Loan Pricing Structure and the Nature of Interest Rates

Transcription

1 Loan Pricing Structure and the Nature of Interest Rates S. Blake Scharlach Senior Vice President / Director of Capital Markets Sales TIB- The Independent BankersBank, N.A.

2 S. Blake Scharlach Blake joined TIB in January 2008 and has more than 22 years of investment and banking experience. He currently serves as Director of Capital Markets Sales, Senior Vice President and Designated Principal in the Investment Sales department of TIB, overseeing the sales and trading operations. He also serves on TIB s Internal ALCO committee. Prior to his tenure at TIB, he worked at two community banks in Texas where he worked as a lender and investment portfolio manager and served on various committees. He currently holds his Series 52 (Municipal Securities), Series 53 (Municipal Securities Principal) Series 63 (State), and Series 72 (General Securities) licenses. Bachelor of Arts, Economics Washington and Lee University, Lexington, VA Master of Business Administration Cornell University, Ithaca, NY He is a subject matter expert in: Capital markets strategies for financial institutions Advising banks on investment strategies Purchases and sales of fixed income securities US government securities Municipal securities Interest rate swaps and hedging instruments Corporate securities Asset/Liability management Portfolio management Bond math Economics S. Blake Scharlach bscharlach@tib.bank

3 Good investing is 50% psychology, 48% history, and 2% finance. - Morgan Housel Source:

4 Economist Projections Beginning Rate Economist Projections Ending Actual Rate Predicted Change Actual Change Accuracy % 5.10% 4.02% % 4.30% 2.21% % 3.20% 3.84% % 4.10% 3.29% % 3.30% 1.87% % 2.70% 1.76% % 2.10% 3.03% % 3.20% 2.17% % 3.20% 2.27% % 3.00% 2.44% % 2.80% 2.40% % 3.00% 2.68%

5 Results as of 9/30/15

6 Life Comes at You Fast

7 Dec. 30, 2017 Mar. 14, 2018

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10 Paul Krugman Economics professor at MIT, Princeton, and CUNY 2008 Nobel Prize in Economics

11 John Kenneth Galbraith Harvard Economics professor 40+ years Economic Advisor to four US Presidents There are two kinds of forecasters: those who don t know, and those who don t know they don t know.

12 1988 Fed Rate Hikes March 1988 Funds Rate (start): 6.50% March 1989 Funds Rate (end): 9.75% Reasoning: Inflation above 4% Fed Funds: Year UST: 182 (elasticity to funds: 49%) 10 Year UST: 112 (elasticity to funds: 30%) Time between first raise and final raise: 261 days Time between final raise and first subsequent cut: 84 days

13 Fed Rate Cuts May 1989 Funds Rate (start): 9.75% September 1992 Funds Rate (end): 3.00% Reasoning: Inflation abated, 1990 recession Fed Funds: Year UST: 365 (elasticity to funds: 54%) 10 Year UST: 257 (elasticity to funds: 38%) Time between first cut and final cut: 1,192 days Time between final cut and first subsequent raise: 549 days

14 1994 Fed Rate Hikes January 1994 Funds Rate (start): 3.00% February 1995 Funds Rate (end): 6% Reasoning: Inflation above 3.5% Fed Funds: Year UST: 183 (elasticity to funds: 61%) 10 Year UST: 141 (elasticity to funds: 47%) Time between first raise and final raise: 364 days Time between final raise and first subsequent cut: 154 days

15 Fed Rate Cuts July 1995 Funds Rate (start): 6.00% December 1998 Funds Rate (end): 4.75% Reasoning: lower inflation, response to Asian economic crisis Average GDP: 4.1% Avg. Inflation: 2.5% Unemployment (U-3) steadily fell from 6%-4% Low oil prices Fed Funds: Year UST: 146 (elasticity to funds: 83%) 10 Year UST: 156 (elasticity to funds: 89%) Time between first cut and final cut: 1,229 days Time between final cut and first subsequent raise: 225 days Massive tech growth

16 Fed Rate Hikes June 1999 Funds Rate (start): 4.75% May 2000 Funds Rate (end): 6.50% Reasoning: Irrational exuberance Fed Funds: Year UST: 80 (elasticity to funds: 64%) 10 Year UST: 51 (elasticity to funds: 41%) Time between first raise and final raise: 322 days Time between final raise and first subsequent cut: 226 days

