Financial institutions trying to minimize their interest rate risk are finding these to be difficult times.
Interest rates are at historic lows. While that may be good for borrowers, it makes things more complicated for institutions which get their bread and butter from interest off loans.
Expectations that rates will rise, even if not much in the next 12 to 18 months, make banks want to invest their money in shorter-term securities.
"Banks or thrifts should not be making long-term commitments in this type of environment," said Ed Townsend, head of a new commercial bank and thrift division at Stifel Nicolaus Co. in Oklahoma City.
"There is not adequate loan demand locally, so financial institutions have to buy investments to get the earning assets they need."
The tricky part is finding investments that pay enough but do not tie up the institution's money for too long.
"What do you do when you can't find enough loan demand and you can't extend your investment because it is not prudent to do so? You have to be extraordinarily careful with your asset-liability management, your interest rate risk, and investments."
Townsend served for four years as chairman, president and chief executive officer of Local Federal Bank FSB. His leadership helped the thrift achieve 1992 record net income of $53 million, the highest ever reported for an Oklahoma financial institution.
Townsend's division, the first of its kind for Stifel, has been under development since he joined the St. Louis-based brokerage in January. The division will advise institutions on asset-liability management, or the management of interest rate risk. In a separate function, it also will develop securities products specifically designed to solve problems financial institutions face.
Many of Oklahoma's banks and thrifts reported record profits during 1992, in large part because of favorable interest rate spreads _ the difference between interest earned on loans and the interest paid on deposits. The spreads were favorable because deposits repriced at lower rates faster than loans, which tend to have longer maturities.
Banks and thrifts do not want long-term investment commitments with rates as they are because they want to be able to put more money in loans as soon as rates rise.
"As the higher-yielding assets are maturing off the books, they will have to be reinvested. Since rates are lower, the level of profitability will decrease somewhat if rates remain where they are. Higher-yielding assets will have to be reinvested in short-term products. The dilemma is what will you invest the money in to get some return over the cost of funds even as low as they are?"
An institution's cost of funds includes everything it takes to run the bank from deposit insurance premiums and staff salaries to the interest rate paid to depositors.
Investments in Treasury bills, notes or bonds do not provide a high enough return to cover that cost because depository financial institutions cannot fund themselves at a lower rate than the federal government, he said. …