Why the Windshield Is Larger Than the Rearview Mirror

I started my last blog by talking about what a difference a year makes regarding the posture banks are taking on deposits. I should really start this blog by saying what a difference a month (or even a day) makes. Most of my previous post was written prior to the failure of Silicon Valley Bank and Signature Bank and really focused on the tactical side of pricing and using Q2 PrecisionLender to optimize strategy. Today I’m focusing more on the qualitative side of things now that we’ve seen what a potential worst-case scenario looks like and how quickly things can go wrong. 

There’s always value in looking in the rearview mirror and understanding what led to current events. The issues in the banking sector can be traced to the massive inflows of cash into our economy to stem the economic downturn from the pandemic. That liquidity ended up flooding the banks’ balance sheets. And when loan demand was soft, treasurers attempted to maximize return and invested in longer-term securities. Knowing that inflation headwinds were blowing, they were still confident that price increases were transitory and never imagined how aggressively and quickly the Fed would have to move. Those securities quickly lost value, and the unrealized losses made them mostly illiquid. At the same time, loan demand increased and deposit outflows started to rise due to higher prices.

Many institutions are now looking at significant capital deficiencies should the need to sell Held to Maturity (HTM) securities arise. Fortunately, that is not likely since the Fed has set up the Bank Term Funding Program (BTFP) that will allow banks to borrow up to 100% of par value on securities that may have declined in value due to the change in rates. I wrote about “waking up the sleepy money” in my previous blog, but the events of the past few weeks have also awakened memories of the 2008 financial crisis and a theme that many had not considered for quite some time. Bankers are now dusting off their “Safety and Soundness” marketing items and talking points, calling out their stability and strength and the like. These factors are now front and center as depositors decide where to leave their funds. 

Proper Alignment and Balanced Tires Make for a Smoother Ride  

Everyone has read about the massive amounts of deposit outflows from smaller community banks into treasury funds and the systemically important financial institution (SIFI) banks, so I won’t repeat that here. What I would like to talk about is how Q2 PrecisionLender, when used as part of a long-term strategy, can set a bank up for success in difficult times.  

Banks tend to get hyper focused on one side of the balance sheet or the other and bounce back and forth between appetite for loans or deposits. Again, just a year ago, banks were mostly flush with liquidity and seeking to deploy that liquidity into earning assets. Now the tide has shifted, and banks are looking to shore up liquidity as loan demand has grown despite the higher costs to borrow.  

One of the great benefits of the Q2 PrecisionLender platform is the ability to have constant focus on relationship growth and not just loans or deposits. As you can see from the charts below, Q2 PrecisionLender clients tend to run a lower loan-to-deposit ratio than the industry as a whole. 

*Note: All figures are from FDIC, and Peer Group represents all banks over $25 million in total assets (4,541 banks).

This lower loan-to-deposit ratio was maintained even when commercial loan growth at banks using Q2 PrecisionLender outpaced the industry as a whole, all while maintaining a superior net interest margin. We are still working to understand the overall movement of deposit balances in and out of banks, and in the first quarter results, we have been able to see some movement of those balances between industry size cohorts in our dataset. Look for more specifics on that in future Market Updates.

Q2 PrecisionLender clients also maintained superior asset quality. 

As these graphs show, Q2 PrecisionLender clients that have been on the platform for at least a year have been able to keep consistent focus on both assets and liabilities, positioning their balance sheet to maintain a smooth ride over the bumpy road of the current liquidity crisis and maintaining a superior net interest margin.   

The View From the Front Seat 

Now that we have looked in the rearview mirror and examined outcomes, let’s focus on the windshield and where we are going, which is the real story here. Past performance isn’t always a guarantee of future results. As we move into the next few quarters, we at Q2 expect an unprecedented focus on renewing loans, with upward pressure on rates and decreasing credit quality at the same time.  

Banks will need to deeply examine each relationship, especially as credit facilities mature, and will need to determine the strategic value of the client to the bank’s balance sheet. Bank clients will also be assessing their banking partnerships to determine if the bank is still a good fit. As we move into the future, it won’t be all about who has the lowest rate on loans and who has the highest rate on deposits. The two-way risk profile that we now face (both risk to client and to bank) will drive down price elasticity.  

I recently had a conversation with a bank client who was complaining that their bank would not “pay up” for a depository account. They felt like the bank was being “cheap.” I explained that if the bank was paying less than market rate for their balances, that was a sign that the bank didn’t have to “pay up” to maintain adequate liquidity levels—an indicator of strength. Clients will need to be reminded that often the banks that pay the highest rates for deposits may be in trouble.  

Astute borrowers will know they have more negotiating power than ever if they are a net depositor, as many still are. Q2 PrecisionLender was built for tumultuous times, and the stakes have never been higher for our clients. I recently visited a client who had not yet reviewed the new Q2 PrecisionLender feature that allows for the repricing of the depository relationship. One of their most profitable clients was a net depositor. As I walked through the pricing opportunity with him, he was amazed by the new power of the platform to reprice the existing deposit book and know exactly where the sweet spot was for maintaining the relationship versus maintaining profitability—and where the two intersected.  

Along with this functionality, the Q2 PrecisionLender Relationship Awareness tool allows bankers to look at the value of the relationship in two ways. Most bankers prefer what we call “FTP value,” which locks in the funds transfer pricing (FTP) rate for fixed-rate loans at origination. The other method the platform employs is “Strategic Value,” which applies FTP rates based on the current market. In today’s rate environment, many of the fixed-rate instruments that were originated several years ago would show a small to negative margin. This view is analogous to comparing the market value of the loan book to the current value of the deposit book, which, in most cases, has a slightly negative beta and hasn’t repriced up as quickly. In considering loan renewals, knowing the exact value of the instruments on both sides of the balance sheet in a forward-looking view is crucial to making the best business decision for the bank. 

At this point in the rate cycle, there is no more powerful tool than Q2 PrecisionLender to drive balance sheet strategy, specifically deposit-gathering and deposit-repricing activities. Q2 PrecisionLender is the world’s most advanced sales and negotiation tool, with most of our recent innovations centered on enhancing capabilities in Deposit and Treasury Services pricing capabilities to help bankers strengthen relationships and portfolios across the full breadth of the commercial bank. Q2 PrecisionLender's Customer Success organization, including our Advisory Team, is here and ready to discuss options to optimize the platform to meet your strategy and goals. 

Get More Insights at Our Upcoming Webinar

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