Pub. 10 2020 Issue 4

9 PUB. 10 2020 ISSUE 4 While every institution is unique, many banks have responded to the shift in li - quidity by asking two questions: how does this affect the asset side, and what are the options on the liability side? On the asset side, management teams wonder what to do with excess cash in a world where most bond yields are disappointingly low. Even though liquidity profiles appear strong and are trending stronger, economic uncertainty creates unpredictability in depositor behavior. As such, some institutions feel more comfortable with investments that main - tain maximum flexibility in the future — sale-ability and pledge-ability — with lower yields as a trade-off. Other institutions have looked to extend their investment portfolios further out on the curve to increase yield while mitigating tail risk by match funding with 5+ year structures at historically low rates. For instance, banks have worked with some firms to utilize their inexpen - sive, longer-dated funding mechanisms at attractive rates. Many corners of the banking industry are concerned that low rates, slower loan origi - nation, and excess liquidity trends are here to stay for the foreseeable future and have begun searching for loan surrogates. Al - lowing these banks to extend their liability portfolio’s duration at a scalable level opens the door to more asset purchase strategies. We have seen two specific asset strategies gain momentum: exploring community and regional bank subordinated debt as an in - vestment option and analyzing how to invest in municipals without ruining their interest rate plan. As an alternative to extending the liability portfolio, some institutions have swapped fixed rate municipals to floating, thus obtaining an attractive yield with re - duced duration risk and protecting Tangible Common Equity. Exploring risk/reward profiles of earning assets is nothing new to balance sheet managers, but the environment has certainly evolved since the start of 2020. Managing excess liquidity while planning for interest rate risk management has also become slightly more complicated on the liability side. How does a bank choose from the various funding options and hedging strategies available? The deci - sion-making process must consider balance sheet composition (i.e., the availability of liabilities to hedge), impact to earnings and capital (in addition to liquidity) from the strategy, and practical applications, such as hedge accounting. It’s generally recommended for accounting simplicity and hedging flexibility to first eval - uate liability hedges when attempting a shift in interest rate risk profile. Many institutions continued on page 10 Some institutions feel more comfortable with investments that maintain maximum flexibility in the future — sale-ability and pledge- ability —with lower yields as a trade-off. Other institutions have looked to extend their investment portfolios further out on the curve to increase yield while mitigating tail risk by match funding with 5+ year structures at historically low rates.