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PCBB Banc Investment Daily October 24, 2017
Banc Investment Daily
October 24, 2017

Is Your Community Bank Hedging Your Risk?

As people age they begin to worry about things such as dementia. After all, Alzheimers is the 56th leading cause of death in the US. Early detection is critical, which is why the findings of University of Chicago researchers are so interesting. They report a simple test smelling 5 different odors of peppermint, fish, orange, rose and leather may help. It seems about 80% of people who only detected 1-2 scents in the research were diagnosed with dementia when tested 5Ys later.
When it comes to banking, there is also plenty of research going on - perhaps not as earth shattering as identifying dementia in the early stages, but interesting nonetheless.
In its latest quarterly report, FDIC research finds community banks are doing well. That does not mean the FDIC doesn't have concerns though. Sure, net interest income climbed by 9%, as loan and lease balances increased 8% overall. Annual loan growth is still at or above GDP growth though, so that has the FDIC a bit more concerned.
That is because community banks are especially susceptible to economic downturns. Given that over 50% of assets for this group carry a longer than 3Y maturity, the FDIC is concerned interest rate risks could be rising so banks are warned to carefully monitor and manage this risk.
There are some moves you can make to sustain growth without compromising a prudent risk profile. First, make sure that your credit risk process is firmly followed. Clearly, credit risk should not be compromised so late in the recovery cycle. Use multiple sources to get a fuller credit picture of customers if possible. Next, be sure all employees are up-to-speed on policies and procedures. Finally, have a strong approach to your ALLL. This will be increasingly important of course with the advent of CECL, so make sure you start asking the necessary questions now to incorporate any updates and process improvements.
Next, closely watch liquidity risk, as depositors have greater mobility these days. Keep your current customers happy as you move to lock them in with cross sell and longer terms (where prudent). This makes moving undesirable for them. Then, bring in new customers for a greater pool of deposits, while still keeping your spread as wide as possible. This may be easier said than done, but coupling nurtured relationships with creative promotions can go a long way to attract new customers.
You may also want to look at interest rate risk in your existing loan portfolio. If you have a large portion of longer-term assets like many community banks, you should consider options to hedge it. Transforming fixed rate loans for customers to floating rate ones for your bank is easier than you think (call us and we will show you how). Keep in mind that with longer term fixed rate loans, debt service is stabilized for customers in rising rate environments, which keeps credit from deteriorating.
Longer term liabilities may also be considered with respect to interest rate risk. Particularly with Trust Preferred Securities (TRuPS), many banks saw their rates float lower following the 2008 recession. Given the current low rate environment, there is still time to consider swapping your floating rate TRuPS to a fixed rate profile.
Maintaining a healthy risk profile is important for continued success. It is an ongoing process that should be re-evaluated as economic factors or customer behaviors change. To get help with hedging to help shore up your portfolio risk profile, feel free to contact us for more information.