The Sun Still Shines!

The elections are over, and the sun appeared on the horizon Wednesday morning as scheduled.  “Status quo” is the phrase being used to forecast the next four years.  Unfortunately, the current state of affairs will not continue for that long.  Rising taxes, continued implementation of Obamacare, sequestration, shrinking asset yields and international problems could combine to make 2015 very different than 2012.

So what do we, as bankers, do now?  My guidance over the last few months has been to wait until the election results were in, and then wait another week to see how the markets react.  We’re now in that week of waiting, and waiting is still wise.  But at some point, we must set a course for deploying excess funds, either into loans at rates below our traditional comfort level or into securities with huge premiums or painfully low yields (or both).

I have no great wisdom to impart on the asset side of the balance sheet, but I do want to speak forcefully on liability pricing.  The Federal Reserve has committed to a Zero Interest Rate Policy for another 30 months, and the troika responsible for that commitment just received a four year contract extension.  The old adage “Don’t bet against the Fed” is more appropriate now than ever.  Here’s the forceful part:

If you are paying more than 0.50% on a one year CD, stop!

I feel safe predicting that asset yields will continue to fall.  Most of our nonmaturity deposit rates are near zero (or should be!).  If your market demands CD rates above the cost of replacement funds (FHLB Dallas 1 year bullet advance @ 0.48% this morning, QwickRate 1 year CD offerings in the 0.40% range, brokered CDs priced similarly), shift your funding to the cheaper sources.  It’s an easy way to boost a sagging NIM.

When promoting this strategy, I often hear “My regulators don’t like those funding sources.”  Perhaps that is true, but the 2010 Interagency Policy Statement on Funding and Liquidity Risk Management states:

“An institution should establish a funding strategy that provides effective diversification in the sources and tenor of funding.  It should maintain an ongoing presence in its chosen funding markets and strong relationships with funds providers to promote effective diversification of funding sources.

Funding should also be diversified across a full range of retail as well as secured and unsecured wholesale sources of funds, consistent with the institution's sophistication and complexity.”

If an examiner gives you grief over your prudent use of wholesale funding sources, point them back to their own regs.  You should have policy limits in place for each category of wholesale funds, as well as a limit on aggregate wholesale funding.  The last four ratios on our monthly Funds Management Report address these items, and there should be no shame in the appropriate use of wholesale funds.

The other response I get sounds something like “But, I’m taking care of my customers” or “I don’t want to lose my customers”.  I understand this concern, but the price of taking the “safe” route and paying up on deposits could be huge.  If you want to pay a core customer who has large, low-cost deposit balances or large high-yield loan balances a bit more on a CD, no problem.  Just don’t overpay for the rest of your CDs.  Rate shoppers (local and foreign) should have your bank on their Do Not Call list.  Their funds are not core – regardless of the FDIC’s definition – and will rarely be cheaper than wholesale funding sources.

If you have a competitor overpricing his CDs, share this article with him or send me his contact information.  I would be glad to help him save some money while normalizing your market’s deposit rates.  That’s a Win-Win situation in a Lose-Lose market.

One other parting thought:  If you own some of the long MBS the Fed continues to overprice via QEinfinity, take some gains and redeploy the proceeds into products that are not as overpriced.  I have seen several recent portfolio restructurings that resulted in minimal change to duration, yield and credit risk while providing a nice pop to current year earnings.  I’ll be glad to tell you more if you are interested.