tag:blogger.com,1999:blog-5389144729834496735.post7967091694667864073..comments2024-03-17T05:15:55.634-04:00Comments on The Brooklyn Investor: Net Interest Margins etc.Unknownnoreply@blogger.comBlogger12125tag:blogger.com,1999:blog-5389144729834496735.post-15951994647813253762012-06-20T11:15:53.153-04:002012-06-20T11:15:53.153-04:00Hi, nice post. I have been wondering about this to...Hi, nice post. I have been wondering about this topic, so thanks for sharing. I will certainly be subscribing to your blog.internethttp://instacms.comnoreply@blogger.comtag:blogger.com,1999:blog-5389144729834496735.post-66882574629466530552012-06-19T23:05:52.079-04:002012-06-19T23:05:52.079-04:00Great post. Too many blogs just put up subjective ...Great post. Too many blogs just put up subjective commentary and not actual facts and figures to back up their opinion. I like what you've done with NIMs and US banks here, and have just added your blog to my RSS reader.<br /><br />Keep it coming!Anonymousnoreply@blogger.comtag:blogger.com,1999:blog-5389144729834496735.post-18594168411620239142012-06-19T23:01:51.120-04:002012-06-19T23:01:51.120-04:00Fantastic blog. Just wanted to bring the conversat...Fantastic blog. Just wanted to bring the conversation back to the question another poster had earlier that I have never been able to wrap my head around. With all these hedges in order to match the duration (I assume they are also hedging the negative convexity of the mortgage loans?) who is really on the other side. People have told me for years that the banks lay off the risk but where is it really going? At some point, someone has to take that exposure, it doesn't just go away. This has always confused me. <br /><br />I guess at a high level the fixed exposure that is laid off is taken by someone looking for increased duration which should be offsetting another position so if the entire marketplace hedged, they could all net out their exposure? It just seems at some point someone has to take the risk. <br /><br />Apologies for the long post.Anonymousnoreply@blogger.comtag:blogger.com,1999:blog-5389144729834496735.post-13254821410826881252012-06-19T14:42:39.921-04:002012-06-19T14:42:39.921-04:00This has been a very useful discussion for me. Th...This has been a very useful discussion for me. Thank you.<br /><br />I like the analysis you did to get to the $370M net number. <br /><br />FWIW, I've been doing some more investigation - and the FFIEC call report for Wells Fargo (Sioux Falls) has some very useful information. The call report breaks out values for securities/loans/leases with maturity over 15 years. Securities with 15+ year maturity are roughly $90B and loans/leases with 15+ yr maturity are roughly $130B. So, I'm getting much more comfortable with the loan durations and rising interest rate exposure.<br /><br />I still wonder who is on the other side of any interest rate hedges? Hedging interest rates via swaps is a zero sum game, so someone has long-term interest rate exposure. Who can that be besides the banks?<br /><br />Cheers,<br />Tom LTom Lnoreply@blogger.comtag:blogger.com,1999:blog-5389144729834496735.post-71937159727350180912012-06-19T12:07:52.071-04:002012-06-19T12:07:52.071-04:00OK, I took a quick look. I may look into the swap...OK, I took a quick look. I may look into the swaps and hedges later if I have time, but for now here is where I would start: <br /><br />WFC has $770 billion in loans outstanding. A big rise in rates would cause the fair value of this portfolio to decline. <br /><br />But first, we can already see that $112 billion of this is loans maturing in less than one year. Also, $147 billion of loans more than a year out is floating rate or adjustable rate. <br /><br />So combining the two, that's $259 billion. So the interest rate exposure only applies to the other $511 billion. <br /><br />We also see that WFC has $141 billion in long term debt outstanding. A rise in rates would cause the fair value of this to decline too, so that would be an offset to the loan portfolio decline (banks often issue bonds for asset/liability management purposes). <br /><br />So right there, netting out this stuff, you have $370 billion in interest rate exposure. I bet the WFC bond maturities are longer than the loan book, so from a duration standpoint it would probably offset more interest rate risk than the amount of bonds outstanding suggests. <br /><br />This is before any swaps or other hedges.<br /><br />I did say above that banks are probably matched up duration-wise, but that's probably an overstatement. <br /><br />To the extent that they don't have to mark to market and they can hold loans at a positive spread, it won't hurt the bank and the thinking is probably that rising rates will also mean higher interest income on new loans being made so that would be an offset.kkhttps://www.blogger.com/profile/06299974418283948333noreply@blogger.comtag:blogger.com,1999:blog-5389144729834496735.post-40558825520695940312012-06-19T11:12:18.420-04:002012-06-19T11:12:18.420-04:00Hi, that's a very good point. The interest ra...Hi, that's a very good point. The interest rate sensitivities for WFC probably just addresses income statement and not the balance sheet.