Pub. 11 2020 Issue 3

Pub. 11 2020 I Issue 3 Fall 15 West Virginia Banker Continued on page 16 This segment of the balance sheet is “upside down” by 20 basis points, resulting in a pre-tax earnings drag of $50k and an after-tax earnings drag of $40k, assuming a 21% effective tax rate. Simply removing the negative spread would be a penny accretive to EPS, six basis points accretive to ROA, and 24 basis points accretive to NIM. The transaction also shrinks the balance sheet, nudging the TCE ratio from 11.00% to 11.58%. Before pressing on, three notes to consider: 1. For illustrative purposes, we assume that the gain on the sale of securities offsets the debt extinguishment charge. This is convenient, but not always the case. Importantly, the relative size of these accruals dictates the impact on GAAP and regulatory capital. The realized gains on the sale of securities are accretive to regulatory capital, but most likely neutral to GAAP capital because most of the gain already lives in OCI. Alternatively, the debt extinguishment charge reduces both regulatory capital and GAAP capital. Today, banks can sell agency MBS and agency CMBS (DUS and GNPLs) into the Federal Reserve’s strong bid to source gains that offset the debt extinguishment charge. For what it’s worth, institutional investors tend to strip both accruals out of core earnings. 2. It is self-evident that wholesale leverage earning a neg- ative spread is inefficient. Wholesale leverage earning a positive spread can also be inefficient if it steers the asset-liability profile away from neutral in a meaning- ful way, clouds earnings or relative profitability metrics, weighs disproportionately on capital metrics, or precludes alternative uses of capital that could create franchise value or foment incremental demand for the shares. 3. We assume removal of match funded wholesale leverage. Thus, there is no impact on the bank’s asset-liability pro- file. Again, convenient, but not always the case. Strategy 2: Remove $25 Million of Inefficient Lever- age and Relever at a Wider Spread Management might choose to leverage the 58 basis points of capital by adding $25 million of match funded wholesale leverage. The net effect is to return the balance sheet to its initial size. Specifically, management evaluates rolling a 3-month FHLB advance and creating term rate protection with a 5-year pay-fixed swap costing 0.55% (a.k.a. the “Beat-the-Spread” funding strategy) and deploying the funds into securities yielding 1.50%. By executing this strategy, Bank A converts a negative spread of 20 basis points into a positive spread of 95 basis points without skewing its asset-liability profile. The strategy produces five cents of EPS accretion, five basis points of ROA accretion and six basis points of NIM accretion.