Sometimes how we choose to measure something can lead to incorrect conclusions. While mathematically 30 is 50% more than 20, a 30-year amortizing loan is not 50% riskier, or 50% longer than a 20-year amortizing loan. The amortization term is often a poor measure for bankers to use to make credit decisions. In this blog, we will explain why the amortization term can be a misleading measure, why bankers should be using average life, and we will provide readers with a downloadable average life excel calculator for bankers to use for their own analysis.
Tag: Interest Rate Risk
Many community bankers are now considering how to position their asset and liability portfolios for declining interest rates. On the one hand, interest rates should be falling more, and on the other hand interest rates are being talked down against a backdrop of still strong economic data.
A flat yield curve has us scratching our heads – should we be originating fixed or floating rate loans? If bankers believe that the current shape of the yield curve is a harbinger of an impending recession, then booking fixed rate loans may be a winning strategy. However, if you believe, as we do, that there simply isn’t enough data as yet to point with a moderate degree of confidence to an economic recession in 2019 or 2020 then booking floating rate loans may be a better strategy. We have developed a technique and loan structure to assist bankers who espouse the former scenario and are
One of the easiest ways for community banks to increase profitability is to stem commercial loans from refinancing to a competitor. Competition is intense, and community banks that develop a strategy to retain profitable clients can increase income substantially. While most banks devote resources to marketing, sourcing, and booking new business, much less emphasis is placed on maximizing profitability on the existing loan portfolio by identifying and controlling customer loss (or refinancing risk). We would like to share one specific strateg
For all banks, the flattening yield curve is impacting profitability. The difference between the Two-Year swap and the Ten-Year swap rate is around 12 basis points. For banks over $15B, this flattening moves net interest margin (NIM) lower and then improves past the one year mark. However, for community banks under $15B, the flat curve not only moves net interest margin down, but this lower profitability becomes worse over time.
At last we left off on the story of the Secured Overnight Funding Rate (“SOFR”), SOFR just started trading (HERE). At that time, we discussed the very first rate setting, the rare wonder of seeing a new index created and what bankers need to do to prepare for the possibility of using a new index in their investment and loan process. Now, as of last week, there is a newly created futures market.
Our lending strategies have recently changed. In the last six months, the FOMC has raised interest rates by 75 basis points, and FOMC members project another increase in September 2017. That is a total of 100bps increase over a 12 month period, with another 100bps projected over the next 12 months after that. Meanwhile, long-term rates (both five-year and ten-year) have decreased by approximately 30bps in the last six months.
We are in a period of rising rates. Since December of 2015, the Fed Funds Target has increased 75 basis points (bps). This is similar to the first set of rate increases that started back in early 2004 and ended in the third quarter of 2004 where the Fed Funds Target Rate also went up 75 bps. Back then, banks increased their cost of funds a scant four basis points.
Most community banks are eagerly anticipating rising interest rates. The banking industry has historically fared well when interest rates rise, and banks’ cost of funding lags - net interest margin expands and banks’ profitability increases. However, in this particular rate cycle, there are a few unusual industry and market developments that community banks must consider. From analysis shown below, and anecdotal discussion with CFOs and CEOs, banks must be mindful of their strategic and balance sheet positioning for the next few years.
In a previous blog, we described what factors community bank managers might want to consider in analyzing a loan hedging program for their specific needs. In that blog, we listed the pros and cons of using a hedge to control risk and increase profitability. We then wrote a follow-on article that analyzed the various instruments and strategies common in the bank hedging market to include swaps and other interest rate derivative instruments. We provided an in-depth