17 Fed Rate Cuts December 2000 Funds Rate (start): 6.50% June 2003 Funds Rate (end): 1.00% Reasoning: recession / dot com bubble Fed Funds: Year UST: 371 (elasticity to funds: 67%) 10 Year UST: 268 (elasticity to funds: 49%) Time between first cut and final cut: 903 days Time between final cut and first subsequent raise: 371 days

18 Fed Rate Hikes June 2004 Funds Rate (start): 1.00% July 2006 Funds Rate (end): 5.25% Reasoning: concerns over housing bubble Fed Funds: Year UST: 125 (elasticity to funds: 29%) 10 Year UST: 43 (elasticity to funds: 10%) Time between first raise and final raise: 732 days Time between final raise and first subsequent cut: 448 days

19 Fed Rate Cuts August 2007 Funds Rate (start): 5.25% December 2008 Funds Rate (end): 0.25% Reasoning: financial crisis Fed Funds: Year UST: 309 (elasticity to funds: 62%) 10 Year UST: 258 (elasticity to funds: 52%) Time between first cut and final cut: 456 days Time between final cut and first subsequent raise: 2,556 days

20 2015-current Fed Rate Hikes December 2015 Funds Rate (start): 0.25% Current Funds Rate: 2.50% Reasoning: recovery from financial crisis Fed Funds: Year UST: 93 (elasticity to funds: 41%) 10 Year UST: 56 (elasticity to funds: 25%)

21 The Tale of the Tape (elasticity) Fed Moves 5 Year Elasticity 10 Year Elasticity % 30% % 38% % 47% % 89% % 41% % 49% % 10% % 52% 15-? % 25% Average: 56% 42% Median: 61% 41%

22 The Tale of the Tape (elasticity) Fed Moves 5 Year Elasticity 10 Year Elasticity % 30% % 38% % 47% % 89% % 41% % 49% % 10% % 52% 15-? % 25% Rising Rate Average: 49% 31% Falling Rate Average: 67% 57%

23 The Tale of the Tape (timing) Fed Moves Duration Time at Extreme Total , , , , , , ,556 3, ? 225 Time will tell Time will tell 1,199 so far Average rising rate cycle (first raise to first cut): 548 days (23%) Average falling rate cycle (first cut to first raise): 1,870 days (77%)

24 So What Does All That Mean? Prime + 1% vs. 5yr swap % 16.00% 14.00% 12.00% 1) Falling Rate Environments Last Longer than Rising Rate Environments Do 10.00% 8.00% 6.00% 4.00% 2.00% 0.00% 11/1/1988 7/1/1989 3/1/ /1/1990 7/1/1991 3/1/ /1/1992 7/1/1993 3/1/ /1/1994 7/1/1995 3/1/ /1/1996 7/1/1997 3/1/ /1/1998 7/1/1999 3/1/ /1/2000 7/1/2001 3/1/ /1/2002 7/1/2003 3/1/ /1/2004 7/1/2005 3/1/ /1/2006 7/1/2007 3/1/ /1/2008 7/1/2009 3/1/ /1/2010 7/1/2011 3/1/ /1/2012 7/1/2013 3/1/ /1/2014 7/1/2015 3/1/ /1/2016 7/1/2017 3/1/ /1/2018 Prime + 1 5yr fix

25 So What Does All That Mean? Prime + 1% vs. 5yr swap % 16.00% 14.00% 12.00% 2) Longer rates lag the overnight rate when rates are falling (and with less severity) 10.00% 8.00% 6.00% 4.00% 2.00% 0.00% 11/1/1988 7/1/1989 3/1/ /1/1990 7/1/1991 3/1/ /1/1992 7/1/1993 3/1/ /1/1994 7/1/1995 3/1/ /1/1996 7/1/1997 3/1/ /1/1998 7/1/1999 3/1/ /1/2000 7/1/2001 3/1/ /1/2002 7/1/2003 3/1/ /1/2004 7/1/2005 3/1/ /1/2006 7/1/2007 3/1/ /1/2008 7/1/2009 3/1/ /1/2010 7/1/2011 3/1/ /1/2012 7/1/2013 3/1/ /1/2014 7/1/2015 3/1/ /1/2016 7/1/2017 3/1/ /1/2018 Prime + 1 5yr fix

