Are you a Wheel of Fortune fan?
If the answer is yes, then you know when a contestant wins the match and gets to the bonus round, the most obvious letter choices are provided as a clue: RSTLNE. The contestant then chooses three additional consonants and one more vowel to help solve the puzzle.
When managing risk and fair value results where fixed rate mortgages on the books are losing value in the face of rising market interest rates, bankers have their own version of RSTLNE to help manage the fair value challenge.
Similar to the common letters for solving a clue, bankers also have very common techniques to help manage portfolio risk and their fair value risk. According to Ice Data Services BondEdge Analytics, the value of a generic CUSIP 30-year mortgage-backed security with a 3.5% coupon that originated in 2021 has fallen to 89% of par. When shocked by +100 basis points, the value falls to 84% of par. Economic Value of Equity (EVE) for banks or Net Economic Value (NEV) for credit unions can decline rapidly if mortgages of this nature comprise a sizable portion of the balance sheet.
Unfortunately, given the potential loss on sale, most financial institutions do not have the option of selling these lower-priced mortgage loans.
First, do not make the task more difficult by continuing to add long-term, fixed rate mortgages to the books. Instead, you can sell new originations into the secondary market. If priced appropriately, there will be a gain on sale of each loan, generating additional revenue.
Though the average life of low-rate mortgages is lengthening as prepayments slow down, every bit of paydown on this portfolio helps, even if just a little.
Focus on loan growth that acts as a counterweight to those fixed rate mortgages. If you’ve added new borrowers from mortgage volume, you have an excellent opportunity to generate additional wallet share. For example, from a simple query of mortgage borrowers, you can find borrowers with high credit scores and significant equity in their homes and offer them home equity lines of credit (HELOCs) at a favorable rate. HELOCs with variable rates that can be repriced immediately when prime rates change hold their value when rates rise.
Since you’ve already pulled information on these borrowers to generate new HELOCs, why not go a step further?
Do they have auto, RV, or boat loans with other financial institutions? The credit report you already have on file will tell you. Offer to refinance them at a better rate. These consumer loans, especially auto loans, have relatively short average lives that help provide some counterweight to mortgage loans.
Even more, since you’re already communicating with these low credit risk clients, why not offer them a great deal on checking, savings, and money market accounts?
Depending on their rates, such core deposits are valuable – especially in upward rate shock calculations. A certificate of deposit (CD) can also help EVE/NEV in rate shock calculations as a CD’s interest rate and maturity length can become more valuable in upward rate shocks – providing an excellent counterweight to the challenges of fixed rate mortgages.
Will these RSTLNE ideas completely solve your fair value challenges? Probably not. But they will help. And you’ll generate profitable new volume.
Most financial institutions don’t want to resort to complicated and often risky hedging transactions. So, taking many small steps in the asset liability management process can be an effective way to help lower your fair value risk.
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