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How to Maintain Profitability in 2021

by Brittany Rollek, Director of Client Services, ALM First Financial Advisors

While uncertainty continues and financial institutions grapple with credit performance and what to expect in terms of potential losses down the road,finding new opportunities to enhance bottom-line performance while remaining flexible is vital. Many depositories have already tightened where they are willing to lend as changes in delinquency reporting requirements, payment assistance programs and forbearance make quantifying risk difficult andcause institutions to think twice about adding risk to the balance sheet.

A Huge Challenge to Overcome

Spreads have been tightening on high
quality liquid assets while excess liquidity has remained, making it more difficult
for depositories to manage margin.Atraditional investment portfolio with tighter
spreads and the absence of significant opportunities to streamline expenses or
reduce operational costs leaves little room for error. However, there are other
levers that financial institutions can push to generate profitability.

One of the strategies depositories have deployed relates to their resources. While shifting resources to a more active and profitable business line like conforming mortgage lending may be easier said than done, it is an example of being nimble and opportunistic as an organization.

Partnerships are another avenue to
generate profitability. Tapping into lending partnerships, through
participations or even partnering with traditional competitors, such asFintechs,
can bring in a steady stream of higher-yielding assets. However, evaluating the
pricing and risk-adjusted returns that come along with different programs is
integral to profitability.

Best Practices for a Better Bottom-Line

Financial institutions must look
beyonda flashy yield to evaluate costs, risks, and determine whether an opportunity
is best for the institution given pricing, resources and alternatives.It’s easy
to focus on top-line yield, which is why using a quantitative model that
addresses all of the necessary components is a must. This doesn’t merelyinclude
the credit component, it takes a host of other factors like the cost of
acquisition (including internal lending team bonuses and indirect dealer incentives)
or prepayment risks, into consideration to dissect the true, risk-adjusted
value.This is one thing I see missing from many models that causes tension between
the lending and finance teams.In the current environment especially, you have
to look at more than top-line yield, credit cost and the treasury rate before
you can say yes. A very robust modeling framework is required and so is
education to ensure all departments are on the same page.

When everyone understands what the
institution is working towards and is on the same page regarding how each
decision will impact the bottom-line, generating additional profitability becomes
simpler. Often, lending teams have volume-based incentives while finance teams
have bottom-line driven incentives. This creates tension. Education, incentive
models, structure and alignment are all important aspects to consider when
trying to drive performance.

Using arisk dashboard is another key
part of the puzzle. It’s not about the burden of seeing where we have too much
risk; it’s about seeing where we have room left in our risk budgets so we can
pull the appropriate levers. When used effectively, a risk dashboard enables
our ability to narrow our focus to ideas that are the best fit for the
institution and allows us to potentially push basis points to the bottom line.

Having the right team in place to
implement the new ideas we uncover through risk dashboarding and analysis is
huge. We can have great models and the appropriate analysis, but if we don’t
have a team that can clearly discuss those themes and execute them, we cannot
realize the profitability.

Avoid Potential Pitfalls

Remaining in a very traditional
mindset of what a depository is and how you provide value can limit your
opportunities, especially when it comes to reducing your cost of funds.If your
goal is to always provide the top deposit rates and lowest loan rates, there is
simply not enough room in an environment like this to profitably manage your
funding and your assets. When you evaluate your funding as a spread to swaps,
it allows us to see where we may be missing the mark or missing opportunities
to generate profitabilityand eating into our profits. Don’t miss an opportunity
on interest expense to capture basis points as you plan for 2021. Depositors today
likely care less about rate and more about the safety and soundness of their
funds and ability to access them when needed.

Control What You Can, Stress Test the Rest

The fluidity of the current economic
environment should be matched with agility in your business plan. Most of the
depositories we work with are looking to expand their toolbox to generate
stronger, sustainable performance.Using derivatives is a great example. If you
don’t have ability to hedge your core balance sheet, there is likely an opportunity
there as institutions are continuing to see mortgage loan growth. However, they
may be hesitant to add long-term risk exposure. Hedging that riskcould allow
your depository to be more flexible, agile, and opportunistic.Rather than
avoiding risk, try to manage or hedge that risk and add that profitability to
the bottom-line.

We’re advising our clients to control
what they can, specifically by ensuring they have access to all of the tools or
levers available to them, and stress test the rest. For example, another round
of strong fiscal stimulus could push deposit growth rates even higher next year,
or we could see the exact opposite if additional stimulus is smaller or
non-existent. Working through the outcomes of each scenario and the asset
strategies necessitated in each helps to improve both preparedness and

It’s a challenging time for the
industry, but it’s also very exciting as we’re pushed to evolve more quickly. Financial
institutions should be more forward-thinking to stay relevant and continue to
provide value. While there is a likelihood for increased consolidation in the
future, institutions that remain open to new ideas and new opportunities are
more likely to pull through.

Be Flexible Enough to Change Course

The expedited evolutionof the
depository landscape is a trend that I think will ultimately be positive for
both the institutions and the consumers.While no one has a crystal ball, we do
have a few closing pieces of advice for 2021: Stay open to new ideas, build the
team that can help you implement them, and be flexible enough to change course.

About the author:
Brittany Rollek joined ALM First Financial Advisors in 2013. As a Director for the firm, Brittany is primarily responsible forthe client’s management team to customize and implement actionable and effective ALM and investment strategies to maximize client performance. Additionally, Brittany proactively designs sensitivity analyses and scenarios to test client balance sheet exposure to various factors and formulates action plans to optimize client performance within policy and risk tolerances.As a Director, Brittany also ensures our clients receive accurate and timely information.

Prior to her current role, Brittany held the role of Manager of the Financial Modeling Group, responsible for overseeing and ensuring the quality of financial reporting including ALM analyses, MSR valuations, “what-if” analyses, and other financial modeling results.

Brittany holds a bachelor’s degree in economics from Davidson College in North Carolina.

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