Brittany Rollek 0:00

And so now more than ever, we see institutions tapping into lending partnerships as a critical component of generating spread on the balance sheet. And whether that be participations and generating loan growth or loan acquisitions through that type of space, FinTech and partnering with different FinTech operations, which again, were a competitor to the credit union industry. And it's now partnering with those competitors to really tap into those models and create that loan and lending environment.

Mike Ensweiler 0:40

Welcome everyone to the ninth episode of In Your Best Interest: an ALM First podcast, a show that will explore common depository challenges, give you a view an insider's view of the latest market trends and share stories and insights from industry leaders. I'm your host Mike Ensweiler. In early March a lot of people thought we'd have a V-shape recovery, go into temporary lockdown, get the pandemic under control, and then basically open everything up again maybe a year later, get the jobs back. I recently saw an ABA news bite on the mixed recovery of consumer discretionary spending that stated while spending on entertainment and transportation is still well below pre-pandemic levels. Spending on apparel and merchandise has largely recovered and spending at restaurants and hotels has definitely improved. This morning, I saw on Bloomberg that US personal income falls after federal jobless benefits expire. Now there's talk of a sort of Nike swoosh shaped recovery with a big downturn and then a steady increase over the next couple of years. The bad news is that we're going to be in this for awhile with elevated unemployment rates, business closures, and people out of work. The good news is that if this holds true, it would be a faster recovery than the great recession. Depositories have seen low mortgage delinquencies thus far in 2020, partly due to the fact that they're working with members and customers on payment relief, but as these programs begin to expire and months go on, the delinquencies could rise. Regardless of your view of the economic recovery type severity and timing, the reality is that depositories will continue to face challenges with margin compression for the foreseeable future. With that backdrop, this week's episode will focus on profitability in Q4 and heading into 2021. Today we are joined by Brittany Rollek, a director of advisory services at ALM First Financial Advisors. Brittany consults and works with depositories ranging from $500 million in assets to over $5 billion in assets from across the country in areas of asset liability management, balance sheet strategy and portfolio management. Thank you so much, Brittany, for joining us today.

Brittany Rollek 3:18

Thanks Mike, happy to be on the podcast with you.

Mike Ensweiler 3:21

Now, before we get started and we get into the theme of the day, which is profitability heading into 2021. Tell us a little bit about yourself.

Speaker 1 3:31

So I was born and raised in Western New York - GO BILLS. I graduated high school in 2005 at the age of 16, started my undergrad at Davidson college in North Carolina, where I received my BA in economics in 2009, which was a fantastic year to enter the job market by the way , uh , and found my way to ALM First, almost eight years ago now. I started as a financial analyst quickly worked my way up and managed our financial modeling group for a little while, and then moved over to advisory where I sit in my current role as a director, and I've been here for the last five plus years, getting to work with institutions ranging in size from $50 million to billions in assets. And it's been an awesome ride.

Mike Ensweiler 4:17

That's something I didn't know about you is that you graduated high school at 16. What I did know about you, and then I'm going to share this fun fact, so you can smack me when you see me at the office later, is that you played hockey goalie for , um, in college. So you did that as a 17 year old?

Brittany Rollek 4:37

I did, yes. I went to college really to predominantly to play division one field hockey. I was a goalie for the Davidson Wildcats field hockey team. And yeah, I played there four years of hockey and actually I still stay connected with the game. I actually coach as a part time coach for a private high school in the area. And it's been a great distraction. And I definitely think my husband for holding down the fort while I get some me time in. Because maybe a more well known fact, especially to my clients who've been on calls with me for the last six months and have heard them in the background. I've got three wild and crazy boys ages , six, four, and two. And if that wasn't enough excitement, we added two pandemic pooches to our circus. So it's been a lot of fun, but yeah,

Mike Ensweiler 5:26

A lot of balls in the air. And I think that's a great segue into what we're talking about today. You know, you mentioned you work with a variety of community institutions focused on consumer mortgage, as well as commercial credit. What are some of the challenges that each one of those types of institutions is facing in this environment?

Brittany Rollek 5:46

You know, it's been really interesting, you know, we've been working with a range of institutions. I see a lot of different challenges that are varied, but they all actually are quite similar and you can narrow it down. I think pretty much three themes, which is uncertainty, spreads and resources. And, you know, especially on the uncertainty side credit performance right now, and what to expect as potential losses down the road is relatively unknown. It's still a huge unknown, and I liken it to really flying blind in a storm. And your gauges haven't been tuned recently, or they may not even be working at all. Uh , and a lot of that comes from the fact there's been changes in delinquency reporting requirements with the payment assistance programs and forbearance , uh, and as well, just changing landscape relative to business lending risk. You know, it definitely is making institutions think twice about adding risk to the balance sheet and also what to expect down the road as far as performance of what is already on the balance sheet. And because of that, we've seen a pretty significant tightening in credit boxes across the industry and where institutions are willing to lend. And so that is definitely I think, a huge challenge to overcome.

