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Challenges Facing Community Banks

Challenges Facing Community Banks

Release Date: February 17, 2021
Participants: Lonnie Harris, Scott Carrithers
Topic: Challenges Facing Community Banks

Click here to listen now, or read the transcript below:

Scott Carrithers: Welcome to the latest installment of the Leaderboard Report. I'm Scott Carrithers, Managing Director for Country Club Bank’s Capital Markets Group. 

In today's Leaderboard Report, we will hear from Lonnie Harris of Country Club Bank’s Asset Management Group, who will discuss a few challenges facing community bankers today. 

Lonnie Harris: Thank you, Scott. As many of you know, I've been working in asset liability management for a long time. In fact, Sean Doherty and I founded Asset Management Group in 1995, and we've been a part of Country Club bank since 1998. 

In our role at AMG, Asset Management Group, we attend and lead many ALCO meetings every week. And, in the last few months, there have been quite a few reoccurring themes pop up. 

As a little background, we all know that community banks are flush with liquidity at this point. And we also know that yield on earning assets have steadily declined. 

We continue to hear several of the same questions, which are:

Number one, do other banks, are they challenged with the excess liquidity that we have? 

And the answer is, yes. Almost every bank we work with has excess funds. In fact, I can't think of a single bank that wasn't selling overnight funds at the end of December. In fact, the average funds sold was a little less than 10% of their total earning assets. And we had about 8% of the banks, for that period, that were selling more than 10% of their total earning assets overnight. 

Now, as you all know, on a really good day, you're going to receive about eight basis points for those funds. So, this brings up the question, are others struggling to maintain their yield on earning assets? 

The answer is yes. In fact, this time last year, most banks were in the high threes, some are even greater than 4%. But at the end of December, the average for all of the banks we worked with was down to 3.1%. And we have seen a steady decline really since March of 2020. 

The next question is what can we do to maintain our spread and margin in this environment? Well, along with excess funds, we've got a declining yield on loans. And we have a very low investment rate, or reinvestment rate for bonds that are matured, are called. So, with excess funds, lower yields on loans, and low investment rates, it's really difficult to maintain those spreads and margins. It's not uncommon, in fact, when we see bonds called, or matured, that are yielding 2% or more, those bonds are replaced with 50 basis points. And those are securities that are very similar to what just matured. 

So, it's understandable with all of those factors that banks are struggling to maintain spread and margin. A basic component of spread margin, of course, is cost of funds. The good news is that most banks have really reduced the rate on all classes of deposits. And, ironically, as rates have declined, the balances have continued to grow. 

The one area that's been most difficult to reduce cost on has been the CDs. Even though we know now that current offering rates on CDs is probably 30 or 40 basis points, many CDs were put on the books earlier, and they won't really mature or you won't have a chance to reprice those CDs for a year or even longer. So, that's something that you're just going to have to wait for because you cannot do anything about that. 

Our data, for all the banks, indicate that the current cost of funds for most of our banks is between 30 to 60 basis points. That's far lower than it was this time last year. But yet, spread and margins still continue to decline. 

Let's take a look at a few strategies to combat these large cash balances in this current environment. First, take a look at your loan portfolio. We see many banks that we think could afford, both in terms of interest rate risk and in rate, to put 10- to 15-year real estate loans on the books. Now, in moderation, you have to consider where your current position is, but it is well worth looking at your real estate loans and the length that you have on the books today.

In terms of excess cash, there are still some options, decent options, that exist in securities. We recommend, first, keep an eye on credit. Just because we are having to accept a lower rate than we would like, we do not recommend to lower credit standards. So, first of all, do credit, then talk about length, in terms of maturity or duration. And then talk about types of securities. 

Fixed-rate, mortgage-backed securities are an excellent choice, great cash flow, chart durations, and those have been very popular. MUNI, municipal bonds, GOs, general obligation credits, are a solid option. And those should be considered in all cases where there's a tax advantage. And then those are closely followed by bullet agency securities and taxable municipals. Those are all very good options. And if you have more than 10% of your total earning assets, or even approaching 10% in total earning assets, you really should consider looking at investment options if you haven't done so yet. 

Keep in mind your bank's long-term strategy, your bank's risk tolerance, and what you consider to be an acceptable yield. But keep in mind, if you're only getting eight basis points overnight, even a security that yields 40 basis points or 50 basis points will be far better in terms of your long-term income than that eight basis points. 

On the deposit side, continue to do what you have been doing for the most part in money market savings. And now and that is really, really lower what you're paying on those accounts. They're going to be really sticky, and we can do a deposit study to show you how sticky those accounts are. But overall, the deposit rate is not related to the deposit balance in today's world. 

Each bank is different. Each bank has lots of variables that other banks may not have. But what we're saying is develop a strategy, develop a plan. As we are often reminded at Country Club, plan your work and work your plan. Thank you for listening. Give us a call at 800-226-1923 if you think we can help you. Thank you.



This information is intended for institutional investors only. The material provided in this document/presentation is for informational purposes only and is intended solely for private use. Past performance is not indicative of future results. This material is not intended as an offer or solicitation for the purchase or sale of any financial instruments.

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Capital Markets Group

Capital Markets Group


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