It is that time of year again. Ink on budgets is (mostly) dry, and there is an overabundance of forecasts and predictions to digest. One interesting note from many of the mainstream economic prognostications is how “vanilla” they appear to be.
There seems to be a proliferation of modest yield curve changes, mild movements in GDP, unemployment and inflation, and a message of relative calmness after the last five years’ markets and rates being anything but calm.
While the forecasts for this year may not be calling for high volatility, do not forget that as Morgan Housel notes in The Psychology of Money, “things that have never happened before happen all the time.”
From the Editor
“Every decision is risky: it is a commitment of present resources to an uncertain and unknown future.” – Peter Drucker
One theme every executive I’ve spoken with this year would agree upon is that uncertainty abounds.
Look no further than the markets’ evolving expectations for interest rate policy from the Federal Reserve and the corresponding move in bond and equity markets.
Clearly, there are a myriad of variables that will ultimately shape our economy during 2025 and beyond.
Unfortunately, with all this noise, most just don’t really know what to make of it all! And on top of that – it seems to change by the minute!
Fortunately, in this month’s Bulletin, DCG Managing Director Zach Zoia summarizes a recent discussion from DCG’s On the Balance Sheet® podcast with colleague Joe Kennerson.
Joe coherently lays out the key variables that may influence earnings in 2025. The discussion focuses on deposit trends, lending expectations, margin forecasts, hedging strategies, and bond market activity.
So we encourage you to peruse this summary, and, if compelled, to download the recent episode with Joe to help narrow your focus on the important trends and considerations for your business moving forward.
Vinny Clevenger, Managing Director
Accordingly, prudent balance sheet managers should be prepared for a wide array of potential outcomes.
To help with the key items risk managers should focus on in 2025, we recently interviewed DCG Managing Director Joe Kennerson during a recent episode of On the Balance Sheet podcast and asked him his thoughts on five key questions for the upcoming year. This Bulletin summarizes the important items your ALCOs should be devoting their time to.
With that in mind, here is the Top 5 for ’25 list:
1) The battle for deposits is still top of mind
Deposit cost pressures finally started to ease at the end of 2024 as the Fed embarked on 100bps of cutting from September through December. Overall deposit costs declined by 8bps in Q4 ’24 per DCG’s Deposits360°® database, while balances were up 1% (and 2.5% on the year). Additionally, newly opened CD rates decreased by 83bps in 2024, settling in just above 4%.
However, as the expectation for fewer cuts this year and next has dwindled, the ability to attain incremental cost relief is popular conversation at ALCO meetings, with many trying to ascertain:
How much relief can be generated with no additional cuts? and,
Where is the available relief on the next 25-50-100bps of movement?
The other challenge that remains on the deposit front is growth. We are a long way away from the double-digit growth of the COVID years, or even the 4-5% per year growth in the decade prior. Deposits360°’s projection for NMD growth in 2025 is around 2%.
Accordingly, strategies to generate core checking and savings growth remain a high priority, with FIs continuing to mine their own data to deepen customer wallet share.
For more discretionary or investable dollars (MMDA and CD), autopsying balances or accounts that left the institution and creating more targeted strategies to gain the dollars back continues to initiate valuable conversation and insight, especially as online and brokerage rates are much closer to a more tenable 4% now.
Additionally, institutions must analyze the following items in order to manage funding costs lower while enabling growth (if desired):
CD retention / rollover and attrition trends
Alignment of higher yield money market rates versus top tier CD rate offerings
CD specials vs rack pricing and curve normalization
Spreads to wholesale funding alternatives
2) Lending discussions are more important than ever!
The good news is that loans continue to cash flow from COVID era lows and recast into today’s higher rate environment, helping NII levels.
The not so good news for most is that the outlook for loan growth this year is more muted than past years.
This environment might create uncomfortable conversations around the lending function. In many cases, growth comes with lower yields versus what institutions want to be getting, but there is an argument that “at least the new loans are coming on rates above legacy portfolio levels.” Beware, this can be a dangerous proposition.