Mike Ensweiler 7:00

So can I, can I interrupt you real quick? I already have, so I'm sorry for interrupting you, but that's , um , you know , a great point that you made that I'd love for you to just touch on for a second is, you know , everything I hear is that all of these institutions are flush with liquidity yet. You know, what you're saying is a lot of them are tightening up the credit box. And I think that ties in really, really nicely to our theme today, which is, you know, margin compression and how do I ring out extra basis points and I'm not willing to lend, how am I going to generate the income I need to, to not only survive, but to hopefully thrive, especially when I might have a number of employees working from home, I've got increased costs and expenses related to that , um, with , with income down.

Brittany Rollek 7:49

Yeah. And spreads definitely have been tightening on high quality liquid assets. And so when you're in a crisis, especially one that is having impact on credit performance. Whether it's pandemic related or some other market bubble related, what that really puts a lot of emphasis on is, well, we probably don't want to be taking on that credit risk. And so if we're not going to take on that credit risk, and I'm going to go into high quality liquid assets instead, and you look at a more traditional investment portfolio that doesn't have a lot of credit exposure to it. And those spreads have been tightening in over the course of the last six months, and it's really difficult to manage margin and that type of environment. And a lot of that also comes down to the fact that these costs of operating a depository are still really high. And, you know, I don't think it's anything new or novel that institutions want to try and streamline below the line expenses and reduce operational costs. But most institutions are operating at a current point where there's not a whole lot of additional opportunity to do that. So they're trying to generate stronger performance above the line, knowing that we don't really have much room to generate that performance below the line as much anymore. And that's definitely an additional struggle. It's that surplus of funding that's coming in at a cost that really can't be reduced to much further. And then if you're not going to take on credit risk exposure and not kind of take that leap of faith, actually as Nick Ambrosini put it in a couple of podcasts ago, you know, you really are having to look at spreads in the investment space as being significantly tighter and making sure that you're doing everything possible to make those disciplined correct decisions, because there's not a whole lot of room for error.

Mike Ensweiler 9:35

Yeah . And that makes perfect sense. And so I know you mentioned you had three themes. I cut you off after the first theme causeit was pretty thought provoking. So I'll , I'll let you get back to your two themes now or the other two things.

Brittany Rollek 9:47

Well, so that second one was actually your question was so spreads, right? So, you know, again, that it's a significant pressure on net interest margin and it's really not. I think a pressure that most institutions can avoid at this point. Um, and so, you know, again, every, every cylinder that the institution has or every , uh, every lever you have to be firing on all cylinders and pushing all levers right now to generate profitability. And I see consistently one of the issues when I'm talking about different strategies and opportunities with clients, one of the hurdles is resources. And, you know, I think we've all pretty much experienced since March, there's been a time when we haven't been able to get a product or we haven't been able to get something done in a timely fashion because of COVID related resource restraints and challenges. And I think that translates to what our clients are doing and depositories are having to do as well. And, you know, whether it's an , an access to technology concern, and as they're trying to ramp up an initial internal initiative or shifting resources to a more active business line, for instance, like mortgage lending, it's a lot easier said than done. Um , and that can be a huge hurdle when you're trying to be nimble and you're trying to be opportunistic. And you're really trying to shift the balance sheet and make, make very quick and timely changes to profitability. It's not as easy as we all like to think it might be.

Mike Ensweiler 11:12

That makes perfect sense. So, you know, I asked this question of Nick Ambrosini, who you brought up, a few weeks ago and I'm going to pose it to you as well. So as you're talking to clients and you're seeing the different challenges and the similar challenges that they all have, how are you looking to grind out extra basis points perhaps in ways that you were , they weren't thinking about a year or two ago?

