Pub. 7 2018 Issue 3

Community Bank ALCO meetings have a common denominator, “we are probably going to have to raise deposit costs.” Sound familiar? As the “normalization” of Fed Funds continues, competition for your liabilities are coming back. Remember money market mutual funds? They are approaching 1.50%. 1 Corporate cash today, unlike before the Great Recession, sits predominantly in banks. When corporate sweeps, commercial paper, and funds regain the attention of corporate cash managers, competition for deposits will follow. Given the increased use of pledging to gain municipal deposits, wholesale funding, and overall reduced on balance sheet liquidity, liability side margin pressure seemingly looms. At the same time, loan competition is fierce despite valuation froth in many collateral categories. Credit spreads grind lower with every basis point increase in the yield curve, with loans seemingly priced based on the last deal, won or lost. Anecdotal evidence of credit easing abounds in our conversations. Margin Pressure Growing For the last several years, margin pressure has remained below the surface, hidden by rock bottom deposit costs. Yet the tide is heading out, to paraphrase Warren Buffet, soon we’ll know who’s been swimming naked. Regulators almost certainly will be diligent in the current exam cycle, focusing on aggressive late-cycle commercial lending, loosened credit standards to win deals and decreasing levels of on-balance sheet liquidity. Now back to loan spreads. This chart depicts a typical loan rate in 2016-2018 versus the average treasury curve and 5 year investment for each year. The average 5 year investment yield has increased 125bps from 2016 to 2018. Loan rates, however, have generally only moved 30bps, possibly 40bps if you’re an outlier. As a result, the loan spread above a 5 year investment has collapsed from 300bps to just 205bps since just 2016. 2 Given the high probability of deposit cost pressures this year and next, it is increasingly unjustifiable to press to add that incremental loan, absent increased loan rates. It is incumbent on Asset Liability Committees and Senior Management to set pricing expectations to protect your margin. Unlike the majority of the last decade, the yield curve is moving…daily. There is no greater task than educating your Board, lenders, and thus your borrowers, that a return to pricing loans on a spread basis (not rate) has come. Your margin in the years to come depends on it. Feeling The Squeeze? By Brett Patten, Vice President – BOK Financial Institutional Advisors BOK Financial Institutional Advisors 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.bokfinancial.com/institutions. 1 http://www.barrons.com/public/page/9_0204-trmfy.html 2 This information and the accompanying chart are based on internal historical analysis of community bank loan rates and typical investments purchased during that time. Securities, insurance and advisory services offered by BOK Financial Securities, Inc., member FINRA/SIPC and a subsidiary of BOK Financial Corporation. Some services offered through our affiliate, Institutional Investments, Bank of Oklahoma which operates as a separately identifiable trading department of BOKF, NA. NOT FDIC INSURED | NO BANK GUARANTEE | MAY LOSE VALUE All investments are subject to risk, including possible loss of principal. The opinions expressed herein reflect the judgment of the author at this date and are subject to change without notice and are not a complete analysis of any sector, industry or security. Always consult with a qualified financial professional, accountant or lawyer for legal, tax or investment advice.