Dealing with Today s Rising Rate Environment Been There, Done That No Longer Applies

Transcription

1 Dealing with Today s Rising Rate Environment Been There, Done That No Longer Applies Presenter: Daniel Petrilla, Assistant Vice President, PNC s Treasury Management Group

2 Agenda How is the current market and rate environment different? What does it mean for cash managers? Re-introduced and evolving investment choices Cash position and business strategy 1

3 How is the Current Environment Different? Excess cash sitting on the sidelines for an extended period of time Bank s approach to deposits evolved as legislation changed The Federal Reserve and European Bank adjust policies as the economy improves and inflation moves toward targeted percentage Coming off of a historically extended and low rate environment Lessons learned from the financial crisis have the potential to change investment behaviors Many financial professionals were not part of the work force during the last rising rate environment Some foreign currencies currently have a negative interest rate Source: 2017 AFP Liquidity Survey Investment companies have developed a plethora of new short-term investment options 2

4 Current Environment: Impact of Central Bank Policies Federal Reserve European Central Bank Job market continues improvement. October s unemployment rate at 4.1% is the lowest since December Flat wage growth expected to improve with tightened labor market Inflation remains below 2% target Projected Fed Funds increase in Dec 2017, 3 in 2018, reaching a target rate of 2.25% by end of Expectations to begin reducing the balance sheet by selling securities to rationalize rates and reduce money supply Current accommodative policy to provide monetary stimulus, leaving rates negative longer than anticipated Experiencing growth in employment, wages, and GDP, but at a very slow pace Weakness in Euro relative to strengthened US dollar driving increase in net exports Expected to very slowly unwind quantitative easing policy in 2018, with rate increase later in the year 3

5 Current Environment: Impact of Interest Rate Trends Market expects gradual, measured increases Fed funds futures market tends to be more measured than economists and other market predictions Normalized rate environment looks much different than last time. Per market expectations, rates will not reach pre-2008 levels any time soon 6.00% Fed Funds Rates: Historical and Projections 5.00% 4.00% Historical FF Rate PNC Econ FF Forecast FF Futures Forecast 3.00% 2.00% 1.00% 0.00% Sources: 4

6 Short-Term Cash Environment: Historical View vs. Future Outlook Flat Rate Environment Cash levels at all time highs lack of attractive short-term investment options Rising Rate Environment Cash levels at all time highs - not likely to rise further Corporates hoarding cash - minimal expenditures, slow growth Potential repatriation of cash back to U.S. Rate environment most rates near zero with no opportunity cost Financial regulation and its impact on liquidity options Excess cash generated from operations expected to be deployed Potential Repatriation Rate environment - rising rates provide attractive investment alternatives Regulation and its impact 5

7 Short-Term Cash Alternatives Rising Interest Rates Create Competition Investment Products Bank Products Investment Products Bank Products 6

8 Regulatory Changes Influence Banks Views of Deposits Deposits tied to an entity s operating business provide highest value Deposit valuation varies based on client type and transaction activity Banks will compete for the most valuable deposits Competition among banks will increase as alternative investment options become more attractive 7

9 Regulatory Changes Drive Product Evolution Repeal Reg Q Basel III LCR MMF Reform Interest-Bearing Checking Hybrid Checking (Earnings Credit and Interest) Relevance of Sweep to investments Banks define valuable deposits by client type and activity Accelerated Maturity CDs Notice accounts Repo Sweep elimination Floating NAV funds fees & gates Ultra short bond funds Separately Managed Accounts Exchange traded funds Elimination of Prime fund sweeps 8

10 What Does This Mean for Cash Managers and Treasurers? Changing environment may prompt need to review and update investment policy Renewed focus on the risk and return of allowable investments Closer management and allocation of operating, reserve and strategic cash Prepare for shift in liquidity needs. Increased capital expenditure, M&A activity, repatriation, changes to lending approach likely outcomes of changing environment Understand re-introduced and emerging short-term investment products 9

11 Investment Policy Considerations Key elements of an investment policy Investment objectives Risk tolerance Time horizon Permissible investment types Asset allocation Investment performance metrics Potential changes in a rising rate environment Counterparty limits and due diligence Acceptance or restriction of investments with floating NAV and liquidity fees and gates Allocation among bank deposits and other liquidity alternatives given cash segmentation Acceptance of emerging investment products Priority of risk vs. return 10

12 Liquidity Continuum Options Driven by Cash Segmentation Cash Increase focus on yield Increase focus on liquidity and safety Checking and Savings Daily Operating Cash Sweep Services MMDAs, CDs, Offshore Deposits Reserve Cash Short Term Fixed Income Securities MMDA & CD s Money Market Mutual Funds Separately Managed Accounts Strategic Cash Ultra Short Bond Funds Customized Portfolios Daily Operating Cash is needed to support daily operations Short term in duration Safety primary characteristic Passively managed Reserve Cash serves as a cushion for unforeseen events Up to 1 year duration Liquidity primary characteristic Actively or passively managed Strategic Cash is reserved for a particular duration and purpose Up to 2+ years duration Yield primary characteristic Actively managed 11

13 Determining Appropriate Cash Segmentation Cash Management Style and Investment Alternatives Questions Cash Characteristics (purpose and term) What are your cash needs? Do you currently have excess cash? How much daily liquidity is required to manage your business? Do you have any reserve cash to invest for 3, 6, or 9 months or strategic cash to invest for 12 months or longer? Cash Management Style How are you currently investing your cash? What rate of return are you earning? Are you familiar with investment alternatives that are more relevant in a rising rate environment? Are you familiar with new investment alternatives? Investment Policy, Risk Tolerance, Tax Status Do you have a written guideline or approved investment policy? What are your credit requirements? Are you permitted to keep a large portion of your cash in the bank? Are taxes or currencies important to you? What is your sensitivity to interest rate risk? 12

14 Determining Appropriate Cash Segmentation Cash Management Style and Investment Considerations Cash Characteristics (purpose and term) The intended use of excess cash and a sense of when the funds will be needed are critical in determining an appropriate liquidity management solution Key things to consider Balance predictability and perceived term Liquidity requirements Intended use of cash Cash Management Style Each company has unique preferences for managing liquidity. An appropriate solution will align with the cash manager s stylistic preferences. Key things to consider Active, passive or outsourced Level of sophistication Time and staffing available Knowledge of investment alternatives Investment Policy, Risk Tolerance, Tax Status All cash managers must also consider the risk, diversification, and tax implications of the liquidity management solutions they employ. Key things to consider Permissible investment options Diversification requirements Risk tolerance Tax status Interest rate risk 13

15 Re-introduced and Evolving Investment Alternatives WHY? Rising rates introduce opportunity to utilize varied and relevant liquidity options Client demand for products similar to those available before the financial crisis WHAT? Re-emerging Options Investment sweeps Money market funds Separately managed accounts Evolving Options Interest-bearing and hybrid checking Ultra-short bond funds Private structures FNAV money market funds WHEN? NOW is the time to consider myriad liquidity options within a short-term investment strategy 14

16 Been There Done That Does Not Apply: A Call To Action Revisit investment policy Review annually at a minimum How does the policy address interest rate risk Does the policy consider new and re-emerging investment products Evaluate and re-calibrate cash segmentation approach Greater relevance in a rising rate environment Cash segmentation can influence investment duration as well as investment priorities of liquidity, safety, and yield Understand the solutions you will use and employ sufficient expertise Seek continued education and knowledge of short-term investment options Meet with investment and banking advisors Pay attention to market and rate conditions Use knowledge and investment strategies to employ effective cash forecasting 15