Brittany Rollek 11:35

Yeah, I think that probably one of the newer or growing areas that institutions are using to generate profitability is partnerships. And, you know, most institutions have a relatively steady stream of mortgage lending, but other areas of lending are not nearly as strong. And they may even well suffering as far as loan growth. And so now more than ever, we see institutions tapping into lending partnerships as a critical component of generating spread on the balance sheet. And whether that be participations and generating loan growth or loan acquisitions through that type of space, FinTech and partnering with different FinTech operations, which again, were a competitor to the credit union industry and, and generally financial depositories at large, but it's now partnering with those competitors to really tap into those models and create that, that loan and lending environment. And then also merchant lending relationships. You know, we've seen this probably come up more over the last few years, but again, I see this as an area where we're going to continue to see more growth and more expansion. Um , and you know, institutions are really having to think outside of the box in order to acquire assets and that's going to come with some risks, right. And, you know, being able to evaluate the pricing and the risk adjusted returns and the risks that come along with those different programs is really important and integral to profitability. So, you know , just looking at that flashy yield is a very narrow perspective to base your decisions upon, and you really have to count up the pieces, evaluate the cost, evaluate the risks and determine whether that opportunity is really the best for the institution, given the pricing , uh, and also again, your resources and your alternatives.

Mike Ensweiler 13:25

And I agree with you. And so, you know, the, the exercise or the textbook exercise of kind of breaking down those components and, and not focusing on that, that top line yield, that sounds great to a lot of people, but I've talked to a number of CFOs and I'm sure you have as well. Um, it's tough to put that into practice internally sometimes because certain people, whether it's bonds or loans, or what have you, people focus on that top line yield instead of the economic benefit. So if I have that challenge internally, how , how do I sell that upstream?

Brittany Rollek 14:05

I think it's about presenting a model that's truly quantitative that again, addresses all of the different components that you would potentially see with any given product, right? You know, if it's alone, you have to make sure you're capturing the credit component and you have to make sure you're capturing the cost of acquisition, right? If that's either a bonus structure for your lending team, or that's a cost to obtain an asset from a dealer or another indirect channel, you have to make sure that those are quantified , uh, and , and included in that analysis. And then really it comes down to a robust model that is able to dissect the risk based cost . And I think that, that's the one thing I see missing from most of these models, which causes the most tension between say the lending team and the finance team. And again, it's that idea there that it's not just saying, okay, here's the top line yields on the product. Here's a credit cost that I'm going to strip away. Here's a treasury rate and that's it. And that's all I need to think about. Again, there's other risk based costs associated with every decision that an institution's making and every asset that's going on the balance sheet. There could be options costs associated with those assets. Mortgage assets are , are required a very robust modeling framework to evaluate the prepayment risk. And if you're not including that within your models, then again, it's going to be pretty hard to sell any model, both to a lending team and a finance team. It really needs to take into account all of those components. And, you know, again, I think it , it all comes down to education and getting departments on the same page. That's huge. You know, when you, when you talk about incentives and lending tends to be more volume based and it's incentive structure, finance tends to be more bottom line performance incentive-based. And when there's that disconnect, it can create a lot of tension in that decision making process. So, you know, it's not just about the model and the tool that you use and how you evaluate it. It's making sure that everybody understands what you're working towards and being on that same page, because that's how basis points go to the bottom line. That's how we generate additional profitability. It's when everybody's on the same page and working towards the same goals and understands how each decision will impact that that's when the best decisions are made over and over again.

Mike Ensweiler 16:41

Yup . Yup . So education pricing, models, incentive structure, alignment, those are all really good themes. Um , that I just heard you say, what are some other common practices or maybe best practices of those who are doing better than others in this environment?

Brittany Rollek 16:59

Yeah, I think there's in addition to those, you know, one of the things I would point to as a risk dashboard , uh , and you know, I look at that not as being a burden of showing us where we have too much risk, it really shows us where we have remaining room. And that's a key part of this puzzle as well, and clearly seeing where you have remaining risk budget, or you can think about it is where I still have room to pull on levers. It helps narrow our focus as asset managers to those ideas, which really are the best fit for the institution and getting those ideas analyzed, getting them downstream and again, where they have the best opportunity to push those basis points to the bottom line is through that process. Uh, so I would say definitely risk dashboarding , um , and having a team that can get it done. That's huge. Uh, you know, we can have great models. We can have the appropriate type of analysis and , uh, and modeling. But if we don't have a team that can clearly discuss those themes and get those downstream and get the board onboard , those bright ideas are never going to get done. And so that I think is a very consistent theme of institutions I see, that are doing well and doing well consistently.

Mike Ensweiler 18:14

So it sounds a lot like my golf game, you can have a good strategy, but unless you can execute, it doesn't matter.

Brittany Rollek 18:22

Exactly like your golf game.

