We are only two months into the New Year and even though the last 60 days or so have been relatively quiet on the rate front it appears many expectations for 2019 were a product of fourth quarter 2018 “numbers.”
The 10-year treasury at the end of November 2018 was around 3.23%. At year end it had dropped to around 2.68% and now it is about 2.64%. Most budgets for 2019 were put together in the fourth quarter of last year and to the extent they are based on treasury yields or predicted Fed rate moves it might be time to reconsider the process. Keep in mind, it is still very early in the year and some of the issues that have altered current rates and expectations may be resolved, including possible trade wars and potential government funding. But, at least think about the topics outlined below:
- Predicted increases in COF (cost of funds)
COF for many community banks spiked (exploded) between the end of the second quarter and the end of 2019. Increases of 50% (50 basis points to 75 basis points) were not uncommon and in many cases even greater increases were noted. These increases were a reaction to competition in most cases as loan deposit (L/D) ratios have soared in the last few years putting a premium on deposits. Most banks have “accommodated” their retail deposit base and are most likely going to the wholesale market for more funds-which should stabilize at current levels if the Fed does NOT increase overnight rates. Therefore assuming wholesale rates stabilize-COF for many banks will NOT increase.
- Yield on Earning Assets (YEA)
Again, most community banks price fixed rate loans on many factors, NOT exclusively on the treasury market but many use NY Prime for variable rate loans. Therefore earlier expectations of three to four Prime rate moves in 2019 should of course be modified.
A quick look at the current yield curve vs. the curve in November 2018 will explain decreased expectations of yield on investments on average about 50 basis points in the ten year range.
- Overall ALM Strategy
Conventional wisdom suggests shortening assets and lengthening liabilities in a “rising rate” environment. Obviously, this means you can reprice assets on the way up, while avoiding repricing liabilities. Conversely, if “rates” are heading down the “opposite” strategy is dictated. That is, lengthen assets while shortening liabilities.
Where do you think rates, COF & YEA are headed? Maybe it is a good time to review previous assumptions, and to manage the balance sheet accordingly.