“This is Jim Reber speaking.”

“Hi Jim, this is Charlie Brown from Community Trust Bank calling. Do you have a minute?”

“Hi Charlie, I always do for you. Great to hear from you! Tell me about your 2023 results and your 2024 plans.”

“We have always been a glass‑half‑full bank, and although we didn’t set any records last year, we’re pretty close to as profitable as we’ve ever been. And we’ll take some credit for doing the blocking and tackling. We’ve got very low past-dues, and we like our collateral positions with our loan portfolio. So maybe we paid attention to what happened in 2008 and 2020 and learned something. We’ve also been able to leverage some fintech tools in our underwriting, so our efficiency ratios have improved somewhat.”

“That seems to be how community banks in general have done. Tell me about your net interest margin—that’s been a hot topic with boards, investors and, not least, examiners.”

“In the past two years, community banks’ asset/liability positions have gone from ‘asset sensitive’ to ‘neutral,’ so adding in some floaters wouldn’t aggravate your rate risk posture.”

“Well, it’s shrunk. I guess margins started coming down last April or so. But we’re still about where we were in mid-2022, and maybe we’ll see some relief this year. Clearly, cost of funds have come down since October. We’re currently doing a combination of brokered deposits and the Bank Term Funding Program (BTFP), which have turned out to be viable alternatives. Examiners have seen this at a number of other community banks, so they’re familiar with them.”

“Charlie, I’m used to hearing logic and forethought from you, and this sounds like a reasonable approach. What does loan demand look like for the year?”

“We’re expecting a slowdown, and that’s one reason I called you. Most of our loan portfolio was booked when rates were every bit of 300 basis points (3%) lower, and I expect a lot will pay off as they balloon or reset. What are my alternatives as a lender?”

“I can see several options. One is to get busy offering floating-rate loans. At the moment, since short rates are equal to or higher than longer ones, you wouldn’t have to suffer any loss in yield immediately, and you just might retain the credit. And a floater could sound good to a borrower in 2024. Also, in the past two years, community banks’ asset/liability positions have gone from ‘asset sensitive’ to ‘neutral,’ so adding in some floaters wouldn’t aggravate your rate risk posture.”

“But Jim, if rates really do begin to fall, won’t my margins begin to suffer even further?”

“I mentioned I had several ideas. One is to also buy some fixed-rate bonds that should stay around for a while but can also protect your margins if rates fall. For example, moderately seasoned 15-year mortgage-backed securities (MBS) with 4% coupons are available at prices well below par. Their average lives right now are about five years, so they’d be a great complement to your floating rate loans. And here’s where the story gets better. These bonds have borrowers’ rates of near 5%. In a lot of rate environments, they’re highly refi-able. Remember the prepayment avalanche in 2021? If this happens again, your yield will improve thanks to the discount book price. There’s a good chance they’d have some unrealized gains too.”

“Any other strategies the smart bankers are doing that I need to know about?”

“This is an idea for banks trying to take advantage of the yield curve shape, have low-rate risk exposure and maybe even are buying into the “higher for longer” theme. Investors can enter into a ‘pay fixed, receive floating’ rate swap and arbitrage their way into more than 100 basis points (1%) of margin right now. This trade really began making sense when the bond market rallied in the fourth quarter and short rates remained anchored to fed funds.”

“But what happens when the Fed starts signaling it’s going to start cutting rates?”

“The floating rate index, which remember is Secured Overnight Financing Rate (SOFR), usually stays highly correlated to fed funds. So, until the first rate cut actually happens, your ‘received’ rate will not move much; doesn’t matter what the Fed members say, it’s what they do. But you’ve put your finger on the decision to be made: How long of a contract do you use? Many bankers have been doing two-year terms recently.”

“Jim, I always manage to learn something when I talk to you or your Stifel colleagues.”

“Glad to help, Charlie. And keep me posted on how your year plays out. Thanks for your call.”

Education on Tap

2024 webinar series continues

ICBA Securities and its exclusive broker, Stifel, present “Solutions for a Challenging Environment,” the next installment of the 2024 Community Banking Matters webinar series on April 11 at 1 p.m. Eastern. To register, visit icba.org/icba-securities

Bond Academy registration open

There are still some slots available for the ICBA Bond Academy on April 22–23, 2024, at the Peabody Hotel in Memphis, Tenn. Up to 11 hours of CPE credit are available. The event is hosted by ICBA Securities and Stifel. For more information or to register, contact your Stifel sales rep or visit icba.org/icba-securities