Here are three key questions that should be making their way into the lending discussions at ALCO:
Absolute yield or relative spread? Be aware of accepting sub-optimal spreads in an environment that calls for discipline and potentially wider spreads just to spur growth.
Refinance risks or opportunities. Understand how your current coupon stacks are composed and be prepared for 2025 and 2026 maturities/re-pricings.
How is our “menu”? Use the yield curve and options to your advantage to give the customer what they need and your balance sheet what it needs.
3) Margin outlooks are improved but not guaranteed
Most NII models show continued tailwinds from the current non-inverted rate environment, with NII levels increasing from quarter-over-quarter and year-over-year standpoints. However, models are not always indicative of reality given they are based on thousands of assumptions and an imperfect forward-looking rate environment, thus it is critical to understand the drivers of the better earnings outlook.
For many, this is due to a combination of asset yields climbing upward as well as residual relief on the funding side, most often from term CDs and borrowings coming due over the next 6- 12 months.
From there, it is critical to evaluate both scenario and sensitivity analyses to better triangulate where risks may lie if the rate environment and/or balance sheet behave as expected.
From the scenario analysis perspective, do you understand the impact of:
A hard landing with rates collapsing?
A “reigniting” of inflation?
Various incremental moves in between the extremes of both of the above?
From the sensitivity analysis perspective, do you understand the impact of:
Loan volume contracting and/or pricing coming under additional pressure?
Deposit/funding mixes shifting further towards higher rate sources?
4) Yield curve changes might mean hedging will get costlier
While the recent de-inversion of the yield curve is a welcomed proposition for the cost of funds and net interest margin levels, it is complicating the hedging discussion.
For the last few years, it actually paid to put on higher rate insurance like “pay fixed” swaps, and many community institutions took advantage of that. However, it is certainly not normal for “the insurance company to pay you to insure your house.”
Not surprisingly, it seems some have less appetite to continue hedging given that those dynamics have changed.
Yes, it is true that one of the biggest obstacles we hear from bankers is “we missed the opportunity” this time around.
Interestingly enough, some of the best executed hedges of the last cycle were not transacted when the curve was inverted in 2022 or 2023 like some may posit, but rather when the curve was steeper in 2020 and 2021 and the insurance had an upfront cost.
Don’t miss the next opportunity! Make sure your policies have been formally approved and your ALCO/Board are educated so you can better manage your interest rate risk going forward.
Ultimately, being prepared to execute is essential no matter where rates go, and groups should be asking the following as it pertains to their hedging programs:
Legacy hedges: keep, terminate, what to do upon maturity?
Future hedges: how much more protection might I need, and which vehicle is best for us?
5) Bonds will (finally) make a comeback
Finally, DCG is talking to more institutions about bond strategy becoming a bigger component at ALCO versus the past few years.
Now there are certainly groups who have strong loan demand and can fund it with cash flow coming off the securities portfolio, and if that is the case, there is a strong argument to do just that.
But for many, loan demand is muted, and bond purchases have been limited during the past several years. In fact, some institutions desperately need to “replenish” their investment portfolio as they have directed legacy cashflows into loan growth as industry deposits have declined.
Accordingly, ALCO teams must evaluate:
Falling rate protection via discounted securities or bonds with built in call protection
Collateral management and strengthening of pledge-able assets to the Fed
Predicting the future is difficult, if not impossible
When the herd coalesces around a certain forecast, history usually implores us to beware and think about what happens if the consensus is incorrect. Great risk managers understand this and will make the ALCO function a place to drive strategic conversation to help their institution manage and thrive despite the rate and economic environment.
After all, let us not forget: things that have never happened before happen all the time.
For more insights from Darling Consulting Group, click here.
Zach Zoia is a Managing Director at Darling Consulting Group. He helps management teams throughout the country develop strategies to improve financial performance and more efficiently and effectively manage liquidity, capital, and interest rate risks.
Zach began his career with DCG in 2008 as a financial analyst. He earned a BS in finance from Boston College and an MBA from Babson College.
© 2025 Darling Consulting Group, Inc.
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