Trends in Asset Liability Management
THE LEADERBOARD REPORT
Release Date: 7.21.2021
Participants: Scott Carrithers, Lonnie Harris
Topic: ALM observations from AMG
Click here to listen now, or read the transcript below:
Welcome to the latest installment of The Leaderboard Report. I’m Scott Carrithers, managing director for Country Club Bank’s Capital Markets Group.
In today’s Leaderboard Report, Lonnie Harris will provide us with an update on trends the Asset Management Group is seeing with clients at the midpoint of 2021.
Thanks Scott. Today’s report is a follow up of the Leaderboard we did in early February of this year, based on our attendance in ALCO meetings and reports produced at that time. Our current ALCO observations and most recent reports have changed a bit since February, but not dramatically.
First, the huge inflow of deposits that created the large balances in Overnight Funds Sold have not left the balance sheet. The rate of incoming deposits has abated to some extent, but the big balances in money market, savings and NOW are still on the books, even as rates have dropped dramatically. Keep in mind: We still see a large number of banks that have more than 10% of their earning assets in funds sold.
That being said, the Overnight Funds Sold position has declined in some banks. About 25% of the banks we work with have reduced the balance by funding assets with the new deposits—either loans or securities—and, a small number have been able to replace maturing wholesale deposits—mainly home loan advances—with retail deposits. Obviously, the reallocation of overnight funds to loans or securities will increase the yield on earning assets , and replacing home loan advances with retail deposits will reduce the cost of funds. So, both are productive strategy.
In terms of new loans, we have some good examples of “following the existing game plan” with loans added in the banks’ traditional market space—with no major concessions to either rate or term. But, this is certainly not the norm. Traditional loan demand, in most cases, has not been strong enough to make a difference.
More often, we have seen some creative new loan structures (at least at the bank) that focus on a new “product” that may compromise traditional term or rate, but generally not credit. Although the expectation is these new loans will be fine, many banks have decided to sacrifice rate for a shorter duration rather than to “reach” by making a somewhat higher yielding loan for a much longer period.
A word of caution: Making “long-term” loans at historically low rates cannot be mitigated by a simple interest rate swap., We understand swaps and we have implemented them when appropriate. but, in most cases, a swap is not necessary to mitigate risk. There is a saying that “You can’t swap away bad pricing.” This is true regardless of the rate environment.
Second, in most cases, a swap is unnecessary, considering the deposit profile of most community banks—that is, relatively long duration and low beta—and the concept of “cost averaging” related to loan rates. The increase in “pandemic-related” large balances in non-maturing deposits generally indicates that maintaining an acceptable “spread” is obtainable. Plus, keep in mind, new loans will be made when rates increase, thereby “averaging” current rates upward.
Banks that have added securities have been able to “beat” funds sold without dramatically extending duration. The most popular investments have been mortgage-backed securities with 10- to 20-year finals and a duration of three to five years. Yields range between 55 basis points to 1.5% depending on many factors, including the yield on the 10-year Treasury on the purchase date. Other popular choices have been municipal bonds (both taxable and tax-free) and traditional agencies, including canaries.
Another word of caution: We have seen some “non-traditional securities” that promise a great yield, primarily based on prepayment assumptions that may or may not come true. It is the typical “yield chasing” that occurs in every lower rate environment, so be careful to fully understand the long-term impact of securities that you put in your portfolio. We highly recommend basic, well-known, conservative investment options that have an established prepayment profile that can be verified and used to make reasonable prepayment assumptions going forward.
Overall, even for the banks that have not reduced funds sold, it appears to us that the yield on earning assets seems to have bottomed out. By that, I mean most banks have been able to maintain their current yield on assets for about the last three months or so. Now, the bad news is about 50% of these banks, the yield in earning assets is below 3%! Reality must be that in most banks, yield on earnings assets is about as low as it is going to go, considering the “new” pricing structure.
Cost of funds for most banks is still in the 40 to 60 basis point range, but continue to slowly decline. The decline is primarily because the new CD rates are slowly taking effect as longer CDs mature, and either reprice or go away.
To summarize, no one knows how long the “new” deposits will remain on the books, but do continue to add loans that comfortably fit your historic game plan, add traditional securities that you understand, and, of course, continue to cut rates where possible.
Give us a call at (800) 226-1923 if you think we can help. Thanks for listening today.