Mike Ensweiler 18:27

So, okay. We talked about some of the best practices of those who are doing better. What are some of the pitfalls that you're seeing to avoid?

Brittany Rollek 18:37

You know, I think that really comes down to staying in a very traditional mindset of what a credit union is or what a depository is and how you provide value back. Um, you know, again, we work probably with predominantly credit unions . So from that lens, I still see institutions who are not taking advantage of those opportunities to be able to reduce their cost funds . And, you know, when you sit in a framework and you use that traditional lens of I'm gonna provide the top deposit rates, and I'm going to provide the lowest lending rates or loan rates, again in an environment like this, there's not enough room to, to use that as a baseline for how you build the balance sheet and how you manage your , your funding and your assets. I think, you know, if you're not evaluating already your funding as a spread to swaps, then having a model for the asset side where we do evaluate a spreads and swaps framework will completely miss all of that potential to generate profitability. And, you know, it , it becomes really obvious when you evaluate your funding cost in that type of framework where you're missing the mark and where you're eating into your profits. And so I would definitely say, you know, don't fall asleep at the switch or miss an opportunity to capture basis points on interest expense , uh , because that is one of those areas. Again, we, aren't going to have a lot of room for it, but if you aren't taking advantage of those opportunities and the fact that depositers right now probably care less about the rate on their deposit accounts and more about the safety and soundness of their funds and being able to tap into them when they want to. Then, again you're missing a low hanging fruit there from a profitability standpoint.

Mike Ensweiler 20:29

So, you know, as part of the intro, I set this up, you know, we've heard a lot for the economic recovery. We've heard a lot of different shapes for this recovery. A U-shaped recovery of V- shaped recovery, a W-shaped recovery, a Nike swoosh shaped recovery. The reality is that no one really knows what this is going to look like. So how are institutions modifying their business plans or operating plans or financial projections as a result of the uncertain recovery?

Brittany Rollek 21:01

I think the fluidity of the environment and the recovery really has to be matched with agility in the business plan. And, you know, not over committing, I think too , too stringent of a plan or a plan that in order to work has, you know, very specific requirements that need to be met. I think it is probably the most viable of options and strategies for institutions at this point. Uh, you know, most institutions that I work with are looking at adding tools to expand the toolbox, to help them generate stronger sustainable performance. And derivatives is a great example of that, right? If you don't already have the ability to hedge and hedge your core balance sheet, I think that provides an excellent opportunity for institutions who are looking at where they currently see a lot of their loan growth or loan production, which is predominantly in firstly in residential mortgages, but are afraid to add that asset to the balance sheet because of that longterm fixed rate asset interest rate, risk exposure. And if you're not looking at the real benefit of hedging as a way to take that opportunity and add it to the balance sheet, then again, you know , you're not being as agile or as flexible as you could be, or as opportunistic as you could be. Um, so, you know, thinking about ways to, rather than just avoiding risk and where you could have some potential for performance instead, try to manage that risk or hedge that risk, and actually add that profitability to the bottom line. So, you know, I think it's definitely a pretty open and closed case for core balance sheet hedging, there's other ideas and different strategies. I think that each individual institution can definitely take a look at. But again, I think, you know, it's just about being flexible and maybe thinking about those tools you haven't used before to manage that risk rather than avoiding it altogether .

Mike Ensweiler 23:07

You know, perhaps that's one of the silver linings Brittany that comes out of this, this environment or this pandemic is that there definitely needs to be a sharper pencil or more laser focus on hedging or managing balance sheet risks. You know, I'm sure pre-crisis in the mid two thousands it was, you know, at least what I saw was pretty easy to, I don't want to see be lazy, but, but not to have as finely tuned , um, models and focus on managing those risks. But yeah, I think that, you know, that could be something that definitely , um , is an end result of the environment we're in now. So do you see any other silver linings for your clients and, or the industry as a result of this new environment?

Brittany Rollek 23:57

Absolutely. It's a really challenging time to be a depository, but I think it's also a really exciting time for the industry overall. And the pandemic has definitely expedited the need for evolution and, you know, the way we think about the balance sheet, the way we think about managing the balance sheet, the way we think about capitalization and capital requirements, you know, I think institutions have to be more forward-thinking in order to stay relevant and continue to provide value to their stakeholders. And, you know , those who are going to be open to new opportunities or exploring ideas that they haven't before are going to be the ones that I truly think pull through in the end. You know, we, we know that there's a high likelihood that we'll see some consolidation in the depository space. And I think what that means is institutions will really have to think hard and reaffirm their identity and who they want to be in this space of providing financial services and lending services and figure out what's the best way to stay relevant and also to manage all of those risks that are coming along with that changing landscape. So I think that that's a really exciting part of this huge challenge. Is, you know, figuring out what is going to work for each individual institution. But I think we're going to see a lot of evolution in the depository landscape, and I think that's great for not only those institutions themselves, I think it's great for consumers as well.

