Pub. 8 2018-2019 Issue 3

10 O V E R A C E N T U R Y : B U I L D I N G B E T T E R B A N K S - H E L P I N G C O L O R A D A N S R E A L I Z E D R E A M S FEATURE ARTICLE When rates are rising most banks will shorten loan and bond durations. This is done to hedge the possible exposure to NIM (Net Interest Margin) against rising rates. T his piece will highlight the benefits, afford- ed to banks, from adding longer duration securities and loans to the balance sheet. A long time ago in a galaxy far, far away…. Savings & Loan made a 30 year fixed rate mortgage and funded it with a 1 year CD. Then interest rates rose and a year later the bank had a negative spread. A “long time ago” was in the 80’s, right after disintermediation. Disinter- mediation eliminated the nationwide cap on deposit rates. With capped deposit rates there was almost zero interest rate risk. A depository could make long fixed rate loans or buy long- termbonds without fear of rising deposit rates. Following disintermediation, long-term fixed rate assets created enormous levels of interest rate risk. Funding a 30 year fixed rate mort- gage with a 1 year CD had enormous earnings consequences. Disintermediation spawned a new era. ALCOs were formed and terms like Gap, Earnings at Risk, Economic Value of Equity, and +300 shocks became regulatory favorites. Since the 80’s interest rate risk has taken on nearly as much regulatory scrutiny as credit risk. When rates are rising most banks will shorten loan and bond durations. This is done to hedge the possible exposure to NIM (Net Interest Margin) against rising rates. But if we look back at history we can see that Colorado bank MIMs don’t have risk to rising rates. In fact, revenues (ROA, NIM) have typically increased when the FOMC was hiking rates (Chart 1). Going back to 2000, there were four distinct rate movements. Rates fell 550 bps from 1999 - 2003, then rose 425bps from2004 - 2006, then fell 525bps from 2008 - 2015 and have now risen 200bps since 2015. NIM rose Banks Are Too Asset Sensitive BY ADAM SASLAWSKY, DUNCAN WILLIAMS