26 So What Does All That Mean? 16.00% 14.00% 12.00% 10.00% Prime + 1% vs. 5yr swap % 3) Longer rates front-run the overnight rate when rates are rising (with varying severity based on conditions) 8.00% 6.00% 4.00% 2.00% 0.00% 11/1/1988 7/1/1989 3/1/ /1/1990 7/1/1991 3/1/ /1/1992 7/1/1993 3/1/ /1/1994 7/1/1995 3/1/ /1/1996 7/1/1997 3/1/ /1/1998 7/1/1999 3/1/ /1/2000 7/1/2001 3/1/ /1/2002 7/1/2003 3/1/ /1/2004 7/1/2005 3/1/ /1/2006 7/1/2007 3/1/ /1/2008 7/1/2009 3/1/ /1/2010 7/1/2011 3/1/ /1/2012 7/1/2013 3/1/ /1/2014 7/1/2015 3/1/ /1/2016 7/1/2017 3/1/ /1/2018 Prime + 1 5yr fix

27 5 year fix (currently 6.00%) versus P+1 floating (currently 6.5%) Average you were better off by doing the fixed rate note: 1.37% per year Percentage of the time you were better off doing the fixed rate note: 81.2%

28 Yield Curve Steepness With exception of a few outlier months during economic boom of 1990 s, the best time to book floating rate notes was when the yield curve was much steeper than normal.

29 Yield Curve Steepness Likewise, the best time to book fixed-rate notes has been when the yield curve is flat.

30 Currently, the curve is very flat

31 10 year fix (currently 6.50%) versus P+1.5 floating (currently 7%) Average you were better off by doing the fixed rate note: 2.00% per year Percentage of the time you were better off doing the fixed rate note: 96.3%

32 Right now, you can book a floater at a higher rate than a fixed (~50 bps). Net Income Differential Date Prime + 1 5yr fix Opening Spread Fixed Over Floating 2/28/ % 13.34% -0.41% 3.61% 10/31/ % 11.95% -0.55% 2.93% 5/31/ % 9.59% -0.41% 0.21% 6/30/ % 9.50% -0.50% 0.12% 10/31/ % 9.35% -0.41% -0.08% 12/29/ % 8.91% -0.59% -0.55% 1/31/ % 8.75% -0.50% -0.72% 1/30/ % 9.06% -0.45% 0.65% 9/29/ % 10.02% -0.48% 3.62% 10/31/ % 10.00% -0.50% 3.64% 7/31/ % 8.67% -0.58% 2.64% 6/29/ % 8.74% -0.51% 3.63% 10/31/ % 8.07% -0.43% 3.29% There were 13 occasions when you could have booked a floating rate note between bps higher than the fixed rate option (5y swap + 325). Three of those times, all during the economic boom of the 1990 s, you d have been better off booking the floating rate note. Average win: 45 bps per year. Ten of those times, you d have been better off booking the fixed rate note. Average win: 243 bps per year.

33 Not All 5 Year Fixes are Created Equal $1,200, Principal balances on 5 year loans with varying amortizations $1,000, $800, $600, $400, $200, $0.00 Balance on 5 year full am Balance on 5 yr fix on 10 yr am Balance on 5 yr fix on 20 yr am Balance on 5 yr fix on a 30 yr am

34 We ll pick April 1993 as our case study

35 In April 1993, you could have booked a 5 year fixed rate loan at 7.04% or the floater at a 5% opening rate (very steep curve an instance where the floater performed better) Prime + 1% versus 7.04% fixed April 1993 thru March % 9.00% 8.00% 7.00% 6.00% 5.00% 4.00% 3.00% 2.00% 1.00% 0.00% Prime + 1% Fixed Rate Note

36 Principal-Weighted Loan Yields Term Fixed Rate P+1% floating 5 yr fix / 20 yr am 7.04% 7.38% 5 yr fix / 15 yr am 7.04% 7.36% 5 yr fix / 10 yr am 7.04% 7.33% 5yr fix / full am 7.04% 7.11%