<br /><br />A full analysis won't be as simple as you state either because not all loans are fixed rate; many loans are variable rate. You are also right that bank loans aren't typically marked-to-market but held at par less reserves for losses. <br /><br />But let's say interest rates move suddenly. There will value lost in value of fixed rate loans (that won't be marked), but there will also be a decline in the fair value of liabilities. <br /><br />Also, to the extent banks may do asset/liability management to hedge this duration mismatch, the fair value loss won't be as large as it seems. The hedge can be on the loan side or the liability side. If a bank does a pay fix/receive float swap, then they can lock in their funding cost and if that is lower than their loan rate, that cash flow stream is locked in at that point so it would be immune to interest rate fluctuations (but not to changes in the discount rate to put a value on that). If the value of the loans plunge, the value of the 'pay-fixed/receive float' swap would go up. <br /><br />It is pretty complex for sure.<br /><br />Anyway, the first thing I would do is (if you are worried about duration mismatch) see how much of the loan book is fixed versus floating rate. Then see the duration of the liabs (long term debt). <br /><br />I think in the old days there was more discussion about this in the 10K's, but WFC doesn't seem to talk about this much in the recent 10K. <br /><br />I may be wrong, but I tend to think they are pretty matched these days (after all the problems that have occured in the past 30 years). <br /> <br />If I find something, I'll post it here...kkhttps://www.blogger.com/profile/06299974418283948333noreply@blogger.comtag:blogger.com,1999:blog-5389144729834496735.post-9302818198870526692012-06-19T10:24:40.227-04:002012-06-19T10:24:40.227-04:00Hi kk,
Thanks for the reply. I'm new to bank...Hi kk,<br /><br />Thanks for the reply. I'm new to banking, so hopefully my questions aren't too basic.<br /><br />Regarding WFC, on p78 they talk about earnings at risk over the next 12 months - but this seems different to me than their balance sheet risk. <br /><br />My understanding is that the balance sheet could take a hit on a mark-to-market basis, while earnings are relatively unaffected. This is because loans may be accounted for on a held-to-maturity basis, ie accounted for based on their principle value, not market value. To be concrete, lets assume a 5 year loan maturity, 4% loan yield, and 0% deposit cost. Now lets assume that long term rates jump by 2% tomorrow. The economic value of the loans will decline by about 10%. However, the income statement for the next year will be relatively unaffected. The accounting will still show about a 4% NIM. If this is obvious, I apologize.<br /><br />I'm trying to understand the duration of WFC's ~$750B loan book. I can't seem to wrap my head around this even after going through their 10-K. The best I can find is Table 13 on p43, but this is limited. <br /><br />Am I missing something obvious? How would you estimate the duration of WFC's assets? If the banks are indeed hedging the duration of their assets (by using swaps to convert fixed payments to floating) then who is on the other side of the hedge? Someone has to have exposure to long-term interest rates.<br /><br />Thanks for the discussion.<br /><br />Cheers,<br />Tom LTom Lnoreply@blogger.comtag:blogger.com,1999:blog-5389144729834496735.post-9495565783114789122012-06-19T08:32:59.481-04:002012-06-19T08:32:59.481-04:00Thanks for the comment; no, I don't have a Twi...Thanks for the comment; no, I don't have a Twitter account. <br /><br />Banks basically take deposits from customers (checking accounts, savings accounts, CDs etc.) and take those funds to make loans; credit card loans, mortgages, commercial and industrial loans etc. <br /><br />The 10-2 is important (or was more important in the past) because the 10 year was a proxy for loan rates and the 2 yr was a proxy for funding costs (deposit rates, savings accounts, CDs etc. tend to correlate with the short end of the curve (they also lend/borrow at the Fed Funds rate) and loans (mortgages, for example) tend to correlate with longer term yields. <br /><br />That's the basic, simple model of how banks operate. <br /><br />Typically, if long term interest rates go down, it's OK because short term rates go down too; if loan yields go down, funding cost goes down too so it's OK. <br /><br />Now with short term rates at zero or near zero, further long term rate reductions can't be offset by lower short term rates so any further long term rate reduction just leads to direct NIM reduction and that's no good. That's the problem. <br /><br />As for how banks work, I don't know of any good books about it. <br /><br />I find that the best way to learn about an industry is to just order up a bunch of annual reports, 10K's and stuff like that and read as much as you can. If you can bear it, find a small, simple bank and read the 10K from cover to