Navigating Troubled, Murky Waters

Banks face a cloudy future as they navigate today’s unique environment, characterized by an economic downturn – caused by a health crisis rather than an asset bubble or industry malfeasance – and a prolonged low-rate environment.

“This downturn is different,” says Steve Turner, a managing director at Empyrean Solutions who has focused on balance sheet management and risk over his multi-decade career.

“All of the problems in the last downturn, you pretty much knew where you were. You could look at your balance sheet, you could look at the credit profiles,” he continues. But this time, “we have such a wide range of things that could be happening to us over the next number of months and years.”

With that in mind, Turner joined me as co-host for a virtual peer exchange on Aug. 5, where 10 chief financial officers shared their perspectives on how they’re planning for loan losses and handling the deposit glut, and the lessons they learned from the last crisis.

Asset Quality Remains Strong … For Now
So far, these CFOs aren’t seeing indicators of weakness in their markets. Yet, their experience in the industry tells them that losses are coming. How does a bank still using the incurred loss model justify a loan allowance that aligns with U.S. accounting principles and still prepares it for what history tells them is inevitable?

“The allowance, we’re struggling with that a little bit,” says Suzanne Loken, CFO at $1.3 billion S.B.C.P. Bancorp in Cross Plains, Wisconsin. “Just looking at our data, we don’t see the losses coming through.”

The bank provides talking points to lenders so they can conduct structured conversations with troubled clients, she adds.

Banks are doing their best to monitor the environment, sometimes employing a deeper analysis so they can better assess any potential damage. Joseph Chybowski, CFO at $2.8 billion Bridgewater Bancshares, shares that his team at the Bloomington, Minnesota-based bank created a tenant rental database to better identify troubled areas. “[It’s] a much more granular look on a go-forward basis of what our borrowers’ tenant bases look like,” he explains.

Focus on Deposits, Funding Costs
Arkadelphia, Arkansas-based Southern Bancorp planned to jettison its excess liquidity in 2020, as part of its strategy to improve earnings and profitability. Instead, Paycheck Protection Program loans have swelled the balance sheet of the $1.5 billion community development financial institution (CDFI). “And when these loans are forgiven, our excess liquidity is going to almost double from that perspective,” says CFO Christopher Wewers. “So, [we’re] working hard to drive down the cost of funds.”

In the discussion, the CFOs report that new PPP customers were required to open a deposit account with them to apply for the loan, fueling deposit growth. They expect to deepen these relationships, as their banks essentially kept these customers afloat when their old bank left them out to dry.

The group also confirms that they’re exercising caution around promoting particular deposit products, like certificates of deposit. And the retail team, like the lending team, should be provided talking points so they can better convey today’s reality to customers, says Emily Girsh, CFO at Reinbeck, Iowa-based Lincoln Savings Bank, a $1.4 billion subsidiary of Lincoln Bancorp. “We need to help walk [customers] through and educate them about the market.”

Lessons from the Last Crisis
While the root of the coronavirus crisis differs from the 2008-09 financial crisis, bankers did learn valuable lessons about managing through a prolonged low-rate environment.

“We learned a deposit pricing lesson,” says Michele Schuh, CFO at Anchorage, Alaska-based First National Bank Alaska, which has $4.6 billion in assets. To strengthen customer relationships in the aftermath of the previous crisis, the bank floored deposit rates. “Our assets didn’t immediately downward reprice [then], so we wanted to continue to share and provide some level of above-market yield to the customers that had money deposited in the bank.”

No one could have forecasted that a decade later, rates would remain low. “As rates have come back down … we’ve taken a little bit more practical approach to trying to decide where and how we might floor rates,” she adds.

There’s also caution around hedging. Out of the last crisis, “there were institutions for five years that were betting on rates going up, and [those] institutions lost a lot of money,” notes Kevin LeMahieu, CFO of $2.2 billion Bank First Corp., based in Manitowoc, Wisconsin. “

In the most uncertain environment in memory, how bank leaders look ahead will matter,” says Turner. “Stress testing should look at more scenarios, early warning indicators and processes should be beefed up, and sensitivity to staff and customer concerns should be heightened. Fee income opportunities and creating relationships with new customers from the PPP program will be opportunities to offset some of the lost income from net interest margin compression.”