37 In May 2000, you could have booked a 5 year fixed rate loan at 10.83% or the floater at a 10.50% opening rate (very flat curve an instance where the fixed rate performed better) Prime + 1% versus 10.83% fixed May 2000 thru April % 10.00% 8.00% 6.00% 4.00% 2.00% 0.00% Prime + 1% Fixed Rate Note

38 Principal-Weighted Loan Yields Term Fixed Rate P+1% floating 5 yr fix / 20 yr am 10.83% 6.73% 5 yr fix / 15 yr am 10.83% 6.76% 5 yr fix / 10 yr am 10.83% 6.86% 5yr fix / full am 10.83% 7.42%

39 Net Interest Margin 6.00% 5.00% Interest Income / Avg. Earning Assets 4.00% 3.00% 3.97% 3.97% 3.99% 4.13% 4.27% 4.42% 4.56% 2.00% 1.00% 0.00% Interest Expense / Avg. Earning Assets unch

40 So What Kind of a Bank is Your Bank? 4.80% 4.60% 4.40% Asset-Sensitive 4.20% Interest Rate Neutral 4.00% Liability-Sensitive 3.80% Negatively Convex 3.60% 3.40% 3.20% 3.00% unch

41 Given: Fed Funds and LIBOR are near-perfect proxies Given: Prime rate is Fed Funds + 3% Given: Banks may charge some risk premium in excess of Prime Rate (we ll use 1.5% in this example) Given: The history of Prime +1.5% (Fed Funds %) versus 10 year swap rate % has favored the fixed rate instrument 97% of the time. In other words, overnight money + 4.5% rarely outperforms the 10 year swap %. So what if I offered you a floater at overnight money + the spread of your choice versus 10 year swap plus that same spread?

42 Interest Rate Swaps Balance Sheet Swap ISDA agreement Hedge accounting treatment Bank must post collateral Reporting requirements Nominal amount chosen Bank s responsibility to counterparty is some fixed rate Counterparty s responsibility to bank is some variable rate Settle up each month Loan Level Swap Same requirements as Balance Sheet Swap but amount is based on loan amount Non-ISDA hedging agreement No ISDA agreement No hedge accounting treatment Bank shares first lien with counterparty Fewer reporting requirements Amount is loan amount Loan borrower pays based on some fixed rate that s passed on to counterparty Counterparty pays bank based on loan amount multiplied by some variable rate Settle up each month

43 Utilizing Swap Rates as of 1/2/19 10 yr. 2.65% 1 mo. 2.50% Sell: You give up the right to book a 10 year 10 year swap bps (4.90%) Buy: The deal goes on your books at 1 mo. LIBOR floating bps (4.75%) You re only 15 basis points upside down at the outset, and the Fed s dot plots say two more raises in And you believe the same. Why wouldn t you do it?

44 Non-ISDA Swap (current spreads applied to historical rates) The bank has effectively sold (given up the right to book a loan themselves) a 10 year fixed rate at 4.90% (10 year Swap + 225) The bank has effectively bought 10 years of 1 month LIBOR floating 14.00% 10 yr swap vs. 1m LIBOR % 10.00% 8.00% 6.00% 4.00% 2.00% 0.00% 11/1/1988 7/1/1989 3/1/ /1/1990 7/1/1991 3/1/ /1/1992 7/1/1993 3/1/ /1/1994 7/1/1995 3/1/ /1/1996 7/1/1997 3/1/ /1/1998 7/1/1999 3/1/ /1/2000 7/1/2001 3/1/ /1/2002 7/1/2003 3/1/ /1/2004 7/1/2005 3/1/ /1/2006 7/1/2007 3/1/ /1/2008 7/1/2009 3/1/ /1/2010 7/1/2011 3/1/ /1/2012 7/1/2013 3/1/ /1/2014 7/1/2015 3/1/ /1/2016 7/1/2017 3/1/ yr swap m LIBOR + 225

45 August year swap = 7.97% 1 mo. LIBOR = 5.44% Beginning spread: -2.53% CRYSTAL BALL Short rates will have a big run and within 16 months, LIBOR will rise 287 bps Rates will remain elevated for seven years