Mike Ensweiler 25:30

Yeah, I agree with you wholeheartedly because I think delivery channels are going to change outside of just managing the balance sheet. The whole business model is going to change. You know, one of the reasons I love doing this podcast is to get perspectives from really smart people. And I've asked this before, and I want to get your opinion and insight on something I saw from Black Rock recently that stated the U.S. election is taking place against the historic backdrop of a pandemic recession and domestic strife. The outcome could have significant implications for key policy areas. Fiscal stimulus, public investment, taxation, regulation, and foreign affairs. What concerns, if any, do your clients have about the upcoming election?

Brittany Rollek 26:15

Well, you really leaned heavily into my economics background here. You got me pretty excited about this question. Uh, and, you know, I think it's really hard to pinpoint one specific area that could be of concern with the upcoming election and the potential change in the landscape of, you know, who's in charge from the top down and it's , it's kind of like falling dominoes, right? You know, every aspect of governing and impacts consumer and commercial behavior. And I think that directly impacts depository balance sheets and financial performance as well. You know, probably the most obvious is fiscal stimulus in certainly been one of the more immediate concerns on the minds of the clients that we work with, you know, and another round of fiscal stimulus has yet to be passed. So it's really hard to know what to expect for deposit growth and the potential demand for credit. And then also as well, performance on the asset side of the balance sheet relative to asset quality and delinquency and charge offs. So, you know , that makes it really, really hard heading into budgeting season. And I certainly, you know , when talking with my clients, I wish I had a crystal ball and I could give them that perspective because I know they're all looking for it. And let me tell you, I wish I had it. It would make things a whole lot easier. Um, but you know, when it comes to budgeting and planning and trying to figure out how to capture all of these uncertainties and, you know, especially related to an election and, you know, the executive branch and who's in our legislative branch, I mean, that is, it's just almost impossible, I think, to try and figure this out. So instead of trying to get it right, I think we spend the time on the areas that are more controllable, really pinpoint down to those things, which, you know you have significant control over and then stress test the rest. And that's huge, right. You know, stress test your growth, assumptions, stress tests what does it mean to bring in that much more deposit growth over the next year? You know, I think a lot of industry , um, industry names have been expecting deposit growth somewhere in the range of about 8% annualized growth next year. Well, it's crazy to think this, but the stress would be having even more growth than that, right? Cause that's putting on putting pressure on capitalization. That's putting pressure on continuing to have to put funds to work. So I think, you know , that's a key component here whenever you're facing this type of great uncertainty, really focus on those, you can control and stress test the rest.

Mike Ensweiler 29:01

I set that up with, you know, one of the reasons I love doing this podcast is to get those perspectives. And one of the challenges I have with this podcast is that we just don't have enough time to take a deep dive into any of these things. It's great to , to wet our appetites and I really, really enjoy it. Um, but we are, you know, budding up against the clock here. So what closing thoughts do you have or is there anything that you want to share as we wrap this up, Brittany?

Brittany Rollek 29:31

Absolutely. I think it's stay open to new ideas and build the team which can help you get them executed. That's huge, right? Agility is going to be so needed as we move forward through the remainder of 2020 as we move forward through recovery in this environment. And, you know, being opportunistic is going to make a material difference in profitability. And so, you know, educate the board, educate the executive management team, get everybody on the same course , uh, and be okay with changing course too. Again, because you know, there's, there's only so much we can plan for at this point and being flexible is, is going to be key to maintaining profitability.

Mike Ensweiler 30:14

Well, thank you so much, Brittany, for joining us today and giving us some food for thought as we head into the planning and budgeting season.

Brittany Rollek 30:21

Absolutely. It's my pleasure. Thanks Mike.

Mike Ensweiler 30:31

I want to thank you again, Brittany, for sharing your thoughts on best practices and experiences on squeezing out extra basis points in this environment. At the end of each episode, I like to take a moment and let you know about some additional resources that we have available. If you'd like to learn more on this topic, you can check out our website for educational events as well as be on the lookout for an upcoming profitability webinar as always stay safe, stay healthy. And thank you for listening to In Your Best Interest: an ALM First podcast.

ALM First 31:06

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