Thursday, March 21, 2019 |
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| MANAGING DIRECTOR: Scott Carrithers PORTFOLIO SALES AND SERVICE: Steve Panknin • George Morris • Jeff Goble • Chris Thompson • Sean Doherty Kevin Doyle • Lonnie Harris • Mark Tranckino • Robert Schuyler • Tom Toburen • Josh Kiefer Nicole Burczyk • Kelley Frye • Natalie Regan • Aaron Stoffer • Chuck Honeywell • Gus Koppen |
| 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 |
| 03/14/19 | 2.48 | 2.45 | 2.52 | 2.52 | 2.46 | 2.42 | 2.43 | 2.53 | 2.63 | 2.86 | 3.04 |
| 03/15/19 | 2.46 | 2.45 | 2.52 | 2.52 | 2.43 | 2.39 | 2.40 | 2.49 | 2.59 | 2.83 | 3.02 |
| 03/18/19 | 2.47 | 2.44 | 2.51 | 2.52 | 2.45 | 2.41 | 2.42 | 2.51 | 2.60 | 2.83 | 3.01 |
| 03/19/19 | 2.46 | 2.46 | 2.52 | 2.50 | 2.46 | 2.42 | 2.42 | 2.51 | 2.61 | 2.84 | 3.02 |
| 03/20/19 | 2.45 | 2.48 | 2.49 | 2.47 | 2.40 | 2.34 | 2.34 | 2.44 | 2.54 | 2.79 | 2.98 |
Source: U.S. Department of the Treasury, as of 03/20/2019
Markets in Transition; What to do Now? (Part 3)
This week we discussed where the markets have come from, Bear Flattening, to where we think they may go, Bull Steepening. We have also discussed Interest Rate Cycles (and its cousins the Business and Credit cycles). You can read them here and here if you missed it. In summary, these curves look like this:
Yesterday we discussed how interest rate cycles and Recency Bias (the expectations that what has most recently occurred will occur again or continue) tend to sabotage portfolio income (and overall balance sheet income).
Now, how can we avoid the pitfalls that are often associated with interest rate cycles? In the investment portfolio, we recommend (and have for many years) that we build a bridge across the trough in rates to beat the trap. It looks something like this:
This picture does make this concept look simple, but it is anything BUT simple. It means you will be allocating more $$’s to the investment portfolio at longer durations with non-optionable (or low optionable) securities, when loans have the higher nominal yield. It means lengthening the duration of your loan portfolio as well, by insisting on enforceable prepayment penalties on fixed rate loans out on the curve (when you would be more comfortable with adjustable rate loans). It means variable rate loans with relatively high floors AND enforceable prepayment penalties. It means shorter duration liabilities when your gut tells you to lock in current rates before they go higher. Call us, we will be happy to give you the full picture.
Here is a picture of the average portfolio duration vs. the 2 year Treasury for all banks in the BancPath database:
You can see that as rates increase, portfolio durations naturally (or intentionally) decline.
It requires an enormous amount of discipline and confidence in your outlook. Why? Because to do this you must go against all of your inherent tendencies and biases (there’s that word again). You will also be going against the tendencies of your lenders, senior managers and quite possibly those of your board. They will be telling you that loan demand is strong. Rates are going up (expanding business cycle), and many “economists” will tell you rates will continue to go higher because economic indicators are still very strong, which means more PROFITABLE loans to be booked!
By going against your tendencies you will have to risk performing below your more aggressive competitors for a time, and fighting the doubts that maybe you had it wrong. You will also have to fight the busy-ness of your day. There is never enough time to stop and consider what your NEXT course of action should be when you haven’t even evaluated the last strategic move. Too many other decisions that SEEM more important in the moment. We get it! It happens to all of us. We would like for more clients to take time to try to “read the markets” and anticipate the next cycle for longer term success. It can pay such big dividends, but you also have to risk being wrong.
While you should never make such dramatic changes to the balance sheet that those changes could result in catastrophic consequences (beyond Credit, that is), incremental changes in anticipation of the reality of the interest rate, business, and credit cycles may put your bank on a trajectory of success that could mean a prolonged period of high performance. After all, isn’t that what we are striving for?
