February 2019 from the desk of Stephen Bone
Whole Loan Desk
The Fed is dead, long live the Fed!
I’ve spent my career trying NOT to be a Fed prognosticator. In my humble estimation, the market has more than enough armchair economists looking for a pulpit. However, after spending 25 years in the fixed income markets I have to say yesterday’s Fed announcement was about as close to a Fed cease-fire as we ever get. While the status of the great Treasury unwind is still in question, it sure seems the Fed is prepared to sit out 2019, barring any unforeseen events.
What does this mean for carry investors and the U.S. asset market in general?
The Fed has raised the Fed Funds rate 9 times since 2015. Yes, the rate is ‘only’ 2.50% and the 2-year TSY is ‘only’ at 2.46%, but in this post-crisis era, I think we’re all going to have to get comfortable with the fact this may be the Treasury high-water mark moving forward. I remember the day when this point in the interest rate cycle would have both 2-year and 5-year notes around 6.00%. And to be fair, my elders would probably say they remember when this point in the cycle would have yields at 12.00%, but that’s the point. The overall yield level has to mean less at this point than the fact we’re at a potential turn in the cycle.
We’ve been fortunate in that this lower and tighter rate environment has cushioned mark-to-market losses on both bond and loan assets … rates going from 2% to 6% causes greater mark-to-market losses than going from 1% to 2.5%. The challenge, however, has become knowing when to hold your nose and buy. I remember when a very knowledgeable and astute bank portfolio manager had a policy to buy bonds when the 5-year note was >6% and hold or sell when the 5-year note was <6%. I wonder what that same portfolio manager would do now? (In reality, his biggest decision at the moment is whether his next beach drink will be beer or a margarita, but I digress…)
So what does the typical bank portfolio manager or Chief Lending Officer do?
As in life, the hardest thing is what has to be done. The cycle has given us around 100 basis points. That’s it. That’s likely all you’re going to get. We have to take advantage of that to the best of our ability. The good news is that the most likely scenario at the moment isn’t the much-feared inversion but a continued flat yield curve until the likely year-long wait-and-see period moves to the oh-no-we-have-to-cut period. In a perfect world we would all wait for short term rates to decrease before we mismatched duration into standard bank duration assets. This would ensure greater spread/profits for the roughly same amount of duration mismatch. The only problem is now you’ve missed a year of earnings and longer duration yields have dropped in lockstep with the short end of the curve.
‘You have to do the thing.’
I’ve always liked this quote. It’s a pretty standard sales book quote that is sometimes stated as ‘You have to do the one thing’. It means you have to do the one thing you know is most important but is hard to do. I think it’s derived from Eleanor Roosevelt’s “You must do the thing you think you cannot do.” but it’s all the same. The salesman needs to cold call, the baker needs to bake, the dentist needs to dentist, and the banker needs to buy assets at the end of a Fed tightening cycle.
With longer term yields taking the millennial version of a bashing over the past few years it’s time to add assets. Yes, I know the mortgage market has already refinanced the world, home price appreciation is at pre-crisis highs, the commercial real estate market feels frothy, the auto market is extending a record boom, we’re back to 100% LTV mortgages, etc. etc. etc.
There are always 100 reasons to be concerned about adding assets to a bank’s balance sheet, but the reality is that 98% of the banks in the country are sitting on massive, unprecedented, amounts of capital.
At some point there is going to be a shareholder that will tap those bankers on the shoulder and say some version of:
“Hey, isn’t the government in a DE-regulation cycle? Are we doing a good job of maximizing shareholder value?”
The overwhelming answer to this question is:
This isn’t 1956. It’s a new and scary world out there with marketplace lending, Fintech companies, a rekindling of many crisis-era loan products, etc. With that said, one of the old banker axioms still rings true even in today’s market:
“Don’t fight the Fed.” This can also be translated as “Work WITH the Fed, not AGAINST it.”
Every banker in the country, young or old, needs to understand that the Fed has just handed you a signal. And that signal says “Time to buy.”
It’s time to do the one thing that’s hard to do.
The Banes Capital Group (BCG) Whole Loan Trading Desk is one of the more active in the country, trading a spectrum of unsecuritized loan products from government guaranteed loans (GGL) to residential scratch and dent (SND) pools and non-performing loans (NPL). With an average of 20+ years of experience on the desk, BCG also assists its valued lenders with full balance sheet consulting, optimization, and ALM simulation, as well as advanced loan analytics and pricing. BCG and its Hanover Securities affiliate currently do business with over 800 financial institutions nationwide. Hanover Securities is one of only 11 SBA Certified Pool Assemblers in the country. We strive to be a valued resource for our bank and credit union clients who wish to optimize their performance in both government guaranteed and traditional lending, and we've put the systems in place to help our clients outperform.
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