11 ways community banks can improve NIM now

Net interest margin (NIM) accounts for 90% of a financial institution’s earnings and is a central measure of its financial viability. The pandemic—and response measures from both congress and the Fed—has led to excess liquidity, lower asset yields, thinner NIMs and reduced earnings. The long-term effects of the fiscal and monetary policies on financial institutions remain to be seen. 

But that doesn’t mean your institution is powerless. Focusing on two vital components for your organization—your funds and your people—is critical to both protecting net interest margin today and setting the stage for recovery in the future. Here are some tips and tactics you can employ right now to lead your team through this volatile time.

1. Focus on liquidity

How long will stimulus funds stay on the balance sheet? How quickly will these funds flow out as pandemic benefits programs conclude? What liquidity challenges lie ahead? These are just some of the questions facing FIs right now, and addressing them will require agile, performance-based strategies that minimize idle funds and encourage loan growth. Work with the board to establish a target range for your liquidity ratio and actively manage to that range.

2. Monitor cash and cash equivalents

Determine the level of cash and cash equivalents you need on your balance sheet to achieve that target liquidity range. Once you know that number, monitor it as closely as possible. Ups and downs will occur, but you should be concentrating on the trend.

3. Focus on three numbers: Total loans, total deposits and loans-to-deposits ratio

Follow these trends daily and be prepared to respond as needed. Any time there is a shift in any of those numbers, you'll want to know the day it happened. Forecast your sources and uses of cash at least on a monthly basis.

4. Think long-term on deposit rates

The excess liquidity pumped into the economy during the pandemic has allowed banks to lower their cost-of-funds to historic levels. Most of these funds are sitting in non-maturity deposit accounts that can flow out just as quickly as they flowed in. When that begins, rate increase will drive cost-of-funds higher quickly. Offering higher rates on longer term time deposits now could secure a portion of these funds and protect the NIM from a sharp rise in rates down the road. Access a CD maturity report to analyze and understand the maturity schedule of your time deposit portfolio and look for opportunities to extend the duration.

5. Look for opportunities to invest idle funds

Having funds sitting idle, earning zero or near-zero percent is costing banks money. As the Fed begins to taper its bond purchases and the yield curve steepens, look for opportunities to put some of that excess liquidity to work in the investment portfolio. Work with your investment banker to balance the need for yield and valuation risk. Shorter term (15- and 20-year) mortgage-backed securities will deliver a positive spread over your cost-of-funds, while providing ongoing cash flow that can be loaned out or reinvested at higher yields as rates rise.

6. Create open communication and transparency

Establish and maintain your lines of communication with the board or designated committee(s) and your staff: Morale can plummet quickly in the absence of information. Be transparent and set realistic expectations. Report frequently on progress. 

7. Educate and train your staff

This is the time to have all hands on deck doing everything they can to boost your NIM. Educate staff at all levels, from the boardroom to the teller line, on the value of one basis point in NIM. Train them on the little things they can do every day to move this needle. Talk with them about what metrics are the most important to your institution and how what they do contributes to your success. And just as important, encourage and reward new ideas from your staff.

8. Evaluate your loan portfolio

First, calculate the effect of future rate increases on your loan portfolio. The impact will depend on the pricing structure of your loan portfolio and the extent to which the current indexed yield is below any rate floors that were in place when you made the loans.

Secondly, look at the maturity schedule of your loan portfolio. How can you reprice these loans as they come up for maturity and renewal to increase your net interest margin? If they don’t have rate floors, look for ways to insert those rate floors now.

Finally, price loans appropriately. Make sure you are being paid for the risks you are taking. In this environment, you cannot afford to let your competition drive your pricing. (A loan pricing tool like the one in Deluxe’s Banker's Dashboard will determine the pricing you need to drive your desired results.)  

9. Review your CD maturity schedule

Do you have a nice ladder spread out with relatively equal amounts of CDs maturing each month? Or do you have some large buckets all maturing at the same time? In 12 to 24 months, rates may rise, and you’ll have to reprice those CDs again. Give your customers incentives to go for longer terms. You may even consider adding some longer term brokered deposits or FHLB advances as a hedge against future rate increases. Paying slightly higher rates for longer terms now will provide protection against a sharp increase in your cost of funds in the future. Ask yourself what you need to accomplish, develop your pricing strategy based on that, and communicate that strategy often.

10. Analyze changes to NIM

Are your efforts working? See if you’re gaining or losing basis points. Performance management tools have margin analysis capabilities that can calculate what the monthly impact of those changes will be. Drill down based on loan type to see where you may be gaining points and where you may be losing. That will help you determine where to adjust as needed.

11. Don’t get complacent about your contingency funding plan

When's the last time you reviewed your contingency funding plan? Review and revise as necessary to fit the current economic environment. Work with your board and update those plans. Update your cashflow stress-test scenarios accordingly. Test those contingency funding sources and make sure they’re in place and available.

Conclusion

The current situation is a defining moment for your bank and in your career. It’s not the crisis that will define you and your institution, it's how you respond. The economic situation will eventually settle in to a new normal. Those who adopt a growth mindset will be focused on capitalizing on every opportunity that’s out there. It's what we call Performance Banking. It means intentional actions driving results for community banks. It'll get you through this storm, and beyond.