How Market Changes Alter Earning Assets Casey Peterson Sr. Advisor, Advisory Services Federal Reserve Bank 1
Interest Rates Are On the Rise 4.50% 4.00% 3.50% 2.50% 3.84% 3.29% 1.87% 1.75% 3.02% 2.17% 2.27% 2.44% 2.40% 1.88% 2.99% 2.78% 2.25% Fed Funds is 2.25% an increase of 200 basis points from 2014. The 2 Year Treasury is now 2.78% an increase of 253 basis points from the low of.25%. 1.50% 0.50% 1.14% 1.05% 1.19% 1.50% 0.60% 0.66% 0.24% 0.25% 0.38% 0.75% 0.50% 0.25% 0.25% 0.25% 0.25% 0.25% 0.25% 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 Fed Fds 2 Yr TSY 10 Yr TSY The 10 Year Treasury is 2.98% and moving in a much narrower band over he last few years. 2
Returns on Earning Assets Are Improving 7.00% 6.00% 5.00% 5.76% 5.42% 5.01% 4.79% 4.64% 4.56% 4.51% 4.60% Loan Yield has stabilized over the past few years and is currently experiencing a small increase. 4.00% 4.15% 2.69% Investment portfolio yields are improving quickly and substantially. 1.61% 1.27% 1.13% 1.24% 1.24% 1.35% 1.54% 1.91% The difference between the two returns has gone from 415 basis points to 269 basis points. 2011 2012 2013 2014 2015 2016 2017 Jun 18 Loan Yield Invest Yld Net Margins Are Improving 7.00% 6.50% 6.00% 5.50% 5.00% 4.50% 4.00% 3.50% 2.50% 1.50% 0.50% 6.28% 6.06% 3.21% 3.25% 2.63% 1.95% 5.76% 3.12% 1.61% 5.42% 2.92% 1.27% 5.01% 4.79% 2.80% 2.84% 2.85% 2.88% 1.13% 1.24% 1.24% 4.64% 4.56% 4.51% 4.60% 1.35% 2.99% 3.07% 1.54% 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 Loan Yield Net Int Mar Invest Yld 1.91% Net Interest Margins moves above The largest difference over the last 9 years has been 45 basis points. Net Margin has increased 27 basis points since 2013. Cost of Funds: 2009 1.74% Today 0.62% 3
A Flattening and Higher Yield Curve 3.50% 2.50% 1.50% 2.25% 1.50% 2.80% 1.88% 2.89% 2.96% 3.03% 3.08% 2.33% 2.40% 2.20% 1.97% 1.88% Treasury Curve continues to move higher and to flatten. Spread between 2yr and 10 year is narrowing. 0.50% 1.34% 0.83% 0.25% 0.24% 0.35% Fed Funds 2 YR 3 YR 5 YR 7 YR 10 YR Dec 2011 Dec 2017 Sep 2018 163 bps 52 bps 28 bps 12/30/2011 12/31/2017 09/27/2018 Loan Pricing Loan rates show how flat the yield curve is and that pricing is driven by local and national factors. Credit unions and banks have similar unsecured and real estate loan rates but car loan rates differ significantly. Should credit unions increase their car rates or shift those allocations to loan participations or investments? 4
30 Year Mortgage Spread Relationship 7.00% 6.00% Spread between 30yr FRM and 10yr UST have averaged 154 bps since 2009 Current spread between 30 year fixed rate mortgage and the 10 year Treasury is 163 bps. 5.00% 4.00% 163 bps The average spread since 2009 is 154 bps. The widest spread was 268 bps in 2008 and the tightest spread was 155 bps in 2009. Regularly monitor pricing spreads to determine when to hold or sell loans. 30 yr FRM 10 yr UST Dec-06 Dec-07 Dec-08 Dec-09 Dec-10 Dec-11 Dec-12 Dec-13 Dec-14 Dec-15 Dec-16 Dec-17 5 Year Auto Historic Pricing 6.00% 5.00% 4.00% Current spread between 5 year credit union auto rate and the 2 year Treasury is 63 bps. The average spread since 2011 is 2.07 bps. 314bps 63bps The widest spread was 314 bps in 2011 and the tightest spread is NOW 63 bps.. Dec-11 Mar-12 Jun-12 Sep-12 Dec-12 Mar-13 Jun-13 Sep-13 Dec-13 Mar-14 Jun-14 Sep-14 Dec-14 Mar-15 Jun-15 Sep-15 Dec-15 Mar-16 Jun-16 Sep-16 Dec-16 CU 60 Mo BK 60 Mo 2 Yr Tsy Mar-17 Jun-17 Sep-17 Dec-17 Mar-18 Jun-18 Regularly monitor pricing spreads to determine when to hold or sell loans. 5
Earning Asset Distribution as of June 2011 / 2018 June 2011 June 2018 Investment, 28% Cash Eq., 9% Unsecured, 7% Real Estate, 35% Investment, 19% Other, 4% Cash Eq., 7% Unsecured, 7% Real Estate, 36% Other, 3% Vehicle, 18% Unsecured Real Estate Vehicle Other Investment Cash Eq. Vehicle, 26% Unsecured Real Estate Vehicle Other Investment Cash Eq. Allocation Strategy Real Estate Investments Autos What is the Best Mix of Assets. Depends on Cost Structure Earnings Goal Membership Base Risk tolerance Credit Risk Interest Rate Risk Liquidity Risk 6
