Fed Raises Overnight Funds Target; how does this effect your game plan?

The move to increase the overnight funds target by 25 basis point to 1% yesterday was not unexpected.  But, where do we go from here? Will there be more hikes down the road, and if so, how many, and how do community banks adjust accordingly? The FOMC stated that it was sticking with its “gradual” plan and policy makers still expect a total of three rate hikes for 2017. Yet, there were numerous talking heads flooding the airwaves after the announcement suggesting perhaps three more moves (four for the year) before year end because the Committee’s policy remains “accommodative”.

So, in response to the Fed’s behavior, what are some basic strategies that might benefit community bankers going forward?

First, in terms of managing interest expense, do not rush to jack-up the rates paid on interest bearing deposits, at least across the board. In fact, initially, do nothing. Be patient. Many banks have not raised rates at all since the initial Fed hike in December of 2015 (25 basis points to 50 basis points) and again resisted increases after the second raise in December of 2016 (50 basis points to 75 basis points) and they have yet to feel a deposit pinch. Others have not been so lucky, but most have reacted in a measured way. If a few accounts begin to leak, respond with some “top drawer” specials and work with individual depositors.

If, on the other hand, you are beginning to experience a real liquidity crisis, crank out some “strategic” specials that will not blindly re-price (reward) a broad spectrum of depositors. And, be creative. If 10 million dollars are needed, what about a “niche” Money Market account that requires large balances and pays 1%, rather than a new CD maturity that pays 1.50%? There are no guarantees but many of the new, large balance MM accounts are most likely very sticky. At least that is what we have seen.

Lastly, if deposits are needed immediately, issue brokered CD’s or take some FHLB advances to address immediate needs, while you play catch-up with the retail market. Secondarily, it might not be a bad idea to stretch some FHLB advances out on the curve a bit, at least beyond one year, going forward.

On the asset side, temper the demand for fixed rate loans with a robust rate, one you can live with, if rates do continue to climb. We can hear the lenders howling in the background, but figure out the right rate for the loan, and determine what the variable “indifference rate” would be as an alternative. It is far easier to put on loans these days than it is to raise deposits, so it might be inevitable that some form of wholesale borrowing is around the corner.

Finally, continue to buy bonds to shorten duration while adding greater yield. Continue to cost average, now is the time to increase the overall yield on the portfolio.