Skip to main content

Community Bank's Easy Leverage Strategy

The credit scare/crunch may present a great opportunity for many independent banks who depended on regional home bank system for the funding. This morning Fed funds traded at only 0.25-0.75%, plenty liquidity for banks if you can access it. At the same time Libor 1M and 3M rates went up over 10 bps at 4.11% and 4.33%, indicating extremely tight credit markets. Due to the enormous liquidity Fed has pumped into the system, the funding cost from FHLB, like FHLB Boston, are significantly cheaper than Libor markets. For example, FHLB Boston this morning offered 0.85%, 0.95%, 1.19% and 1.75% for 1 week, 2 week, 1 month and 2 month fundings for its members. On the asset sides, agency (Fannie , Freddie and FHLB) debts were priced at level never seen before in term of spread to treasury in history. Two year agency yield spread is 100 bp over same maturity treasury, historically it has been only between 20 - 30 bps (see the first chart from Bloomberg) and 2 year swap spread had widen over 150 bps over treasury, a historical record (the second Bloomberg chart). FHLB issued $400 millions 1 yr maturity callable note (Bermuda) at 4.00% yesterday. For community banks, this offers a great opportunity to take advantages the dislocations between Fed fund market and Libor market to book some real juice spreads by leveraging balance with very limited interest risk exposure.


If we laddered FHLB short term funding from 1 week to 3 month, and invest in the new 1 yr/3m nc agenecy note at par with yield 4.00%, the bank would be able to lock in spread of whopping 250 bps for next couple of month (See table below).


50 bps DownBase case50 bps Up
1 wk0.35%0.85%1.35%
2 wk0.45%0.95%1.45%
1 month0.69%1.19%1.69%
2 month1.25%1.75%2.25%
3 month2.25%2.75%3.25%
Blended Short term FHLB Funding1.00%1.50%2.00%




FHLB 4.00 10/6/094.00%4.00%4.00%
Yield Spread3.00%2.50%2.00%
Price Return0.01%0.00%-0.25%
Total Return3.01%2.50%1.75%
Parallel curve shift assumed; horizon date 4/1/2009

The most likely outcome is that asset will be called away considering the extraordinary fear and uncertainty in the credit market, we should not be surprised if calm and rational gradually return in the next couple of quarters with or without $700 billions government's rescue packages. The credit spread would narrow and eventually back to norm. The agency spread to treasury currently is not only wide but even much wider than before Uncle Sam took over Freddie and Fannie. Agency debts got the explicit back from government, this temporary indiscriminate sell off from distressed institutions would come to end. Any sign of relief in the market, the asset will come off book so you enjoy 250 bps spread for a quarter. Certainly the only downside is that relative short during of asset and only enjoy income for a quarter or so.

Labels

Labels:

Popular posts from this blog

Dollar and crude oil price

The skidding of dollars against the major foreign currencies, especially Euro were constantly blamed for the seemingly unstoppable skyrocketing crude oil price. The logical explanation for this relationship often quoted was that crude is traded in dollar and the weakening the dollar is the major reason the higher crude oil and hence gasoline price paid at pump. If the arguments for this negative relationship contributing to a high crude price. We would expect a significant correlations between crude price and dollar strength. Are there any significant correlations between oil and dollar? Regressing crude price with dollar index ( DXY ), we did found the strong negative correlations between the two beginning early 2006 up to now. The correlations reached to the highest at -0.96 today. However, this relationship were neither stable nor constant over time. We can see from the attached chart (the green area represents positive correlations and red areas indicated negative relationships...
Read more

Is US Treasury Yield Curve Flattening or Steepening?

There have been nine 25 bps rate hikes since the Fed tried to normalize short term interest rates, or Fed Funds rates, from Dec 17, 2015, the first hike to the latest of round on December 22, 2018. The short term borrowing rate rose from almost zero percent to the target of 2.25-2.5% as of now, and short term bond yields also climbed along with overnight rates. The benchmark yield of 2 year Treasury bond was near 1% when Fed made the first 0.25% rate increase on December 17, 2015, and it rose nearly 140% to about 2.39% as this note generated. However, the long bond or the yield on 30yr US Treasuries is traded at roughly 2.95%, almost the exactly where it was 3 ¼ years ago. The table below looks at the bond yield changes from the date that the Fed made the 1st hike to today. Also visually, the central bank’s gradual rate hike policy since 2015 has pushed yields on short (2 year) and intermediate term note (5 year) steadily marched higher and while 30 year bond yield fluctuated a...
Read more

What history tell us about “Sell in May and Go Away”?

US stock market has experienced one of the best first four-month performance over the last four decades, produced 17.5% price return comparing to 19.1% in 1987. It is the third best price return for S&P 500 index since 1950; the top four-month performance belongs to 27.3% in 1975 as the stock market recovered from a severe bear market in 1973-1974 when the index nosedived more than 42% in two years. With calendar flipped into May and onto summer season of sun, beaches, most likely we would hear a lot of about old Wall Street saying “Say in May and go away” in the media. Moreover, primarily because of the unprecedented nature of speed and magnitude of the current market rally against the backdrop of weakening macroeconomic and corporate earnings backdrops during the period.  Sell in May and Go Way has delivered 6 times more return Historically, the six months between Nov-April frequently experienced extraordinary stock market performance than the six months between May to Oct...
Read more