A little more than a year has passed since February 2023, but it feels like a decade; so much has happened in a short period of time. On Valentine’s Day 2023, the Fed Funds Target Rate (FFT) had already risen to 4.75% from just 0.25% on Feb. 14, 2022. Despite that 450 bps increase over just 12 months, very few organizations were experiencing significant upticks in cost of funds (COF) or suffering from deposit run-off. As banks finalized their budgets for 2023, very few expressed concerns about large runoffs or material COF increases.

Those of us who were keeping a close eye on this situation, and expressing such concerns, came across a bit like Chicken Little. We had been speaking publicly about the danger of looming, already-in-motion deposit disintermediation since the summer of 2022. We noted that, as in geology, the forces of enough pressure and enough time are also historically undefeated when it comes to banks’ COF responding to sustained, much higher short-term wholesale rates. In February 2023, the distance between banks’ COF and the prevailing wholesale rates reached historical highs. We called this difference a Funding Advantage and said it was destined to deteriorate materially in 2023.

Also in 2022, we coined the term “the Beta Trap” and proclaimed something that seemed crazy unless you know where/how to look. In September 2022, we publicly stated that all banks’ ALM models were broken, and most management teams would not discover this unpleasant truth until late 2023 or early 2024. Our examination of historical deposit funding advantages versus current funding advantages, coupled with our insights around “the beta trap,” led to our widely-disseminated study, “Hidden in Plain Sight” (April 20, 2023), which expressed concern that if the FFT remained near or above 5%, much lower ROAs could emerge across the industry in 2024 — dangerously lower for a significant portion of the industry.

In February 2023, the surface water looked calm, but just beneath, there was a flurry of activity. One month later, depositors got a wake-up call! First with concerns for safety and FDIC insurance, and second, with an examination of what rate they were earning and how it compared to treasury bill rates. What followed for industry participants over the next two quarters was the acceptance of runoff, remix, or both. Remix often took the form of short-term borrowings, short-term brokered CD issuance, and short-term retail CD specials.

Between Q3 2022 and Q4 2023, for banks in Colorado between $250MM and $5B in total assets, the percentage of their total term liabilities maturing or repricing in 12 months or less rose from 10.5% to 19.6%, from a balance of $2.0B to $4.0B.

Why was nearly 80% of this new funding secured with a maturity of 12 months or less? For three main reasons:

1. The beta trap issue caused ALM systems to accidentally misrepresent what was coming for COF. Banks’ internal interest rate risk models did not reveal the true risk to NIM and ROA. Why pursue longer liabilities if rates going up further are not seen as a material risk to the bank?
2. The massive yield curve inversion led many to a bias that the Fed would cut rates by year-end of 2023, making the shorter liabilities seem the more prudent choice.
3. Retail customers were attracted to shorter-term CDs, with higher yields and less lock-up than longer CDs on offer.

The events in Q1 2023, coupled with decisions on new liability maturities, sowed the seeds for the coming Great Rollover (of liabilities) in 2024. Colorado banks will not be immune. Not only will maturing liabilities need to be replaced, but in addition, NMD balances are still a disproportionately large slice of total funding and are at historically wide — and likely unsustainable — funding advantages to wholesale. While there is no specific maturity on this outsized NMD hoard, some of it will also effectively “roll over” in 2024.

This all sets up a problem: Unless the Fed eases materially, very few banks are set up with a plan that allows them to be a price setter rather than a price taker. The good news is it doesn’t have to be this way. Banks armed with discipline and objectivity can approach The Great Rollover from a position of strength, no matter what interest rates actually end up doing for the remainder of 2024. Awareness of and adherence to four simple principles can help strengthen your position:

1. All future cash flows matter, not just those over the next 12 months.
2. Ignore widely held rate biases; acknowledge that forecasting rates is impossible and perilous.
3. Consider and compare the full spectrum of choices across multiple future interest rate scenarios and over a reasonable time horizon that exceeds the next 12 months.
4. Remember that not everything that counts can be clearly counted.

If your team keeps these principles at the forefront of your decision-making, you have the potential to become a price setter, not a price taker, and it is possible to achieve three beneficial outcomes at once:

1. Diminish your risk of NIM compression if rates rise instead of decline.
2. Avoid regret if rates do come crashing down in 2024, as is currently expected by many.
3. Maybe most importantly, reduce your exposure to potential acute liquidity risk in the future.

Principles and processes are the backbone of wise decision-making around capital allocation. This is just as true in crafting liability structures as it is in asset selection. The better educated your team is in these matters, the better prepared you will be to thrive through this Great Rollover experience. The CBA is a resource, offering timely events and programs in the weeks to come. Perhaps we’ll see you there!

Brian Leibfried is a partner and managing director of insights at Performance Trust Capital Partners. He can be reached at bleibfried@performancetrust.com.

Performance Trust has been advising community banks for nearly 30 years and is a registered broker/dealer, member of FINRA/SIPC.

This is intended for educational and informational purposes only and is not intended to be legal, tax, financial or accounting advice or a recommended course of action in any given situation. This is not an offer or solicitation to purchase or sell securities. The information is subject to change without notice.