By Katie Reiser
As banks across Wisconsin begin their budgeting process for 2025, it is a tumultuous time with uncertainty on many fronts. WBA interviewed three experts whose insights can guide bank leadership as they plan for the year ahead.
Augustine Faucher, Ph.D. is senior vice president and chief economist at PNC Financial Service Group. Faucher addressed WBA members during the 2023 Midwest Economic Forecast Forum. Look for more information in the PNC Fall Economic Outlook Survey.
Prepare for Slower Growth
Faucher cautioned that banks should expect slower growth in consumer spending and business investment growth, but still expects economic expansion, sharing, “I think we’ll see consumer spending increase, but at a slower pace than what we saw in 2023 and so far in 2024.” Faucher added, “banks need to be prepared for the fact that we may still see some softer demand for borrowing out there.”
“As the labor markets soften, we’re witnessing both smaller job gains as well as slower wage growth…I think we’re going to see more pressure at the lower end of the income distribution,” which Faucher explained is, “having more of an impact for low-wage workers and workers with less formal education.” But, he points out that upper income households are still benefiting from rising home values and stock prices that have been up over the past year, “I think higher income households are generally doing better, so retailers that are appealing to upper income households will hold up better than retailers focused on middle income or lower income households.”
Goods prices are down slightly over the past year, and Faucher points to progress over the last few months, particularly with less housing inflation. “We’ve seen a lot of supply come online in the multifamily market, and that’s slowing housing inflation,” he stated.
Commercial Real Estate Worries
Faucher underscored concerns about the commercial real estate market, especially the office market, “there’s a lot of debt that was rolled over from when interest rates were low in 2020–2021 that is going to be coming due.” This places stress on borrowers and office values are down from where they were before the pandemic. Said Faucher, “we just have lower structural demand for office space out there, so I think that banks should be prepared for distress in commercial real estate, in particular in the office real estate market.” He predicts that it will take time for that market to get through some of these structural issues and envisions a lot of ups and downs for another couple of years.
Fed’s Goals
Faucher believes the Federal Reserve won’t need to see inflation at 2% before cutting rates, stating “I think as long as we’re making progress there, we’ll see the Fed cut rates in September, maybe in November or December later this year.” He added, “but I think we will see, in particular, the short end of the yield curve move lower over the next year or so, with the Fed cutting fed funds rate and pushing down short-term rates.”
Marc Gall is senior vice president and asset/liability strategist, BOK Financial Capital Markets. BOK Financial Capital Markets is a WBA Gold Associate Member and specializes in balance sheet and investment strategy for financial institutions. Gall has been a frequent presenter at WBA seminars, webinars, and conferences.
Funding Balance Sheets
A challenge for banks will be looking at deposit rates. Gall asked, “If the Fed cuts interest rates, how much cost savings can banks reasonably assume, and how quickly can they assume that they’re going to get it?” Gall posed more questions for banks to consider, “what actions will banks need to take to reduce deposit costs? Is it going to be subject to whatever the rest of the market does?” For example, if competitors don’t start lowering rates on deposits and your bank still has CD specials at higher rates, will your bank aggressively move rates down and be an outlier, risking the loss of those deposits?
These are challenges from a strategic standpoint that management teams are going to have to figure out as they formulate their budget for 2025, because that cost side is going to be particularly important.
Yield Curve Pressures
As the front of the yield curve has inverted more, reinvestment rates on term loans and investments have declined from the beginning of summer. Gall suggests management teams take a hard look at loan growth assumptions for 2025: With a potentially slowing economy, where will loan demand come from? What loan rates are reasonable in this environment? With inconsistent pricing in the market, what growth and pricing strategy is best for our bank? Gall explained that many are feeling the pinch of margin pressures in 2024, but it might potentially get worse, or not get meaningfully better until significant movements from the Fed. “The initial 25 basis points or 50 basis points may feel like a movement in the right direction.” But, he warned, “the inverted yield curve is still going to be painful until we get that to normalize.”
