call us and we can talk, and love to have that discussion.
Ed Sloane:
Very good. Well, this concludes the podcast. I want to thank our guests for participating in this important discussion. And thanks to our audience members for listening today. Be sure to visit us at firstbusiness.bank, to check out other resources we offer banks and business leaders. We invite you to experience the advantage with First Business Bank. If there's any way we can help, please reach out to us.
Speaker 1:
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