If your ALCO Committee’s consensus opinion on the direction of interest rates influences how your bank or credit union manages Interest Rate Risk (IRR), then the answer is likely the former rather than the latter.
During my 12-year banking career, working at four large regional banks (with total assets ranging from $15-40 billion), I had the blessing of sitting on the ALCO Committee as an A/L Analyst and Jr. Portfolio Manager as well as an A/L Manager and Sr. Portfolio Manager at a $24 billion bank. Over time, I came to the realization that no one could accurately predict rates, so the focus of my ALCO meetings evolved into answering two primary questions:
- What is our exposure to changes in rates?
- What can we do about it?
As I shifted the committee’s focus away from the direction of interest rates, we adopted a strategy of keeping our change in Net Interest Income as close to 0% (from base) as possible and sought to grow earnings by growing and/or optimizing the balance sheet.
As of 12/31/18, 4,979 (92%) of all FDIC insured banks are defined as community banks and have average total assets of roughly $450 million. Unlike my experiences at much larger institutions, with dedicated Treasury (e.g. ALM, Funding, Investment Portfolio) personnel, the community bank CEO/CFO often handles Treasury functions. In other words, managing interest rate risk consists of wearing a “Treasury” hat for a few minutes per month and trusting and/or relying heavily on outside resources that may also sell investment securities.
I often tell people that most banks only begin to add seasoned Treasury staff after they’ve stopped getting away with not having it and something bad happens. I’ve seen more than one bank, grow from $½ billion to $10 billion, before the day of reckoning. Think back to 2000-01, when the Fed lowered the overnight rate by 475 basis points (to 1.75% from 6.50%), over the course of 14 months. Institutions that were overly asset-sensitive saw their margins get crushed, which usually led to the CFO, who was never paid anything extra for wearing the aforementioned “Treasury Hat,” getting fired. Fortunately for the new CFO, he or she can now make adding staff, with a solid understanding of IRR, funding and portfolio management, a stipulation for taking on their new role. As the old saying goes: “Fool me once, shame on you. Fool me twice, shame on me!”
What to do now?
If your institution is a smaller credit union or one that falls into the community bank category, hiring an experienced Treasury person (or more) can be expensive and is most likely untenable. Therefore, I would encourage you to develop a relationship with a person or company that only has one mandate: helping your institution understand and manage interest rate risk.
I can’t tell you when rates will go down (or up), but there is historical precedence for slower economic growth when the Treasury curve becomes flat or inverted.
Conclusion: Hold Your Bets Please
According to Wealth Manager magazine: over the more than 20 years of the Wall Street Journal’s semi-annual survey (prior to the “Great Recession” in 2008), the consensus forecast of economists has been on target regarding the direction (not the absolute level) of interest rates, a mere 30% of the time!
