Pub. 3 2012 Issue 2

www.wvbankers.org 8 Time sure flies when you’re having fun, and that’s probably why it doesn’t seem like it’s been over three years now that the Fed Funds rate has been next-to-nothing. S ure enough, it was the December 2008 meeting of the Federal Open Market Committee that resulted in the target for the overnight lending rate being slashed from 1% to virtually zero. There it has stayed and, it appears, there it will stay; at least for a while longer. Ac- cording to statements released subsequent to its January 2012 meeting, the FOMC has extended its timeline for extremely low rates until the latter part of 2014. History is a great teacher, and for com- munity bank portfolio managers, it may be helpful to think about what lessons have been learned in other low interest rate environments. All too often, pro- tracted periods of low rates are when mistakes are made. In what may be an oversimplified description, these mis- takes are either the result of not doing enough on the one hand, or trying to do too much on the other. Inaction Is Not an Option For portfolio managers who might be characterized as not doing enough, the mere fact that rates move to low levels becomes the rationale behind the expec- tation that their rapid rise to previous levels is imminent. In other words, if interest rates are low, it must follow that they’re going to soon rise. Those managers who subscribed to that school of thought back in December 2008 are still waiting for that imminent rise. During this wait, some have adopted an investment strategy that focuses on the avoidance of market risk by selecting only short maturity securities or similar alternatives; cash or cash-like substi- tutes. The cost of such a strategy has not been insignificant. While potential market depreciation has been mini- mized, the opportunity cost in the form of foregone earnings has been expen- sive. As we almost daily watch the yield curve continue to flatten, the problem of margin compression becomes ever more severe. Instead of reducing risk, this type of strategy merely trades one type of risk for another. While market risk is small, earnings risk is great. Not All That Glitters is Gold On the other end of the spectrum reside those who, it might be said, try to do too much. It’s not hard to become frus- trated by what seem like unattractively low yields on just about everything in which community banks tradition- ally invest. It’s this frustration that often leads to investment choices that, in turn, often lead to regrets. There’s no such thing as a free lunch, and if something looks too good to be true, it probably is. The sometimes irresist- ible pull of what may seem like a “great deal” may obscure the fact that there are probably good reasons why some alternatives are forced to offer what ap- pear to be such “great deals.” What is often overlooked when yield is the primary consideration is how certain kinds of securities will behave when, eventually, rates do begin to rise. To be sure, some degree of exposure to market value depreciation is inevitable. The trick Don’t Step in a Hole By Lester Murray, Sr. Vice-President/Financial Strategies Group, The Baker Group

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