Pub. 7 2016 Issue 2

SUMMER 2016 21 West Virginia Banker 0.38 1.17 0.43 0.678613 0 0.2 0.4 0.6 0.8 1 1.2 1.4 Today 42583 42675 42767 42856 42948 43040 43132 43221 43313 43405 43497 43586 FF Futures/COF's Fed Fund Futures WV Banks (60) Deposit rate impact 1 5.25 1.6 3.39 1.73 3.08 0 1 2 3 4 5 6 37970 38061 38153 38245 38336 38426 38518 38610 38701 38791 38883 38975 39066 39156 39248 39340 39431 Fed Funds Bank < $10billion WV Banks (60) Graph 1 WV National 94% 96% 31.47 42.65 Correlation Coefficient >80% = statistically strong Slope Basis point move for every 100bps 0.38 1.17 0.43 0.678613 0 0.2 0.4 0.6 0.8 1 1.2 1.4 Today 42583 42675 42767 42856 42948 43040 43132 43221 43313 43405 43497 43586 FF Futures/COF's Fed Fund Futures WV Banks (60) Deposit rate impact 1 5.25 1.6 3.39 1.73 3.08 0 1 2 3 4 5 6 37970 38061 38153 38245 38336 38426 38518 38610 38701 38791 38883 38975 39066 39156 39248 39340 39431 Fed Funds Bank < $10billion WV Banks (60) Table 1 We can visually see that when the Fed moved from 1.00% to 5.25% that COFs followed suit. We can take it a step further and calculate the re- lationship. In Table 1 we show the results from our regression analysis. The correlation coefficient shows the strength of the relationship (>80% statistically significant) and the slope shows the magnitude of the movement. For example, if the Fed hikes rates 100bps and COFs increases 10bps, the correlation coefficient is 100% and the slope is 10. If the correlation coefficient was below 80%, the relationship could be too weak. In Table 1, we see that between 2004 and 2006 WV bank COFs had a 94% correlation coefficient to Fed hikes. This shows a statistically strong relationship between WV banks COFs and Fed hikes. The next step is to calculate the slope to gauge the exact basis point impact. During this period, the slope measured 31.47. For every 100bp move from the Fed, WV banks COFs moved 31.47bps. In Graph 2, we apply Fed Funds Futures expectations (blue line) for the next 3 years. Effective Fed Funds are currently .38% and May 2019 contracts reflect that it will rise to 1.17%. By using the regression results we can make a forecast for COFs in the state. By May 2019 COFs will rise from .43% to .68% (green line) or 25bps (FF rate up 79bps * 31.47% = 25bps). That is low exposure. Comparatively, WV banks have very low sensitivity. This is due to a higher percentage of core deposits, less sensitive to rising rates. West Virginia banks have the ability to extend asset durations (increasing income) more so than other banks. This leads to more income which increases performance and capital and ultimately reduces risk. These results were run for an aggregate of 60 banks. However, this analysis should be run individually for every bank. I would urge any bank to apply this principle to gauge risk, but more importantly, to position the bank for greater long run performance. n Graph 2 Mr. McKeithen joined Duncan-Williams, Inc. in 2011 as Managing Director of Fixed Income Strategies with over 18 years of experience working with financial institutions. Chad’s areas of expertise include: Depository interest rate risk; Leverage/ growth strategies; Portfolio reconstructing; Commercial loan pricing; Liquidity management; Funding strategies and pricing; Macro balance sheet management. Chad routinely educates ALCO’s, directors and senior management on all asset and liability topics and is also a frequent speaker and author for national and state financial organizations. He will be speaking at the WVBA 2016 Annual Convention.