46 Zooming in in August 1993 to July 2003 Net Payments (based on $1mm loan on 25 year amortization at 7.97%) Year 1 ($20,174.75) Year 2 $ Year 3 ($1,064.12) Year 4 ($1,597.01) Year 5 ($287.22) Year 6 ($4,692.87) Year 7 $2, Year 8 ($2,150.28) Year 9 ($26,990.26) Year 10 ($30,478.48) ($84,034.32)

47 Monthly Settlements

48 But the opening spread was 253 basis points! That was a big hill to climb! Right now we re taking about a 15 basis point opening spread! 10yr swap mo LIBOR Opening Spread Net Settlements 8/31/ % 7.58% -0.04% ($354,731.79) 7/31/ % 10.94% -0.03% ($271,690.31) 9/29/ % 11.38% -0.01% ($316,611.74) 1/31/ % 7.57% 0.01% ($375,574.43) 10/31/ % 11.00% 0.03% ($289,886.84) 12/31/ % 6.85% 0.07% ($351,447.52) 8/31/ % 11.25% 0.08% ($310,538.72) 9/28/ % 7.37% 0.09% ($390,157.13) 11/30/ % 11.81% 0.13% ($334,461.15) 10/30/ % 7.49% 0.13% ($142,405.76) 5/31/ % 7.57% 0.14% ($399,187.41) 7/31/ % 7.64% 0.15% ($373,304.26) 8/31/ % 7.89% 0.16% ($176,711.91) 11/30/ % 8.23% 0.17% ($182,699.93) 7/31/ % 7.57% 0.17% ($408,238.03) 11/30/ % 11.00% 0.20% ($323,937.20) 10/31/ % 8.87% 0.25% ($362,828.29) 12/29/ % 7.94% 0.27% ($167,477.96) 9/29/ % 8.87% 0.30% ($362,048.89) 6/30/ % 7.91% 0.33% ($188,538.87) 1/31/ % 7.82% 0.34% ($293,289.50) 6/29/ % 7.57% 0.35% ($420,336.42) 12/29/ % 10.75% 0.35% ($300,029.87) Since the inception of the swap curve, there have been 23 months where the opening spread has been within 20 bps of current levels. Average net swap settlement outflow for each of those times: ($308,527.56)

49 What if the customer wants to prepay? Counterparty has bought a swap on the backside to hedge themselves. If a customer decides to prepay their loan for whatever reason, Counterparty still has to unwind its hedging swap. They have written in a two-way prepayment penalty into the deal based on current 1 month LIBOR pricing as of the date of payoff. It s called Symmetrical Yield Maintenance. It s pitched as bank-friendly because: 1) In a falling rate environment, it prevents prepayments because the customer has to pay a prepayment penalty. 2) In a rising rate environment, it actually pays the customer to pay you off early, and you can put that money to work in a higher interest rate environment.

50 Then why does the Counterparty need an equal priority on your lien position? They don t have a formal ISDA agreement to govern the swap and they need to protect themselves. It takes the choice of waiving or reducing the prepayment penalty out of the banker s hands it HAS to be paid. The Counterparty will not release their share of the lien until they ve been made whole. But what about a default? The structure of the deal does not have the Counterparty participating in any part of the credit risk, just the swap risk. In the event of liquidation, they will not release their lien position until they ve been made whole, and therefore you cannot liquidate until they ve been made whole.

51 1m LIBOR Forward Curve

52 LIBOR vs. Fed Funds Fed Funds isn t an exact proxy for LIBOR, but it s pretty darn close!

53 Scenario: You booked a 10 year swap on $3mm in January The Fix: 4.165% (10yr swap as of January bps) The Float : 1m LIBOR bps Settlements you paid: $273, Settlements paid to you: $5, $2, Net Settlements Each Month $1, $0.00 ($1,000.00) 1/1/2012 3/1/2012 5/1/2012 7/1/2012 9/1/ /1/2012 1/1/2013 3/1/2013 5/1/2013 7/1/2013 9/1/ /1/2013 1/1/2014 3/1/2014 5/1/2014 7/1/2014 9/1/ /1/2014 1/1/2015 3/1/2015 5/1/2015 7/1/2015 9/1/ /1/2015 1/1/2016 3/1/2016 5/1/2016 7/1/2016 9/1/ /1/2016 1/1/2017 3/1/2017 5/1/2017 7/1/2017 9/1/ /1/2017 1/1/2018 3/1/2018 5/1/2018 7/1/2018 9/1/ /1/2018 ($2,000.00) ($3,000.00) ($4,000.00) ($5,000.00)

