Is Your Bank Prepared to Profit From Higher Interest Rates?

On December 14, 2016, the Federal Reserve boosted its benchmark interest rate by 25 basis points to a range of 0.5 percent to 0.75 percent. While this is still incredibly low by historical standards, it is notable because it’s only the second time since the financial crisis of 2008 that the Fed has raised this rate.

The move continues to support economic growth and sustains a friendly environment for borrowing and risk-taking. It also recognizes that the U.S. is enjoying strong employment and price stability, and healthy inflation, as well as positioning the economy to ride the expected acceleration that will occur as a result of the new Trump administration.

For banks, the Fed decision is great news—if you are prepared to take advantage of it. (As you should be—going into the announcement, Fed Fund futures prices indicated a 95% likelihood of an increase.) Banks stand to profit on loans when rates rise. We see three critical areas that will help to ensure you are well positioned to take advantage of the growth opportunities in the market:

Asset/Liability Planning

If rates progress as planned, we’ll see a more favorable yield curve providing better opportunities for loan pricing and security yields. Given the fact that we haven’t seen this scenario in more than a decade, we all run the risk of being caught in reaction mode. It’s important to consider what strategic actions your bank will pursue so that you are prepared to take advantage of any potential opportunity.

Capital Planning

Growing numbers of banks are taking advantage of favorable stock prices with new equity offerings. Two main factors are influencing this trend. First, as we go into a new year, banks are working to bolster strong capital ratios they can deploy for loan growth and acquisition opportunities in 2017. Second, they are taking advantage of the “Trump Bump” in stock prices. While we all acknowledge that this might be a fleeting opportunity, banks are harnessing it to create value. The important point here is that the banks that are using calendar and current events to spot and jump on opportunity are showing evidence of a strategic mindset. At some point, they looked forward to inevitable (a new year) and possible (impact of a new administration) events, and put strategies in place to be able to take advantage of those opportunities.

Liquidity Planning

Deposit growth and retention will only become more important in the rising rate environment. Competition within the deposit market, which has been non-existent for more than a decade, will accelerate in a rising rate environment because deposits are a strong source of low cost funding. Don’t get caught losing them to your competition. Put as much focus on deposits as you do on loans – otherwise, your net interest margin growth could suffer and reduce the capital growth that could be realized through earnings.

If the immediate revenue potential of this new rate increase isn’t reason enough to put the appropriate strategies in place, note that the Fed is projecting three additional rate hikes during 2017. They are betting that the new Trump administration will:

• Unwind regulations currently restricting financial institutions and energy entities (particularly oil and gas)
• Cut corporate tax rates to a possible low of 15%
• Bring more jobs back to the U.S. 

Of course, these (and other) decisions have yet to be made. It’s interesting that the investing community is acting on a future maybe, but it’s fair to say that outlook is favorable for these things to happen. And of course, if Trump doesn’t deliver on these plans, everything could revert back to Obama administration levels.

Regardless of what actually happens, this situation offers an important reminder for banks. If those with an eye towards the future are planning and building strategies around strong future possibilities, don’t be the one that is left asking what if? It’s at inflection points like this that you should consider your ability to take advantage of opportunity. Right now, we encourage you to take a hard look at your bank’s asset/liability planning, capital planning, and liquidity planning.

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