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What ALCO should be thinking about

Changing times demand revisiting multiple strategies

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ALCO Beat articles featured exclusively on are written by the asset-liability management experts at Darling Consulting Group. ALCO Beat articles featured exclusively on are written by the asset-liability management experts at Darling Consulting Group.

By Keith Reagan, managing director, Darling Consulting Group

What are bank ALCO managers talking about today? Darling Consulting recently held its annual Balance Sheet Management Conference. We asked the firm, which provides our ALCO Beat column, to tell us what people heard and said. Keith Reagan, DCG managing director, reports.

While it is impossible to give a complete synopsis of a two-day conference, I will highlight strategic issues that were discussed that likely impact your institution and should be discussed at your ALCO meetings.

The economy

ALCO should not be a committee to forecast rates. Nonetheless, the overall economy and likelihood for yield curve changes were hot topics again this year.

The general consensus for the interest rate environment was for the yield curve to continue to flatten for the remainder of 2017 and into 2018.

The Federal Open Market Committee has increased Fed funds three times since December 2016 with the potential for more throughout the rest of the year. Long-term Treasury rates, however, have declined, compressing the yield curve slope.

With inflation not on the horizon and substantial roadblocks in Washington impacting much hoped for reform and action on industry regulation, taxes, and the economy, the Fed's balance sheet will impact longer-term rates. However, this is expected to be done at a glacial pace.

Strategically, the yield curve shape has major implications for all financial institutions. If you are not running a rising-rate scenario with a flat yield curve through your asset-liability model, it is well past time.

The results may change your strategic initiatives.

Funding strategy

The financial industry is wrestling with the need and desire to grow core deposits, while at the same time trying to lag rates on existing balances. Not an easy task.

Conference sessions ranged from basic liquidity education to the more complex use of data analytics to expand customer relationships (and everything in between).

• If the liquidity profile of your institution is strong, lagging deposit rates and relying more on wholesale funds for growth may be the appropriate strategy.

• If liquidity is tighter, retail strategies may be necessary to reach your goals.

Regardless of liquidity profiles, most banks want to grow core deposit relationships. You likely have the data necessary within your organization to analyze your current customers and to be able to devise strategies to expand these relationships. The buzz at the conference was that utilizing the data to be a strategic tool needs to be a priority going forward.

One piece of data that was discussed throughout the conference was changing demographics. What do you know about the demographics of your deposit base? The makeup of your customer base should be considered as you devise strategies to maintain and grow deposits. Is this information that you have, track, and use? If not, you should be doing so going forward.

Demographics must be considered, but so does the total relationship of each of your customers. Do you have the data necessary to be able to price properly for the total relationships within your customer base? If I could have only one piece of data from a retail deposit base, a total relationship number/flag/code would be it.

Loan strategy

The current yield curve and potential for further flattening has clearly impacted loan strategy.

Have spreads on loans in your pipeline expanded or contracted in 2017? For most attendees spreads appear to be flat to down. This, combined with more and more deposit "specials" available in the marketplace and the financial industry, is creating its own flat yield curve.

Many different strategies can be employed to help increase the profitability of each loan. The use of interest rate swaps, the inclusion of prepayment penalties, expanding fees, and increasing compensating balances were all discussed at length throughout the conference.

Clearly there is no one-size-fits-all solution to loan pricing. However, based on your liquidity, interest rate risk and earnings profile, what are you doing to increase the profitability of every loan deal?

Investment strategy

The current yield curve is causing challenges in the investment world also. Most sectors are well below historical average spreads to Treasury. The unattractive spreads result in institutions stealing loan business away from competition, which reduces spread … and round and round we go.

More strategic issues

A number of other non-ALCO strategies were discussed at the conference.

Succession planning. Many institutions have succession plans for the C-suite, but what about other positions and levels throughout your organization? Do you have succession plans for your board? How about key lending, audit, compliance, and retail personnel?

The demographics of our country are aging, and my guess is, so is your board, C-suite, and other positions that are going to be difficult to fill—especially someone who has anywhere near the amount of experience you may lose. If you are not looking at all levels when you consider succession planning, you should expand your planning.

• M&A: Many institutions represented at the conference have recently discussed M&A, one way or another. A clear message that came through was fortifying your balance sheet (liquidity, earnings, capital, branching, technology, etc.) to be able to negotiate from a position of strength, regardless of whether your institution would be buying, selling, or merging as equals.

• Derivatives: Many institutions are already using them, and with new rules from FASB set to begin as early as January 2018, more will be able to. If you have not used interest rate swaps, caps and floors in the past because of accounting challenges, it is time to take a look at them again.

Exciting changes from FASB are going to make this a tool that should be in most financial institution tool boxes. Start educating yourselves and your boards now to be able to use these tools.

• CECL: Speaking of FASB and accounting challenges, FASB’s CECL—Current Expected Credit Loss—is also not too far off in the distance.

There were CECL sessions at the conference that went into a lot of math and discussions about how there continues to be much uncertainty as institutions assess the appropriate path to choose.

Should you attempt to calculate it in-house? Should you outsource it? Which mathematical method should you choose?

While there is no one clear answer for everyone, it is clear that you need to be collecting data today, regardless of which CECL road you end up taking.

Going forward

Given the challenges impacting every facet of our industry today, the institutions that continue to push for incremental strategic improvement are the ones that will be in the driver's seat going forward.

Consider the strategic highlights above at your next ALCO meeting. Are you continually focused on improving your balance sheet through proactive strategic implementation? This should be your number one priority at ALCO!

About the author

Keith Reagan is a managing director at Darling Consulting Group. He has more than 20 years of experience working directly with community banks, helping them improve their overall performance through proactive management of liquidity, interest rate risk, and capital. He works to develop strategies that best fit the risk/return dynamics of their balance sheets. Reagan has served on the faculty of ABA's Stonier School of Banking, has written many articles for a variety of professional publications, and is the editor of DCG's monthly periodical, the DCG Bulletin.

This column was adapted from the DCG Bulletin. Subscribe to DCG Bulletin for free


ALCO Beat articles featured exclusively on are written by the asset-liability management experts at Darling Consulting Group. Individual authors' credentials appear with their articles. DCG's consultants have served the banking industry for more than 30 years. You can read more about the firm's history here.

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