54 Fed Funds Forward Contracts over the past four months Bloomberg command: FFF9 Comdty CT 3.50% 3.00% 2.50% 2.00% 1.50% Fed Funds Futures Fed Funds Futures Fed Funds Futures Fed Funds Futures 1.00% 0.50% 0.00% Dec-18 Jan-19 Feb-19 Mar-19 Apr-19 May-19 Jun-19 Jul-19 Aug-19 Sep-19 Oct-19 Nov-19 Dec-19 Jan-20 Feb-20 Mar-20 Apr-20 May-20 Jun-20 Jul-20 Aug-20 Sep-20 Oct-20 Nov-20 Dec-20 Jan-21 Feb-21 Mar-21 Apr-21 May-21 Jun-21 Jul-21 Aug-21 Sep-21 Oct-21 Nov-21 Dec-21

55 Fed Funds Futures Fed Funds Futures Fed Funds Futures Fed Funds Futures October 2018 November 2018 December 2018 January 2019 Dec % Jan % 2.40% Feb % 2.41% 2.40% Mar % 2.46% 2.43% 2.38% Apr % 2.52% 2.47% 2.37% May % 2.55% 2.49% 2.35% Jun % 2.58% 2.52% 2.34% Jul % 2.61% 2.55% 2.33% Aug % 2.63% 2.57% 2.31% Sep % 2.65% 2.58% 2.31% Oct % 2.67% 2.59% 2.29% Nov % 2.68% 2.60% 2.26% Dec % 2.70% 2.60% 2.24% Jan % 2.71% 2.59% 2.22% Feb % 2.70% 2.57% 2.18% Mar % 2.70% 2.55% 2.15% Apr % 2.71% 2.54% 2.13% May % 2.70% 2.53% 2.08% Jun % 2.70% 2.52% 2.05% Jul % 2.70% 2.51% 2.03% Aug % 2.69% 2.50% 2.01% Sep % 2.69% 2.50% 2.00% Oct % 2.68% 2.50% 1.99% Nov % 2.68% 2.50% 1.99% Dec % 2.68% 2.50% 1.98% Jan % 2.68% 2.50% 1.97% Feb % 2.67% 2.50% 1.97% Mar % 2.67% 2.49% 1.96% Apr % 2.66% 2.49% 1.95% May % 2.66% 2.48% 1.95% Jun % 2.66% 2.48% 1.95% Jul % 2.65% 2.48% 1.94% Aug % 2.65% 2.48% 1.94% Sep % 2.65% 2.48% 1.94% Oct % 2.48% 1.94% Nov % 1.94% Dec % Average 2.76% 2.64% 2.51% 2.10% Scenario: You have three years left on a 10 year swap booked in January $3mm Sell 10yr swap Buy 1mo LIBOR You sold a 10 year fix at 4.165%. Now there s a payoff request. Ballpark the value of your contract as of October % % = 5.01% 5.01% % = 0.845% 0.845% x $3mm x 3.25 years = $82.4K

