Pub. 5 2016 Issue 1

l e a d i n g a d v o c a t e f o r t h e b a n k i n g i n d u s t r y i n k a n s a s 26 T HROUGHOUT THE ECONOMICRECOVERY, expectations for the future level of interest rates, employment and GDP growth have consistently been more optimistic than the actual reported numbers. The pervasively slow and steady recovery has proven even the median forecast for future economic activity to be widely optimistic for the better part of this decade. In March, the Fed forecast for GDP in 2017 fell to just 2.0% - 2.4%, a range that certainly squares with the average realized growth of 2% since 1st quarter of 2010. Lowered GDP forecasts, strong dollar’s impact on trade, and correspondingly low levels of inflation expectations complicate the situation for the Federal Reserve. This situation has not gone unnoticed by the bond market which has flattened the yield curve substantially from levels seen early last year. This trend, should it continue as the Fed embarks on tightening could certainly become troublesome for managers of interest rate risk positions in the years to come. What does your rate risk look like with a flat curve at low rates? The Fed seemingly would prefer to lift off the front end of the yield curve if for no other reason than to have ammunition down the road to adjust policy in the next recession. However, slowing growth and potential deflationary pressures around the globe are resulting in easing policies outside the United States which have kept a lid on long-term interest rates in the developed world. Consider then an environment where the Fed raises the overnight rate overtime and the rest of the yield curve moves only modestly. Scenarios to Consider Any move towards a flatter curve at relatively low rates seems likely to happen over a period of time as the Fed has communicated thus far a measured and data dependent path to higher Fed Funds rates. Given this guidance we see it plausible that a ramped move to this flat curve shape could happen over a multi-year period. Perhaps a two year ramped rate shock to this curve shape would provide a more realistic assessment of the rate risk position, but an immediate move should be analyzed as well. In addition, you may want to consider a reversion of the deposit mix to pre-crisis levels when running this scenario and others. In this scenario, reliance upon time deposits and wholesale funding would increase while demand deposits and savings accounts would comprise a smaller percentage of deposits as would less sensitive money market accounts. Based upon our experience, we believe this scenario would likely illustrate one of the biggest risks from an earnings standpoint. Strategies to Mitigate the Risk Depending what can be gleaned from these scenarios, and the probabilities you assign to them, there could be several strategies worthy of consideration to help mitigate unwanted rate risk. A few possible strategies include: • Targeting floating rate loans • Converting fixed rate loans to floating • Callable brokered deposits • Floating rate investments Assigning a reasonable probability to a few scenarios and determining the corresponding impact to the rate risk of your institution is a critical function of your ALCO process. Taking on scenario analysis in the coming months which stresses your rate risk position in a variety of monetary policy tightening outcomes will help you uncover and prepare for risks your institution may want to mitigate. The BOK Financial - Financial Institutions Group provides third party asset liability reviews, modeling, consulting, decay rate studies, and investment portfolio strategy and can be reached at 866.440.6515 or learn more at www. boscinc.com/services. NAVIGATING A FLAT CURVE AT LOW RATES WHAT REDUCED GDP FORECASTS COULD MEAN FOR YOUR FUTURE INTEREST RATE RISK POSITION