Loan Pricing Methodologies Risk Based Lending Keep Spreads Thin, Our Members Always Pay There Loans in a Full & Timely Manner Price Leadership We Price Lower Than All of Our Competition, Regardless of Rate Cost- Plus More, More & More Loans Will Solve All Our Problems Loan Pricing Methodologies Risk Based Lending Risk Analytics and Criteria Pricing Incorporates Risk Related Value Versus Return Price Leadership Competition Rate Surveys Market Based Pricing Cost- Plus Funding & Operational Expenses Price Based on Operational Costs 7
Setting an Allocation Strategy The Credit Union Needs a Cumulative Return of 3.58% to Achieve the ROA Goal. Multiple Variables Can Affect the Results Operational Expenses COF s Charge-Offs Overall Risk Tolerance ROA Expectation Earning Asset Returns by Overall Allocation Asset Yield 3.70% Asset Yield 3.16% Asset Yield 2.49% Investments, 25% Investments, 45% Loans, 25% Loans, 70% Loans, 50% Investments, 70% Loans Investments Loans Investments Loans Investments 8
Loan Rates Have Moved Very Little 2011 2018 Change 60 Month Auto 3.55% 3.16% -0.39% Unsecured Fxd (36mo) 10.22% 9.25% -0.97% Credit Card 11.59% 11.71% 0.12% 15 Yr Mtg 3.57% 4.14% 0.57% 30 Yr Mtg 4.15% 4.65% 0.50% Fed Funds 0.25%- 2.25% 200 bps Change 2Yr Treasury 0.26% -2.68% 242 bps Change 10 Yr Treasury 1.92% -3.07% 115 bps Change Other Loan Opportunities Today 2018 60 Month Auto 3.16% 60-72 Mo. Auto Participation 3.90% Unsecured Fxd (36mo) 9.25% Credit Card 11.71% 15 Yr Mtg 4.14% 30 Yr Mtg 4.65% 30 Yr RE Loan Participation 4.13% New Opportunities Auto Participations RE Participations Validate Pricing Faster Volume Cost Efficient Target Asset Yield 3.58% 9
Investments Offer Enhanced Opportunities 2011 2018 Change Fed Funds 0.25% 2.25% 2 Yr Duration 1.40% 2.90% 1.50% 3 Yr Duration 1.65% 3.05% 1.40% 5 Yr Duration 1.80% 3.45% 1.65% 7 Yr Duration 1.90% 3.60% 1.75% 10 Yr Duration 2.35% 3.85% 1.50% Fed Funds 0.25%- 2.25% 200 bps Change 2Yr Treasury 0.26% -2.68% 242 bps Change 10 Yr Treasury 1.92% -3.07% 115 bps Change Cash and Duration Management Have an Effect Cash + Cash Equivalents/Total Assets Ratio Assets: $25mm to $50mm (792 CU's) Weighted Average Investment Yield Assets: $50mm to $150mm (1061 CU's) Assets: $150mm to $250mm (361 CU's) Assets: $250mm to $500mm (354 CU's) Assets: $500mm to $1 Billion (246 CU's) Assets: $1 Billion to $5 Billion (272 CU's) 0% to 5% 1.70% 1.76% 1.81% 1.92% 2.04% 2.13% 5% to 10% 1.59% 1.64% 1.70% 1.77% 1.87% 1.85% 10% to 15% 1.54% 1.57% 1.66% 1.64% 1.65% 1.78% > 15% 1.38% 1.55% 1.55% 1.62% 1.63% 1.75% 10
Breakeven Versus Fed Funds Anticipated Fed Funds Rate 2.50% Anticipated Fed Funds Rate Maturity Breakeven Rate 9/21/2019 2.409% 6 Month Breakeven 2.324% 9 Month Breakeven 2.378% 1 Year Breakeven 2.409% 1.5 Year Breakeven 2.447% 1.75 Year Breakeven 2.462% 2 Year Breakeven 2.474% Maturity Breakeven Rate 9/21/2019 2.608% 6 Month Breakeven 2.327% 9 Month Breakeven 2.475% 1 Year Breakeven 2.608% 1.5 Year Breakeven 2.755% 1.75 Year Breakeven 2.803% 2 Year Breakeven 2.840% Significantly More Options Today. Asset Classes by Return and Duration 5.00% 4.50% 4.00% 3.50% 2.90% 3.16% 3.90% 3.05% 3.45% 4.14% 3.60% 4.65% 3.85% 9.90 12.00 10.00 8.00 Asset Returns Range From 2.25%- 4.65% 2.50% 2.25% 6.80 6.80 6.00 1.50% 0.50% 2.00 2.00 2.00 2.90 4.90 4.66 4.00 2.00 Average Life Range From 0.08% -9.90 years Cash 0.08Eq. 2 Yr Inv 60 mo Auto 60 Mo Auto LP 3 Yr Inv 5 Yr Inv 15 Yr Mtg 7 Yr Inv 30 Yr Mtg 10 Yr Inv 0.00 Rate Avg Life 11
Balanced Allocation Mix Balanced Mix 15 Yr Mtg, 10% 30 Yr Mtg, 15% Cash Eq., 20% Weighted Average Return 3.57% Weighted Average Maturity 3.47 years Auto LP, 25% 5 Yr Inv, 30% Cash Eq. Auto LP 5 Yr Inv 15 Yr Mtg 30 Yr Mtg Barbell Allocation Mix Barbell Mix 30 Yr Mtg., 35% Weighted Average Return 3.46% Cash eq., 45% Weighted Average Maturity 3.35 years 15 Yr Mtg, 20% Cash eq. 15 Yr Mtg 30 Yr Mtg. 12
How Market Changes Alter Earning Assets Casey Peterson Sr. Advisor, Advisory Services 13