Pub. 8 2020 Issue 1

ISSUE 1. 2020 19 and create franchise value. These include, but are certainly not limited to, executing a gain/loss neutral or loss trade to fortify NIM and nudge the balance sheet back to neutral (CECL adopters should serious- ly consider taking advantage of noisy 1Q20 results to optimize their securities portfolios), executing a bulk loan sale to create capacity for future growth, build- ing out a back-to-back swap program to drive fees, and capitalizing on the inverted swap curve to get off the retail curve and reduce funding costs. FOR EVERY YIN IN THE MARKET, THERE IS A YANG The key is to know where to look. For example, just about every bank bemoans the f lat yield curve be- cause it’s bad for new loan margins. Still, the invert- ed swap curve can help banks fight back with lower funding costs. Specifically, banks can use spot-start- ing or forward-starting pay-fixed swaps to syn- thetically extend the duration of their transaction deposits, short-term FHLB advances, or brokered CDs at a lower cost than comparable term funding. Banks have also been using pay-fixed swaps to lock in the rate on trust preferred debt, lock in the cost of future debt issuance, and blend-and-extend existing swaps to reduce funding costs. Importantly, swapping a f loating-rate liability to fixed qualifies a cash f low hedge. As such, chang- es in fair value f low through other comprehensive income, not earnings. The cash f low hedge also creates accounting symmetry in AOCI. So if rates move higher, the pay-fixed swap will be more valu- able, offsetting the concurrent decline in the fair val- ue of the AFS securities portfolio. Of course, if rates move lower, the pay-fixed swap will be less valuable, muting the increase in fair value of AFS securities. THREE MORE GOALS FOR THE COMING YEAR First, know your balance sheet exposure to different curve shapes, not just parallel shocks. Once identi- fied, make sure that you have a firm grasp of all on- and off-balance sheet tactics to remedy them. Next, focus on earnings quality, not earnings quan- tity (ROA vs. ROE). Get better, not just bigger. To do so, make sure to weave core pretax, pre-provision ROA into your short- and long-term incentive plans. Finally, communicate proactively with all of your stakeholders — your owners, your regulators, your employees, and, of course, your customers. Proac- tive communication maximizes the return on effort and creates relationship goodwill for when the cycle turns. Above all, resist the temptation to duck and cover as earnings growth decelerates. Rather, explain to these constituents, confidently and suc- cinctly, how short-term tactical decisions will create franchise value over the long run. 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, work- ing with financial institutions on balance sheet strategy development, which includes 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 strategist of Sandler O’Neill + Partners, L.P. Before that, Hildenbrand worked in Sandler O’Neill’s interest rate products group, focusing on developing and imple- menting 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 fromGettysburg College. Matthew Forgotson is a director of balance sheet analysis and strategy in the financial services group at Piper Sandler. Previously, Forgotson 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.