Gall shared,“while the two-to-10- year part of the curve has uninverted or become more flat, we still have a huge inversion on the short end between zero and two years, which to me creates more of the margin pressure for a lot of community banks and it’s almost getting worse right now versus getting better. For many, margins will likely improve with a more favorable curve and time passing, allowing for repricing of legacy assets.”
Bank Term Funding Program
Some banks ended up utilizing the Bank Term Funding program from the Federal Reserve in response to the bank failures of early 2023, Gall explained, “with the attractive borrowing rate, call option and favorable collateral treatment, some of the banks that we work with borrowed or refinanced it in December or January of last year, which means those are coming due December 2024 or January 2025.”
Many banks will need to consider how they want to refund those borrowings, advised Gall, adding “Given the program isn’t currently available, a thoughtful, strategic funding plan will be critical for banks, incorporating current cost, diversification and contingency funding needs in the decision process.”
Frank Kelly, founder and managing partner Fulcrum Macro Advisors, will be the Keynote Speaker at the WBA Management Conference on September 24 in Green Bay. His presentation, The U.S. Economic, Financial, and Political Outlook 2025–2026, will provide more insights to use in budgeting.
Capital Rules, Cannabis, and Cybersecurity
Kelly described large banks’ efforts to stave off increased capital requirements, “there’s this question of ‘too big to fail’ that still lingers after the 2008 financial crisis,” which factors into the debate about Basel III minimum capital requirements. “It’s been one of the more brutal lobbying battles I have ever seen in my life, and I’m a fifth generation Washingtonian who grew up on this stuff.”
When asked to comment on how the election might influence regulatory issues, Kelly responded, “The first one would be the bank capital rules impacting the largest banks. If Trump wins, I predict that the federal regulators would probably stop pursuing it. If Harris wins, they will continue to press for it.”
A potential huge shift and possible opportunity for many banks is banking for cannabis, although, as Kelly pointed out, “it’s fraught with a lot of concern.” Kelly went on to predict that Congress may try a last-minute push to legalize cannabis banking this fall. Which as Kelly predicts, could then “be a very large business for banks of all sizes because they’ll be able to take the deposits, they’ll be able to make the business loans to them.” He likens it to the lifting of Prohibition in terms of new financial opportunities.
Kelly’s final issue on his “big three” list of issues for bankers to consider is cybersecurity. He points out that it is getting increasingly more perilous for every business, but particularly banks becoming a target of not just cyber thieves, but also foreign governments. He gave the cautionary examples of disruptions in Paris’ transit system on opening day of the Olympics and an elaborate deepfake video call netting scammers $25 million from a multinational firm in Hong Kong, even when employees had made efforts to avoid fraud.
Cyber criminals could target smaller banks in the heartland, Kelly warns, because “that will really shake people up more and create confusion.” Criminals and bad actors in foreign governments could reason, “don’t do it in the big cities where there’s always confusion… do it at a smaller, more vulnerable bank.”
Anxiety and Emotions
WBA spoke to Kelly on the morning of the dramatic market drop, and he remarked, “The market is very emotional, which is never a good thing in finance.”
“Inflation has really impacted folks. It’s very uneven around the country in terms of those feelings. Meaning some people think things are great, but there’s a lot of people with a lot of anxiety.” Fueling that anxiety is a lack of understanding about what’s going on politically and economically. Kelly reflected, “So much of the market is psychological and when people are feeling that anxiety, at some point it sort of bursts out.”
Look to WBA for More Information on Factors Influencing Budgets
While there are numerous complex considerations for banks as they work to create budgets that are resilient and adaptable, some factors are becoming more significant. Banks are expected to increase their technology spending with a focus on enhancing digital banking platforms, improving cybersecurity, and leveraging artificial intelligence (AI) for customer service and risk management. Other areas requiring a larger piece of the budget pie are wage growth and costs associated in upskilling or reskilling, particularly in specialized areas such as cybersecurity, data analytics, and digital transformation. WBA endeavors to keep members abreast of developments with these ever-evolving issues impacting budgeting and will continue to share informed insights, data, and best practices.
I remember how very sure I was after the Great Financial Crisis that rates had to go up, and the rate forecasts all showed rising rates. That position was wrong for over a decade.
By Rose Oswald Poels