Pub. 8 2020 Issue 2

www.uba.org 16 $25 million of match funded wholesale leverage. The net effect is to return the balance sheet to its initial size. Specifically, management evaluates roll- ing a three-month FHLB advance and creating term rate protection with a five- year pay-fixed swap costing 0.55% (aka the “Beat-the-Spread” funding strategy) and deploying the funds into securities yielding 1.50%. By executing this strategy, Bank A con- verts a negative spread of 10 basis points into a positive spread of 95 basis points without skewing its asset-liability profile. The strategy produces 7 cents of EPS accretion, two basis points of ROA accretion, and three basis points of NIM accretion. (Please note: If management were con- cerned about shrinking in the future, they might consider funding the securities pur- chases with short-term FHLB advances or brokered CDs rather than with a pay-fixed swap. The asset-liability implications of liability-sensitive leverage can be offset by purchasing shorter duration fixed-rate or floating-rate bonds.) THE FINAL DECISION Once the strategies are built, evaluate them side by side. Strategy 1 (Delever) delivers slight core net income and EPS accretion, but powerful lift in relative profitability metrics. Strategy 2 (Delever/Relever) generates more core net income and EPS accretion, but less improvement in relative profitability metrics. Critically, Strategy 1 is capital accretive, while Strategy 2 is capital neutral. Based exclusively on the numbers, manage- ment would love to execute Strategy 2. However, management understands that in these uncertain times, capital is king. For this reason, management executes Strategy 1. ADDITIONAL STRATEGY CONSIDERATIONS We have structured this case study to focus on two narrowly tailored strategies, but there is so much more that banks can do right now. Three strategies come to mind straight away: 1. Banks can sell MBS or CMBS into the Federal Reserve’s strong bid. Again, realized gains bolster regulatory capital, though they’remost likely neutral to GAAP capital. Realized gains can also be → financial institutions on balance sheet strategy development, which includes interest rate risk management, investment portfolio strategy, retail and wholesale funding management, capital planning, budgeting, and stress testing. Hildenbrand also runs Piper Sandler Hedging Services, LLC, which is registered as a swap introducing broker with the Commodity Futures Trading Commission and is a member of the National Futures Association. In these capaci- ties, Hildenbrand works closely with the firm’s Investment Banking Group to identify and de- velop strategic opportunities for clients involved in mergers and acquisitions. Previously, he was a Principal and Chief Balance Sheet Strategist of Sandler O’Neill + Partners, L.P. Prior thereto, Hildenbrand worked in Sandler O’Neill’s Inter- est Rate Products Group, focusing on developing and implementing structured wholesale funding strategies for financial institutions. He spent his first four years at the firm in the Asset/ Liability Management Group. Prior to joining Sandler O’Neill in 2004, Hildenbrand worked as a financial analyst in asset/liability management at Tower Federal Credit Union in Maryland. Hildenbrand serves as treasurer on the Board of Directors for Liam’s Room, a not-for-profit organization that focuses on pediatric palliative care, a specialized approach to medical care for children with serious illnesses. He is a frequent speaker at industry conferences and seminars. He holds an MBA in finance from Loyola College in Maryland and a bachelor’s degree with a concentration in accounting and finance from Gettysburg College. Matthew Forgotson is a director of Balance Sheet Analysis and Strategy in the Financial Services Group at Piper Sandler. Previous- ly, Forgotson served as a director in Sandler O’Neill’s Balance Sheet Analysis and Strategy Group since 2018. Prior thereto, Forgotson served as senior analyst and director in Sandler O’Neill’s Equity Research Department, covering small and mid- cap banks and thrifts across the United States since 2010. For his work in 2017, Forgotson earned Thomson Reuters StarMine Awards for stock picking and earnings estimation. For- gotson started his career in Washington, D.C. working for Senator Joseph I. Lieberman and the Center for American Progress. Forgotson earned a B.A. in Political Science with Distinc- tion from the University of Michigan as well as an MBA in Finance from the Zicklin School of Business at Baruch College. used to anchor a portfolio repositioning to curtail credit risk, premium risk and reinvestment risk (i.e., fast paying bonds). 2. Institutions that are participating in the Paycheck Protection Program might view the net income from the program as a “backdoor capital raise.” Banks that are comfortable with their credit and capital profiles might choose to leverage the proceeds. 3. Depositories that are bracing for a deceleration in loan demand could pre-invest projected principal cash flows expected, say, over the next year. This strategy would require sourcing short-term wholesale funding, which would put temporary downward pressure on capital ratios. However, the principal cash flows would be used to pay down the short- term debt, ultimately returning the balance sheet to its original size. CONCLUDING THOUGHTS The key is to think holistically about your options, assessing each strategy’s impact on your institution’s asset-lia- bility, earnings, credit, convexity, cap- ital and liquidity profiles. Then think about how you’re going to communi- cate the strategy to your stakeholders. Does the strategy resonate in a world in which safety and soundness matter so much more than profitability and growth? If so, move forward. If not, revisit your options. n Scott Hildenbrand is a managing director and head of Balance Sheet Analysis and Strategy in the Financial Services Group at Piper Sandler. Hildenbrand heads the Balance Sheet Analysis and Strategy Group, working with