Rates are falling. Margins Are Shrinking. Why, and What Next?

Ann Jones August 19th, 2019

Last month we wrote about an upcoming cut in interest rates. At the time, we wrote about what financial institutions—especially smaller institutions—should expect. A couple of days later the Federal Reserve announced the first target Fed Funds rate cut in a decade. So now we have some clarity—what can we learn?

Managing rates is a long-term game

The latest rate cut shows why managing IRR requires a long-term strategy instead of betting on the Fed’s next move. Consider the past 11 months of FOMC actions and predictions, as well as market indicators. Between September and December 2018, all indications were for continued increases, and the market showed no concern about inflation. The Fed, and the markets, only began indicating 2019 rate cuts in March. By April, the fed was forecasting a rate cut in September. And here we are in August, adjusting to the first cut in a decade.

The moral of the story? It’s not enough to simply react to the Fed and the market. Institutions acting on the basis of forecasts, actions, and market activity over the past year will live with the consequences for a while—as we’ll explore below. Institutions that maintained a long-term strategy, and who have clear insights into their performance, are much better positioned to ride out whatever the Fed, and the market, does next.

Rate-exposed institutions may be stuck with a higher Cost of Funds

Tighter liquidity, competition for deposits and market indicators have increased the Cost of Funds. Many banks are stuck with this higher cost for as long as rates keep falling.

Liquidity is tightening for many institutions. After the great recession many institutions held off on increasing deposit rates, even while the target Fed Funds rate increased, thanks to deposit-heavy customers and low loan demand. But in mid-2018, loan demand finally picked up. This decreased liquidity levels and triggered competition for deposits. Cash-poor institutions had nowhere to go but up.

Banks that reacted too late to this liquidity crunch were forced to offer CD specials at higher rates to generate the funds they needed. Many institutions offered higher rates on longer-term CDs to protect against the future rate increases forecast at the time. Unfortunately, this turned out to be a trap. Banks that gambled on higher-rate CDs are stuck with those higher costs.

How can FIs manage their exposure to rates?

Institutions can do things that will help manage the transition. And Deluxe can help.

Even out your CD maturity ladder

Those higher-rate CDs will all mature around the same time. Banker’s Dashboard provides a powerful CD Maturity Schedule tool. This tool uncovers opportunities to disperse CD maturities evenly to avoid large swings in the Cost of Funds at any given time. A more even CD maturity ladder will allow banks to ride the curve successfully.

Banks can renew some of these CDs with lower rates. Thanks to the flat yield curve, banks can renew CDs for longer terms at maturity; or replace these specials with longer-term wholesale funds. This provides protection against any future rate increases, if the economy heats up again.

Focus on core deposits

Liquidity is at the core of the problem. Core deposits should remain a priority.

Banker’s Dashboard provides insight into the metrics that matter most to your performance. Users can set goals and track progress at-a-glance, and in real time. Banks can also educate staff on how they can impact your Net Interest Margin. Banker’s Dashboard supports these efforts. Dashboard provides users with performance detail down to the individual banker level. This lets FIs hold lenders accountable for securing DDA accounts from loan customers.

Are you struggling with high rates and low liquidity? Contact us today and find out how Deluxe can help you.

This content is accurate at the time of publication and may not be updated.