56 Fed Funds Futures Fed Funds Futures Fed Funds Futures Fed Funds Futures October 2018 November 2018 December 2018 January 2019 Dec % Jan % 2.40% Feb % 2.41% 2.40% Mar % 2.46% 2.43% 2.38% Apr % 2.52% 2.47% 2.37% May % 2.55% 2.49% 2.35% Jun % 2.58% 2.52% 2.34% Jul % 2.61% 2.55% 2.33% Aug % 2.63% 2.57% 2.31% Sep % 2.65% 2.58% 2.31% Oct % 2.67% 2.59% 2.29% Nov % 2.68% 2.60% 2.26% Dec % 2.70% 2.60% 2.24% Jan % 2.71% 2.59% 2.22% Feb % 2.70% 2.57% 2.18% Mar % 2.70% 2.55% 2.15% Apr % 2.71% 2.54% 2.13% May % 2.70% 2.53% 2.08% Jun % 2.70% 2.52% 2.05% Jul % 2.70% 2.51% 2.03% Aug % 2.69% 2.50% 2.01% Sep % 2.69% 2.50% 2.00% Oct % 2.68% 2.50% 1.99% Nov % 2.68% 2.50% 1.99% Dec % 2.68% 2.50% 1.98% Jan % 2.68% 2.50% 1.97% Feb % 2.67% 2.50% 1.97% Mar % 2.67% 2.49% 1.96% Apr % 2.66% 2.49% 1.95% May % 2.66% 2.48% 1.95% Jun % 2.66% 2.48% 1.95% Jul % 2.65% 2.48% 1.94% Aug % 2.65% 2.48% 1.94% Sep % 2.65% 2.48% 1.94% Oct % 2.48% 1.94% Nov % 1.94% Dec % Average 2.76% 2.64% 2.51% 2.10% Scenario: You booked a 10 year swap in January $3mm Sell 10yr swap Buy 1mo LIBOR You sold a 10 year fix at 4.165%. Now there s a payoff request. Ballpark the value of your contract as of November % % = 4.89% 4.89% % = 0.725% 0.725% x $3mm x years = $68.9K

57 Fed Funds Futures Fed Funds Futures Fed Funds Futures Fed Funds Futures October 2018 November 2018 December 2018 January 2019 Dec % Jan % 2.40% Feb % 2.41% 2.40% Mar % 2.46% 2.43% 2.38% Apr % 2.52% 2.47% 2.37% May % 2.55% 2.49% 2.35% Jun % 2.58% 2.52% 2.34% Jul % 2.61% 2.55% 2.33% Aug % 2.63% 2.57% 2.31% Sep % 2.65% 2.58% 2.31% Oct % 2.67% 2.59% 2.29% Nov % 2.68% 2.60% 2.26% Dec % 2.70% 2.60% 2.24% Jan % 2.71% 2.59% 2.22% Feb % 2.70% 2.57% 2.18% Mar % 2.70% 2.55% 2.15% Apr % 2.71% 2.54% 2.13% May % 2.70% 2.53% 2.08% Jun % 2.70% 2.52% 2.05% Jul % 2.70% 2.51% 2.03% Aug % 2.69% 2.50% 2.01% Sep % 2.69% 2.50% 2.00% Oct % 2.68% 2.50% 1.99% Nov % 2.68% 2.50% 1.99% Dec % 2.68% 2.50% 1.98% Jan % 2.68% 2.50% 1.97% Feb % 2.67% 2.50% 1.97% Mar % 2.67% 2.49% 1.96% Apr % 2.66% 2.49% 1.95% May % 2.66% 2.48% 1.95% Jun % 2.66% 2.48% 1.95% Jul % 2.65% 2.48% 1.94% Aug % 2.65% 2.48% 1.94% Sep % 2.65% 2.48% 1.94% Oct % 2.48% 1.94% Nov % 1.94% Dec % Average 2.76% 2.64% 2.51% 2.10% Scenario: You booked a 10 year swap in January $3mm Sell 10yr swap Buy 1mo LIBOR You sold a 10 year fix at 4.165%. Now there s a payoff request. Ballpark the value of your contract as of December % % = 4.76% 4.76% % = 0.595% 0.595% x $3mm x years = $55.0K