cover. If there are words and concepts you don't understand, just google it and you can find out what it means. <br /><br />If you do that, try to stay with simple banks; stay away from JPM, C, BAC for example, as they are huge, complex organizations. <br /><br />WFC is relatively simple, but simple regionals might be better like M&T Bank. Banks in your region might be good to read too. <br /><br />Anyway, that's the best way to learn about it and the best thing is that all of this stuff is available for free on the internet at company websites and the SEC website...kkhttps://www.blogger.com/profile/06299974418283948333noreply@blogger.comtag:blogger.com,1999:blog-5389144729834496735.post-81038106594750676832012-06-19T03:50:50.243-04:002012-06-19T03:50:50.243-04:00Hi, this analysis is really a change compared to o...Hi, this analysis is really a change compared to other blogs. <br /><br />I was surfing couple of months ago, trying to understand how the banks invest their money and didnt quite get the problem with NIM. Could you explain me, how they finance themselves and how do banks invest that money. I suppose that, they collect cds and invest in consumer loans, but why is the spread 10yr - 2yr so important? How and why banks manage to pay for the 1 year deposits more then a 1 year treasury rate, why they don't borrow money from other institutions for lower rate instead?<br /><br />Also, if the rates go down, why they just don't pass it to the consumers (both commercial and depositors) and keep NIM stable?<br /><br />If this is too many questions, maybe you could recommend me online article or maybe a textbook so I could read it, because I am thinking about this for a long time, and it frustrates me that I still don't understand it.<br /><br /><br />Thanks in advance,<br /><br />Do you have a twitter account?Anonymousnoreply@blogger.comtag:blogger.com,1999:blog-5389144729834496735.post-24221863129855796102012-06-18T14:53:53.815-04:002012-06-18T14:53:53.815-04:00Hi, Thanks for the post.
Banks are pretty hedged...Hi, Thanks for the post. <br /><br />Banks are pretty hedged out in terms of interest rate exposure so a scenario like you describe would be highly unlikely. Of course, spiking interest rates would cause all sorts of problems to be sure, but not a linear loss like that. <br /><br />If you dig into the 10K's, banks will usually have some sort of sensitivity analysis somewhere that tells you what happens to the balance sheet with 100 bps, 200 bps shifts in interest rates, yield curve etc. <br /><br />For WFC, I didn't see a table but there was a description in the risk sectinon (page 78) that said that earnings at risk are less than 1% for moves up and down in interest rates. The declining rate scenario was FF unchanged and 10-year Treasuries averaging below 2.0% yield, and the rate rise scenario is for the FF to go to 3.75% and 10-year to go to 5.10%. If those scenarios happened, the earnings at risk (for next 12 months) would be less than 1%. <br /><br />That seems implausible, I know. But through swaps and whatnot, banks have matched up their assets/liabilities pretty tightly. <br /><br />You can go through other bank 10-K's and see all of that. <br /><br />Of course, the problem is that these are 'static' analyses, so they won't tell you what happens in a crazy, volatile environment like the 70s. They just tell you, with the current portfolio as it is and with swaps and other positions in place, if interest rates moved like this or that, this is what the impact would be. <br /><br />etc...kkhttps://www.blogger.com/profile/06299974418283948333noreply@blogger.comtag:blogger.com,1999:blog-5389144729834496735.post-56084413924689475242012-06-18T14:21:14.905-04:002012-06-18T14:21:14.905-04:00EDIT TO LAST POST:
"It would be interesting ...EDIT TO LAST POST:<br /><br />"It would be interesting to see how top-notch banks fared during the rising rate environment of the 1970s."<br /><br />Tom LAnonymousnoreply@blogger.comtag:blogger.com,1999:blog-5389144729834496735.post-4056277578843518002012-06-18T14:19:00.088-04:002012-06-18T14:19:00.088-04:00Thank you for sharing your thoughts, as always.
...Thank you for sharing your thoughts, as always. <br /><br />For the sake of discussion, I'm curious what you think would happen if long term rates rose - not because of economic strength, but because the bond vigilantes returned and demanded a higher yield? <br /><br />Assuming a 5 year duration on a bank's loan book, if rates rose by 2% then the market value of the loans would decline by 10%. If loans/equity = 10 today, then this rise in rates would wipe out all of the bank's equity on a mark-to-market basis. Obviously if rates rose more, then on a mtm basis things are even worse from a balance sheet perspective. <br /><br />Do you think that this can't happen? Or, do you think that this wouldn't be a big deal? <br /><br />It would make a fascinating blog post to see how top-notch banks fared in that environment. But, I'm sure the data will be harder to dig up.<br /><br />Thank you for the excellent blog!<br /><br />Cheers,<br />Tom LAnonymousnoreply@blogger.com