Where are we now? The details of this picture aren’t important (good thing since you can’t see them) it is the concept. The graph below is a picture of the 10Y Treasury Note over the last 10 years, with regression lines included. As you can see, rates peaked at +2 standard deviations late last year. Today they have declined to just +1 standard deviation. Can they go higher? Sure, anything is possible, but we are in the business of managing probabilities, not possibilities. These current probabilities suggest that rates are more likely to go lower than higher. So take that incremental action today to set your portfolio and your balance sheet up for long term success.
That’s it. A long three part series on the markets. We hope that it made you think.
In the meantime, we sincerely appreciate your continued confidence in all of us here at Country Club Bank. Please don’t hesitate to call on us if we can assist you in any way.
Markets in Transition; What to do Now? (Part 3)
This week we discussed where the markets have come from, Bear Flattening, to where we think they may go, Bull Steepening. We have also discussed Interest Rate Cycles (and its cousins the Business and Credit cycles). You can read them here and here if you missed it. In summary, these curves look like this:
Yesterday we discussed how interest rate cycles and Recency Bias (the expectations that what has most recently occurred will occur again or continue) tend to sabotage portfolio income (and overall balance sheet income).
Now, how can we avoid the pitfalls that are often associated with interest rate cycles? In the investment portfolio, we recommend (and have for many years) that we build a bridge across the trough in rates to beat the trap. It looks something like this:
This picture does make this concept look simple, but it is anything BUT simple. It means you will be allocating more $$’s to the investment portfolio at longer durations with non-optionable (or low optionable) securities, when loans have the higher nominal yield. It means lengthening the duration of your loan portfolio as well, by insisting on enforceable prepayment penalties on fixed rate loans out on the curve (when you would be more comfortable with adjustable rate loans). It means variable rate loans with relatively high floors AND enforceable prepayment penalties. It means shorter duration liabilities when your gut tells you to lock in current rates before they go higher. Call us, we will be happy to give you the full picture.
Here is a picture of the average portfolio duration vs. the 2 year Treasury for all banks in the BancPath database:
You can see that as rates increase, portfolio durations naturally (or intentionally) decline.
It requires an enormous amount of discipline and confidence in your outlook. Why? Because to do this you must go against all of your inherent tendencies and biases (there’s that word again). You will also be going against the tendencies of your lenders, senior managers and quite possibly those of your board. They will be telling you that loan demand is strong. Rates are going up (expanding business cycle), and many “economists” will tell you rates will continue to go higher because economic indicators are still very strong, which means more PROFITABLE loans to be booked!
By going against your tendencies you will have to risk performing below your more aggressive competitors for a time, and fighting the doubts that maybe you had it wrong. You will also have to fight the busy-ness of your day. There is never enough time to stop and consider what your NEXT course of action should be when you haven’t even evaluated the last strategic move. Too many other decisions that SEEM more important in the moment. We get it! It happens to all of us. We would like for more clients to take time to try to “read the markets” and anticipate the next cycle for longer term success. It can pay such big dividends, but you also have to risk being wrong.
While you should never make such dramatic changes to the balance sheet that those changes could result in catastrophic consequences (beyond Credit, that is), incremental changes in anticipation of the reality of the interest rate, business, and credit cycles may put your bank on a trajectory of success that could mean a prolonged period of high performance. After all, isn’t that what we are striving for?
Where are we now? The details of this picture aren’t important (good thing since you can’t see them) it is the concept. The graph below is a picture of the 10Y Treasury Note over the last 10 years, with regression lines included. As you can see, rates peaked at +2 standard deviations late last year. Today they have declined to just +1 standard deviation. Can they go higher? Sure, anything is possible, but we are in the business of managing probabilities, not possibilities. These current probabilities suggest that rates are more likely to go lower than higher. So take that incremental action today to set your portfolio and your balance sheet up for long term success.
That’s it. A long three part series on the markets. We hope that it made you think.
In the meantime, we sincerely appreciate your continued confidence in all of us here at Country Club Bank. Please don’t hesitate to call on us if we can assist you in any way.
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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