Pub. 8 2017 Issue 3

www.wvbankers.org 20 West Virginia Banker The (Continued) High Cost Of Waiting By Steve Twersky, FTN Financial Portfolio Strategies Group W ith the Fed still in tightening mode, it’s easy to hold off investing excess funds, effectively waiting on interest rates to rise. This approach can be very costly, however, especially given recent signs that the pace of further increases may be slowing. It can be difficult to have any urgency toward investing excess funds right now. Overnight rates are finally above 1.00% and the Fed is likely to raise the target rate even further. Why buy bonds today only to have these move to losses as the tightening continues? Here are three key things to consider in answering that question. Impact on current earnings A slowdown in the expected pace (and degree) of future target rate increases could be very costly to those accu- mulating cash or staying too short right now. With bond yields of 2.50% to 3.00% available in many intermediate-term structures, you may be sacrificing as much as 175 basis points in current yield by parking funds. The large degree of lost current income also makes it very tough to ever catch up even given ongoing modest increases by the Fed moving forward. Consider the example below, which assumes the Fed con- tinues with a 25 basis point increase in the target rate every other quarter. Quarterly Income on $10 million Quarter Target Fed Bond @ Income Beg Rate Funds 2.50% Pick-Up Oct-17 1.25% 31,250 62,500 31,250 Jan-18 1.50% 37,500 62,500 25,000 Apr-18 1.50% 37,500 62,500 25,000 Jul-18 1.75% 43,750 62,500 18,750 Oct-18 1.75% 43,750 62,500 18,750 Jan-19 2.00% 50,000 62,500 12,500 Apr-19 2.00% 50,000 62,500 12,500 Jul-19 2.25% 56,250 62,500 6,250 Oct-19 2.25% 56,250 62,500 6,250 Jan-20 2.50% 62,500 62,500 0 Apr-20 2.50% 62,500 62,500 0 531,250 687,500 156,250 This simplified example would result in almost a one-third increase in interest income over this three-year period by in- vesting now at 2.50% versus keeping the funds short. Equally important is the needed degree of continued increase in the target rate to overcome, or breakeven on, the sizable initial income pick-up from investing now. In fact, if we were to ex- tend the example above assuming the target rate continues to increase at 25 basis points every other quarter, it wouldn’t be until the third quarter of 2022 (when the target rate would have risen to 3.75%) before the aggregate income catches up with the stay-invested approach. Roll-off already in place Most banks have a large amount of the investment portfo- lio rolling off over the next several years. To the degree you are holding excess funds with the expectation of near-term lending and reinvestment opportunities, it’s important to consider the funds already rolling off. The chart below shows the 36-month shocked roll-off as a percentage of the total portfolio for the banks on PASPort, FTN Financial’s portfolio accounting system. Note that even given an immediate up 200 basis point shock, the average bank would still see over one-third of the portfolio roll-off over the next 36 months. What if the economy falls back? It’s also important to consider the impact of a full stall, or even reversal, of the current economic recovery. This is es- pecially important for those institutions in an asset-sensitive position, as a slowing recovery would put even more pressure on their net interest margins if they are holding too much li- quidity or staying too short in the portfolio. That’s why some focus on call/prepay structure also remains imperative. This can be achieved in many sectors including Agency CMBS, SBAPs, municipals, bullet agencies, and corporates. With the Fed still working to unwind the highly accommoda- tive posture they’ve taken since the subprime crisis, it’s easy to get lulled into waiting on interest rates to rise further. But this approach can be both costly from an earnings standpoint as well as create excess exposure to a slowing or reversal of the current recovery.  Dn 100 UnchangedUp 100 Up 200 Bank 0.6 0.49 0.41 0.38 0% 10% 20% 30% 40% 50% 60% 70% Dn 100 Unchanged Up 100 Up 200 % of Total Portfolio Shocked 36 Month Roll-Off Bank 0.6 0.49 0.41 0.38 Steve Twersky (steve.twersky@ftnfinancial.com) is Executive Vice President andManager of the Portfolio Strategies Group at FTN Financial Capital Markets. In addition, Steve is responsible for managing the full depository institution support platform for FTN Financial. As manager of the Portfolio Strategies Group, Steve assists customers with all aspects of investment portfolio and balance sheet management including regulatory, tax, and accounting issues. In his broader role, Steve helps ensure that FTN Financial’s comprehensive service package for depository institutions remains relevant to the continually changingbanking environment. Steve is a frequent speaker at banking and investment conferences around the country. He joined FTN Financial in 1984 after working at amajor public accounting firm. Steve holds a bachelor’s degree from Indiana University and is a Certified Public Accountant.