Correspondent Blog

The bigger risk to community banks’ business model is not a moderate recession induced by aggressive interest rate increases by the Federal Reserve.  Instead, the more painful scenario for the banking industry is the following: no recession, short-term interest rates holding steady in anticipation of inflation reaching target rates, and a prolonged inverted yield curve….

Our previous article discussed how the banking industry is taking advantage of interest rate swaps to offer borrowers lower rates, allowing banks to earn higher yields, generate substantial fee income, and protect deposit relationships.  Of the largest 250 banks, 90% are using interest rate swaps, and because these largest 250 banks hold 83% of all…

With an inverted yield curve, borrowers have a pricing advantage to lock in long-term fixed-rate loans, while lenders strongly desire to limit loan duration.  One possible solution to this dichotomy is for banks to offer interest rate swaps to hedge individual loans.  This article will review domestic banks’ adoption of interest rate swaps.  Next week’s…

Last week we spoke to a $1.2B community bank management team. The CLO was lamenting how he was losing quality loans and deposits to three aggressive national banks in the territory. An example was a $1.95mm owner-occupied CRE loan, where the borrower had multiple operating accounts totaling almost $500k. While this community bank is not…

Last week, we published an article [here] discussing how fair value accounting for assets and liabilities may have prevented the failure of Silicon Valley Bank, even if sound risk mitigation practices were not resolutely embraced by management.  We argued that valuing assets at historical value or measuring net interest margin (NIM) is not only a…

Analysts, regulators, legislators, and bankers have been attributing the root cause of SVB’s failure in the past month.  Some blame the dilution of the Dodd-Frank provisions, others the lack of oversight by regulators, and others still blame social media for exacerbating the deposit run.  The root cause of Silicon Valley Bank’s (SVB) failure is poor…

In recent articles (here and here), we discussed why banks that take the interest rate movement risk demonstrate lower performance as measured by return on assets (ROA). Empirical evidence, historical bank failures, and common sense teach us that many risks do not translate to higher yields. The second article compared and contrasted community banks’ pay-for-risk…

In a previous article, we discussed the three generic shapes of the yield curve:  normal, inverted, and flat. We also pointed out that the current inverted yield curve is unusual and is expected to last for the near term.  The average community bank’s cost of funding is highly correlated to Fed Funds and SOFR (for…

In the last 12 months, the Federal Reserve went from arguing that inflation was a transitory phenomenon to raising interest rates to fight runaway inflation by three percent in just six months.  The result is not only higher rates but the most severe interest rate hiking cycle in the past 35 years –  and it…

The Federal Reserve Open Market Committee (FOMC) has raised short-term interest rates by 3.00% in the six months between March and September.  The market is now forecasting an additional 1.25% in hikes by year’s end, with the next move coming on November 3rd.  Many borrowers and market participants have been surprised by the speed of…

Last week the Federal Reserve again raised the Fed Funds rate by another 75 basis points – and again, that was in line with the market’s expectation. The question is when will the Fed stop, and what will be the terminal Fed Funds rate? We do not believe that the Fed’s “dot plot” fully reflects…

For decades community banks have taken on fixed rate loan risk mostly through the offering of five-year, fixed-rate, commercial term loans. This is probably the most popular structure for real estate-secured term credit at community banks. Now may be the right time for community banks to abandon this strategy – both for the borrowers who…