Pub. 6 2011-2012 Issue 2

July/August 2011 19 Extraordinary Service for Extraordinary Members. C OMMUNITY BANKS CONTINUE TO face significant headwinds and challenges to perfor- mance. Regulatory issues, weak loan growth, and an uncertain rate outlook are weighing heavily on margins and returns. As bank manag- ers struggle with this environment, it is helpful to remember a few simple rules for prudent balance sheet management. Keep Assets Deployed In the last two years, banks have experienced a substantial change in their asset mix, moving away from loans and into investments. Simultaneously, deposit growth has continued to be steady or strong at most banks. Average loan-to-deposit ratios for banks in the U.S. are now lower than they’ve been in at least five years, and the trendmay not reverse very soon. In the midst of this excess liquidity, banks should take care to keep assets productively deployed in order to avoid a drag on earnings. Over the past 24months or so, large balances sitting in fed funds have amounted to a painful andmistaken bet on rising inter- est rates. It’s better to keep the balance sheet fully engaged and hitting on all cylinders rather than sitting on a large funds balance earning nearly nothing. Manage Cash Flow & Liquidity It has always been our contention that managing interest rate risk in a bank balance sheet is largely a function of cash flow management. Tradition- ally, there is no better hedge against ris- ing interest rates than a steady stream of predictable cash flow that can be redeployed into new, higher yielding assets. In terms of the investment port- folio, cash flow and the volatility of cash Asset/Liability Management: Four Thoughts for the Current Environment Jeffrey F. Caughron , The Baker Group LP Q Liability Management — continued on page 20