US Treasury Market
Date	1 mo	3 mo	6 mo	1 yr	2 yr	3 yr	5 yr	7 yr	10 yr	20 yr	30 yr
11/13/19	1.56	1.57	1.59	1.57	1.63	1.65	1.69	1.79	1.88	2.20	2.36
11/14/19	1.59	1.57	1.58	1.55	1.58	1.59	1.63	1.73	1.82	2.15	2.31
11/15/19	1.59	1.57	1.59	1.54	1.61	1.61	1.65	1.75	1.84	2.16	2.31
11/18/19	1.59	1.57	1.58	1.54	1.60	1.59	1.63	1.73	1.81	2.14	2.30
11/19/19	1.58	1.57	1.58	1.54	1.60	1.59	1.63	1.71	1.79	2.11	2.26

                                                                                                                                                   Source: U.S. Department of the Treasury, as of 11/19/2019

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    Maintaining Yield on Earning Assets as Margin Compression Accelerates… A Few Ideas


How has the current rate environment impacted Yield on Earning Assets (YEA) in most community banks?  This time last year when the ten year treasury was yielding about 3.20% and the outlook was for three or four Fed increases in 2019, YEA was peaking.  Since then, the yield on the ten year treasury steadily declined to the 1.45% range, before crawling up to current levels around 1.80%.  Unfortunately, the Cost of Funds (COF) for most banks remains elevated while the YEA continues to decline.  The combination of outlandish competition (4.25% for a ten year loan on a 20 amortization schedule?) and slowing loan demand has forced many banks to selectively slash current loan rates.  This decreases YEA, spread and Net Interest Margin (NIM).  Below are a few thoughts that may help maintain the YEA.

Fixed Rate Loans-No one is quite sure if rates have stabilized.  It does seem unlikely, however, that rates will be headed up anytime soon (says the Fed).  Therefore, extending a portion of your fixed rate loans to the greatest extent possible may be prudent to lock in what might be higher rates than we’ll see in coming months.  And if prepayment penalties are reasonable to write in, do it.  This is a touchy proposition for both the lender and borrower in some markets but it is standard procedure for most “big” lenders.  If a prepayment penalty becomes a sticking point, use it to negotiate rate and term.

Secondly, in a highly competitive loan situation, it might be acceptable to go with the most competitive rate (not a whacky rate, but a competitive one) to get the deal.  Depending on your rate bias, an extremely competitive rate today maybe a “high” rate this time next year.

Lastly, if we are at or near the end of the current interest rate (and business) cycle, tighten the screws on the “creditworthiness” of your borrowers.  How will your borrowers fare in a significant economic slowdown?

Variable Rate Loans-First, check-out current floors, if any. Floors are prevalent in most loan portfolios but in many cases they are surprising low with many as low as 3%.  All new variable rate loans should have a floor as high as possible, hopefully in the 5% range, or higher.  

Secondly, think about lock-out periods (time to the first reset) if any.  A very short (or non existent) lock-out period could work against you.  It makes the loan ovelry rate sensitive which means it reprices at the next Fed move (or sooner).  But with an adequate floor in place, repricing risk is diminished.   In any event, try to keep the lockout reasonably short (one year or so), assuming you have a reasonable floor in place.

Lastly, consider using an index that is “controllable”, such as Bank Prime.  Naturally the index has to be fair and transparent, but it is controlled by management, and not necessarily the market.

Overnight Funds vs Investment Portfolio- Do not keep excess funds in overnight sold positions. If overnight funds sold have exceeded your target, do not be fooled by the current effective rate of around 1.75 %.  That rate will drop like a rock if and when the Fed moves overnight rates downward again.  Consider getting out on the yield curve a bit.  A 15yr Agency MBS 2.0% coupon priced to yield 2.11% and duration of about 4 years (at the current pricing speed) will provide attractive cashflow and yield.  The MBS is just one example, there are many other options that are excellent alternatives to overnight funds.




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.

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