58 Fed Funds Futures Fed Funds Futures Fed Funds Futures Fed Funds Futures October 2018 November 2018 December 2018 January 2019 Dec % Jan % 2.40% Feb % 2.41% 2.40% Mar % 2.46% 2.43% 2.38% Apr % 2.52% 2.47% 2.37% May % 2.55% 2.49% 2.35% Jun % 2.58% 2.52% 2.34% Jul % 2.61% 2.55% 2.33% Aug % 2.63% 2.57% 2.31% Sep % 2.65% 2.58% 2.31% Oct % 2.67% 2.59% 2.29% Nov % 2.68% 2.60% 2.26% Dec % 2.70% 2.60% 2.24% Jan % 2.71% 2.59% 2.22% Feb % 2.70% 2.57% 2.18% Mar % 2.70% 2.55% 2.15% Apr % 2.71% 2.54% 2.13% May % 2.70% 2.53% 2.08% Jun % 2.70% 2.52% 2.05% Jul % 2.70% 2.51% 2.03% Aug % 2.69% 2.50% 2.01% Sep % 2.69% 2.50% 2.00% Oct % 2.68% 2.50% 1.99% Nov % 2.68% 2.50% 1.99% Dec % 2.68% 2.50% 1.98% Jan % 2.68% 2.50% 1.97% Feb % 2.67% 2.50% 1.97% Mar % 2.67% 2.49% 1.96% Apr % 2.66% 2.49% 1.95% May % 2.66% 2.48% 1.95% Jun % 2.66% 2.48% 1.95% Jul % 2.65% 2.48% 1.94% Aug % 2.65% 2.48% 1.94% Sep % 2.65% 2.48% 1.94% Oct % 2.48% 1.94% Nov % 1.94% Dec % Average 2.76% 2.64% 2.51% 2.10% Scenario: You booked a 10 year swap in January $3mm Sell 10yr swap Buy 1mo LIBOR You sold a 10 year fix at 4.165%. Now there s a payoff request. Ballpark the value of your contract as of January % % = 4.35% 4.35% % = 0.185% 0.185% x $3mm x 3 years = $16.7K

59 Value of the Contract Today Funds Futures are 2.15% 2.25% % = % % = 0.235% 0.235% x $3mm x 2.83 years = $19.9K

60 ISDA Balance Sheet Swap (proposed to a Georgia bank week of 8/27/18) $10mm nominal swap sell 5y swap rate / buy 3m LIBOR /1/1988 7/1/1989 3/1/ /1/1990 7/1/1991 3/1/ /1/1992 7/1/1993 3/1/ /1/1994 7/1/1995 3/1/ /1/1996 7/1/1997 3/1/ /1/1998 7/1/1999 3/1/ /1/2000 7/1/2001 3/1/ /1/2002 7/1/2003 3/1/ /1/2004 7/1/2005 3/1/ /1/2006 7/1/2007 3/1/ /1/2008 7/1/2009 3/1/ /1/2010 7/1/2011 3/1/ /1/2012 7/1/2013 3/1/ /1/2014 7/1/2015 3/1/ /1/2016 7/1/2017 3/1/2018 3mL 5ySwap

61 Applying those spreads (sell 5y swap / buy 3m LIBOR) to a swap Using historical data, here s how that bank would have fared, month by month, since the advent of the swap curve. $1,000, $500, $0.00 ($500,000.00) 11/1/1988 6/1/1989 1/1/1990 8/1/1990 3/1/ /1/1991 5/1/ /1/1992 7/1/1993 2/1/1994 9/1/1994 4/1/ /1/1995 6/1/1996 1/1/1997 8/1/1997 3/1/ /1/1998 5/1/ /1/1999 7/1/2000 2/1/2001 9/1/2001 4/1/ /1/2002 6/1/2003 1/1/2004 8/1/2004 3/1/ /1/2005 5/1/ /1/2006 7/1/2007 2/1/2008 9/1/2008 4/1/ /1/2009 6/1/2010 1/1/2011 8/1/2011 3/1/ /1/2012 5/1/2013 ($1,000,000.00) ($1,500,000.00) ($2,000,000.00) ($2,500,000.00) ($3,000,000.00)

62 OK, but the Fed s raising rates now though It might be a good time to take that chance, right?

63 Late-Cycle and End-Cycle Results

64 Takeaways Falling rate environments usually last longer than rising rate environments Long rates have historically been far less elastic than rising rates, giving fixed-rate notes an advantage Historically, a flat yield curve (like today) represents a bad time to book floating rate loans Tighter amortizations remove a lot of the benefit of the floating rate when there are large opening spreads (fixed higher than float) The longer the duration of the fixed rate, the more that elasticity (or lack thereof on the long end) will hurt comparable floating rate notes. Will the next cycle follow form with previous cycles? Nobody knows.

65 Questions/Comments? S. Blake Scharlach Senior Vice President / Designated Principal Director of Capital Markets Sales TIB The Independent BankersBank, N.A. bscharlach@tib.bank (800)