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Friday, October 19, 2018 |
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MANAGING DIRECTOR: |
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US Treasury Market |
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| Date | 1 mo | 3 mo | 6 mo | 1 yr | 2 yr | 3 yr | 5 yr | 7 yr | 10 yr | 20 yr | 30 yr |
| 10/12/18 | 2.14 | 2.28 | 2.44 | 2.66 | 2.85 | 2.93 | 3.00 | 3.09 | 3.15 | 3.25 | 3.32 |
| 10/15/18 | 2.17 | 2.31 | 2.47 | 2.67 | 2.85 | 2.94 | 3.01 | 3.10 | 3.16 | 3.27 | 3.34 |
| 10/16/18 | 2.19 | 2.30 | 2.46 | 2.66 | 2.87 | 2.95 | 3.02 | 3.10 | 3.16 | 3.26 | 3.32 |
| 10/17/18 | 2.20 | 2.31 | 2.47 | 2.66 | 2.89 | 2.97 | 3.04 | 3.13 | 3.19 | 3.29 | 3.35 |
| 10/18/18 | 2.19 | 2.32 | 2.47 | 2.67 | 2.87 | 2.95 | 3.03 | 3.11 | 3.17 | 3.28 | 3.36 |
Source: U.S. Department of the Treasury, as of 10/18/2018
Recent Observations
As an organization, we (AMG) conduct or participate in an ALCO meeting, on average, every single day. This estimate is probably on the “light” side, but, you get the point. We review a lot of ALM (AMG) reports, balance sheets, pricing strategies, agendas, exam issues, and general concerns about spread, margin, and liquidity. We see what is “working” and what is “not working” every day, in different parts of the country (we have clients in 24 states). Further, we see a variety of banks in an array of demographic locations in the same state, including “city” banks and “country” banks. It is somewhat difficult to lump this broad array of community bank experiences into a single statement, but we have seen the following issues on a regular basis.
First, keep in mind, for the purposes of this discussion we are analyzing banks that are working hard to meet ROA and ROE goals (as opposed to those that are content to be 50% loaned up in perpetuity). To meet somewhat elevated earnings goals most banks have landed in the 75% to 95% Loan to Deposit range. As a result, most have stretched their liquidity quite thin, and now face funding issues. With this perspective in mind, we offer a couple of our recent observations.
Interest expense is increasing at a slightly faster pace than interest income:
This is not always the case but for the most part it is. Most bankers were able to hold the line on raising deposit cost in the shadow of increasing overnight fund increases initially, until the L/D ratio of competing banks increased. Now, as bankers compete for sources to fund their increasing loans, deposit cost has increased dramatically, and has soared in some cases. Many deposit customers have been requesting rate matching on their deposits and bankers have been agreeing to them. Additionally, we have noticed rate specials being offered and other deposit board rate increases. These increases have been, for the most part, to maintain the status quo at best. These rate hikes have been described as a proactive show of “good faith” to hold the line. It has worked for the most part, but keep in mind the Cost of Funds has increased substantially, in some cases 50 basis points or even more. Plus, these “maintenance increases” have not brought in new deposits.
On the other hand, Prime has increased 200 basis points from 3.25% in December of 2015 to 5.25% currently. Yet, new loan rates (not directly tied to Prime) do not reflect the Prime increase, and in many cases do not even reflect the recent increased COF. The Yield on Earning Assets (YEA) in many banks remain in the mid to high 4’s, while the current offering rates are in the 5.00% to 5.25% range. So, a COF of 75 bps subtracted from YEA (4.25%) produces a spread of 3.50%. Plus, the increased offering rate of 5.25% will take many months or even years to substantially increase the YEA.
It is hard for most bankers to say no to “good’ loan request, regardless of the rate or term:
This is a gross exaggeration of course, and we are focusing on IRR, not next month’s income, but we sometimes think it would be wiser to say no to a proposition than to accept some of the terms we see booked. A 20 year amortization schedule with a 10 year rate reset just may be too long for some balance sheets. These terms might be a slight exaggeration to make a point, but it illustrates what we see on a regular basis. Obviously, a “long” loan or long reset period may be concerning if rates increase, but, it can also become an income problem if rates decrease and the loan prepays, or is renegotiated to a lower rate.
Our point, understand the IRR related to each loan, and at some point it may be necessary to put the brakes on and “demand” terms favorable to the bank. This may sound unrealistic or “academic” but it can be done, we have seen it.
As a helpful tool, our Bancpath website contains a free “Loan Builder” to derive an acceptable rate based for a broad array of terms, including maturity; amortization schedule, credit risk; and whether the loan is fixed or variable. We also provide an “indifference rate” pricing schedule that equalizes the difference between fixed and variable rate loans based on the swaps market every Monday in the PMR we send out. These tools are not overly complicated but they can provide a reliable framework to help loan pricing.
These above are just a few comments, call us if you would like to discuss these or other ALM issues with us at 800.226.1923.
This information is intended for institutional investors only. The material provided in this document/presentation is for informational purposes only and is intended solely for private use. Past performance is not indicative of future results. This material is not intended as an offer or solicitation for the purchase or sale of any financial instruments.
•Not FDIC Insured •No Bank Guarantee •May Lose Value