Economic Forecasts and the Treasury Function. Brian Boike Treasurer, Flagstar Bank

Transcription

1 Economic Forecasts and the Treasury Function Brian Boike Treasurer, Flagstar Bank

2 Disclaimer The views expressed here are solely those of the presenter in his private capacity and do not necessarily represent or reflect the views of Flagstar Bank.

3 Agenda 1. The Bank Treasury Function 2. Economic Snapshot 3. Interest Rates: Past, Present, and Future 4. Price Forecasts and Balance Sheet Positioning 5. Conclusions Source: xkcd.com

4 Flagstar Bank at a Glance

5 Bank Treasury Function Develop and execute borrowing plan to manage liquidity and fund the bank Manage fixed income investment portfolio Develop and execute capital plan Measure and manage interest rate risk: the risk to earnings of changes in market interest rates using earnings simulations. Short term variability in bank earnings is often driven by interest rate market volatility. Sample earnings at risk profile : Interest rates Earnings, next 12 months $ Change % Change Increase 2% % Increase 1% % Unchanged % Decrease 1% 9.20 (0.80) -9% Decrease 2% 8.30 (1.70) -20%

6 Economic Snapshot Source: xkcd.com

7 Consumer Sentiment Consumer sentiment has tracked at pre-recession levels for several years: And consumer spending continues to be a source of strength for the US economy (real personal consumption expenditures, monthly): Source: University of Michigan Source: US Bureau of Economic Analysis

8 GDP The aforementioned strong consumer spending is fueling a tepid economic recovery: Source: Bureau of Economic Analysis

9 GDP Components of consumer spending: Source: Bureau of Economic Analysis

10 GDP Components of private investment: Source: Bureau of Economic Analysis

11 Employment National employment at all time highs: Michigan employment levels have increased meaningfully since the recession, but remain below 2000 peak levels: Source: Federal Reserve Source: MI DTMB LMISI Local Area Unemployment Statistics

12 Inflation Total industry capacity utilization remains modest: Source: Federal Reserve Resulting in little upward pressure on consumer prices (CPI year over year % change): Source: US Bureau of Labor Statistics

13 Housing Starts National housing starts remain at historically depressed levels: Source: Federal Reserve And the situation in Michigan is even worse: Source: Federal Reserve

14 Interest Rates Today Source: xkcd.com

15 Current situation: 10 Year U.S. Treasury Lowest in history. Since 1953: Since 2005: Source: Federal Reserve

16 Current situation: Corporate BBB Bond Yield Corporate borrowing rates have followed U.S. Government Rates lower: Spread to U.S. Treasury Rates (the price of credit risk): Source: BofA Merrill Lynch US Corporate BBB Effective Yield

17 Current situation: 30 Year Fixed Mortgage Rates Rates remain extremely low: Spread to US Treasury Rates: Source: Federal Reserve, Freddie Mac

18 Current situation: Federal Funds Rate Historical policy tool for the Federal Reserve, continues at unprecedented lows: December 2015 increase moved the rate off zero for the first time since 2008: Source: Federal Reserve

19 Current situation: Slope of Yield Curve 10 Year Treasury minus Federal Funds Rate: This is the flattest yield curve we have seen post-crisis, despite a Fed that continues to signal less accommodative monetary policy Source: Federal Reserve

20 Why Are Term Rates at Historical Lows? Interest Rates are a price the cost of borrowing money. As a price it is governed by the laws of supply and demand. Supply: dollars that would like to be lent or buy debt Demand: dollars that would like to be borrowed Unprecedented government intervention and international flight to quality and yield have greatly increased the supply of borrowable money in the US. A brief history of Quantitative Easing the purchase of term debt by the Federal Reserve - in the United States: QE purchased $1.45 trillion of US Government Agency mortgage backed securities (MBS) and government-sponsored enterprise debt QE purchased $0.6 trillion US Treasuries Operation Twist 2011 traded $0.7 trillion short Treasuries for longer term bonds QE began indefinite dated purchase program of $85 billion per month of Agency MBS ended October 2014 TOTAL approximately $4.5 trillion of longer-dated high quality (government-backed) debt But wait: cash flows are being reinvested approximately $10 billion per week in Agency MBS purchases

21 Expectations for Future Interest Rates Federal Funds Futures: futures market participants expect a 25 basis point hike late 2016/ early 2017, and another by end of 2018! Fed Funds at 1% by the end of Contrast that with FOMC participants assessment of appropriate monetary policy (Sept, 2016): Source: Federal Reserve

22 Using Price Forecasts for Strategic Planning

23 Reminder: Federal Funds Rate Historical policy tool for the Federal Reserve, continues at unprecedented lows: December 2015 increase moved the rate off zero for the first time since 2008: Source: Federal Reserve

24 Federal Funds Futures September 2010 Federal Funds Futures contract rate: Source: Chicago Mercantile Exchange

25 Federal Funds Futures September 2011 Federal Funds Futures contract rate: Source: Chicago Mercantile Exchange

26 Federal Funds Futures September 2012 Federal Funds Futures contract rate: Source: Chicago Mercantile Exchange

27 Federal Funds Futures September 2016 Federal Funds Futures contract rate: Source: Chicago Mercantile Exchange

28 Federal Funds Futures The 12 month forward contract has not been a good predictor of future rates: Since the last rate cut in December 2008: Source: Chicago Mercantile Exchange

29 Federal Funds Futures The magnitude and direction of the 12 month forward misprediction are related to monetary policy at the time: In the last cycle, both tightening and loosening happened faster than markets anticipated. Source: Chicago Mercantile Exchange

30 Using Economic Forecasts to Position the Balance Sheet 2010: KBW creates the KBW Interest Rate Sensitive Index, a basket of approximately 20 financial stocks best positioned to benefit from rising interest rates The U.S. Financial Industry Is Mostly Well Positioned For Rising Interest Rates (Standard & Poor s, June 2011) Rising Rates A Potential Boon for Some Financials (Barron s, March 2012) Big asset-sensitive banks stand to benefit from rising rates (SNL, June 2013) Big Banks Poised to Ride Rising Rate Tide (Wall Street Journal, Sept 2014) 2015: Sterne Agee: Banks Are More Asset-Sensitive Now Than 2005

31 Using Economic Forecasts to Position the Balance Sheet PrivateBancorp sale puts targets on other asset-sensitive, Chicago-based banks (SNL, June 2016) Some asset-sensitive banks evaluating, giving up their independence (SNL, July 2016) Why? Consider the following hypothetical bank, which is maintaining an asset-sensitive balance sheet: $MM Return on Base bp bp Asset Size Assets Earnings Sensitivity Earnings 1, % % Now suppose the bank sells its asset sensitivity by shortening the term of its borrowings or lengthening assets. ($25 1% rate differential): $MM Return on Base bp bp Asset Size Assets Earnings Sensitivity Earnings 1, % % Mid-Cap Banks Become More Asset-Sensitive (Barron s, May 2016)

32 Prudent Balance Sheet Management Understanding how changes to economic drivers will impact your company s performance is of utmost importance. Use statistical and financial models to run simulations and scenario analysis, both most likely scenarios and low probability events. Understand range of potential outcomes and reposition balance sheet to avoid unacceptable results. Big economic trends are important, such as population and demographics, regulation, changes in consumer behavior, pent-up supply or demand, international developments, etc.

33 Thank you!