Pub. 8 2020 Issue 1

ISSUE 1. 2020 13 I . bond market to optimize your securities portfolio. Gain/loss neutral trades or loss trades can be tailored to enhance book yield and forward earnings. Since most of the unrealized loss is already housed in other comprehensive income, GAAP capital ratios should not move meaningfully (though regulatory ratios will decline). Securities portfolio optimizations can be tailored to reduce credit risk or drive the balance sheet toward a neutral position (asset-sensitive institutions should think about adding duration and lockout; liability-sensitive institutions can capitalize on wider spreads for f loating-rate bonds). As always, before green-lighting a strategy, assess the im- pact on the portfolio’s duration, credit, and convexity profiles. Get back into the neutral zone. We have long argued that it is most efficient to run a neutral balance sheet. Bankers should manage spread, not speculate on rates. Asset-sensitive institutions can tack back to neutral by adding duration and lockout to their securities portfolios, originating longer duration loans, or shortening fund- ing duration either organically or with plain vanilla derivative strategies. For their part, liability-sensitive institu- tions can capitalize on wider spreads for floating-rate bonds (CLOs, FFELP — 97% government guarantee, and SBA floaters — 0% risk weight, to name a few) or extend liability duration either or- ganically or synthetically with pay-fixed swaps. Additionally, given the market’s expectations of lower rates, floors are expensive but caps are cheap. Remember those floating-rate TruPS you’ve been meaning to cap? Now’s the time. Price loans for late-cycle risk. The Feder- al Reserve’s Senior Loan Officer Opinion Surveys show that banks are reluctant to increase loan rates over cost of funds. Ninety-two percent of respon- dents to the July 2019 survey said that loan rates over cost of funds remained unchanged or narrowed over the past three months for commercial and indus- trial loans or credit lines to large and middle-market firms. Furthermore, 90% of banks that reported loosening credit standards cited more aggressive competition from other banks or nonbank lenders as a reason for doing so. In short, banks are letting other institutions dictate their risk-adjusted return parame- ters. This is very dangerous. Loan pricing models need to be recalibrated to the reality that we’re late in the economic cycle. Bank managers must be willing to let irrationally priced loans flow to irrational competitors, not onto their balance sheet. Create “self-help” through expense rational- ization. As revenue headwinds gain force, cost takeout will become increasingly important to sustain earnings growth. Branch networks remain ripe for review as consumers migrate to digital delivery channels. Once savings are identified, take a hard, honest look at your mobile and online budgets. If you’re light, real- locate a portion of the brick and mortar savings, and let the residual fall to the bottom line. Remember that playing catch-up is always more expensive. Communicate Proactively with All of Your Stakeholders. It is essential to communi- cate strategic and tactical shifts, clearly and succinctly, to all of your stakehold- ers — customers, regulators, investors, and employees. All stakeholders should readily acknowledge that bankers have to navigate the trade-offs among soundness, profitability, and growth continuously with no margin for error. As you weigh your options, make sure that you can explain how your final decisions rein- force your commitment to these mutually dependent principles. n Scott Hildenbrand is a managing director and head of balance sheet analysis and strategy in the financial services group at Piper Sandler. Hildenbrand heads the balance sheet analysis and strategy group, working with financial institutions on balance sheet strategy development, which in- cludes interest rate risk management, investment portfolio strategy, retail and wholesale funding management, capital planning, budgeting, and stress testing. He also works closely with the firm’s investment banking group to identify and develop strategic opportunities for clients involved in mergers and acquisitions. Previously, he was a principal and chief balance sheet strat- egist of Sandler O’Neill + Partners, L.P. Before that, Hildenbrand worked in Sandler O’Neill’s interest rate products group, focusing on devel- oping and implementing structured wholesale funding strategies for financial institutions. He spent his first four years at the firm in the asset/ liability management group. Before joining Sandler O’Neill in 2004, Hildenbrand worked as a financial analyst in asset/liability management at Tower Federal Credit Union in Maryland. Hildenbrand serves as treasurer on the board of directors for Liam’s Room, a not-for-profit organization that focuses on pediatric palliative care, a specialized approach to medical care for children with serious illnesses. He is a frequent speaker at industry conferences and seminars. He holds an MBA in finance from Loyola College in Maryland and a bachelor’s degree with a concentration in accounting and finance from Gettysburg College. Matthew Forgotson is a director of balance sheet analysis and strategy in the financial services group at Piper Sandler. Previously, Forgot- son served as a director in Sandler O’Neill’s balance sheet analysis and strategy group since 2018. Before that, Forgotson served as senior analyst and director in Sandler O’Neill’s equity research department covering small and mid-cap banks and thrifts across the United States since 2010. For his work in 2017, Forgotson earned Thomson Reuters StarMine Awards for stock picking and earnings estimation. Forgotson started his career inWashington, D.C., working for Senator Joseph I. Lieberman and the Center for American Progress. Forgotson earned a B.A. in Political Science with Distinction from the University of Michigan as well as an MBA in finance from the Zicklin School of Business at Baruch College.