September 7, 2008 is the mortgage finance industry’s date of infamy. It’s now been a full decade since the secondary market siblings, Fannie Mae and Freddie Mac, have been in legal custody of the Federal Government. For many community banks, that date was the tipping point of a tortuous era of poor loan demand, sketchy credit quality, weak yields and paltry margins. Not to mention Dodd-Frank.
Now, however, things look much better for the economy in general, and community banking in particular. There are many indicators that demonstrate how the industry’s fortunes have turned, perhaps the most visible of which is, wait for it, earnings. For all of 2017, FDIC-insured institutions reported net income of $163 billion, which was a near record. In just the first six months in 2018, these same institutions have reported $116 billion in net income.
Not been made whole, yet
Several other macro-indicators of banking industry health have ebbed and flowed over the last 10 years. One of these would be housing prices. Nationally, single-family residential costs peaked in mid-2006, and much of the Great Recession can be traced to the collapse of the housing market several years later. Prices fell, on average, over 27 percent and bottomed out in 2012. Since then, housing values have recovered, and are now at all-time highs, but are still only about 11 percent ahead of where they were 12 full years ago.
As housing prices have improved, so have Fannie Mae’s and Freddie Mac’s fortunes. The two government sponsored enterprises (GSEs) both continued to post losses through 2011, and taxpayers provided capital draws to keep them solvent. Both have been profitable for the last seven years, and have more than paid back the draws, but as of yet, they are still operating with next to no capital, since the Treasury continues to sweep their earnings into its own coffers.
Go-to for investors
Still, they remain vital to both the housing industry (over 80 percent of mortgage loans are owned or guaranteed by Fannie or Freddie), and to community bank investors (around 40 percent of their bond portfolios are issued by them). Their popularity with portfolio managers is understandable, since these securities are highly liquid, easily pledged, carry a low 20 percent risk weighting, and their credit quality is considered to be one small rung below that of the U. S. Government’s.
And, their supplies are dwindling. Both of these GSEs have been told by congress to decrease their debt loads, and at this point have only about 40 percent of the outstanding borrowings compared to 2013. In aggregate, the investment sector known as “agency securities” has shrunk by about 40 percent in the last decade, as FHLB borrowings also remain well below their 2008 peak. Add to this the finite quantities of mortgage securities and municipal bonds, and we have a fixed-income market that is very stable from the standpoints of liquidity and incremental yield spreads.
About the only negative for community banks in the current zeitgeist is that their investment portfolios have declined in value. What I hasten to remind investors is this represents a myriad of opportunities. First and foremost is that the bond portfolio’s yield is about to go up. Getting there may take some time, as many banks’ liquidity stockpiles are low, but remember that’s a reason that bank earnings are at record levels.
More immediately, bond swaps that remove some below-market yields and replace them with higher yielding investments can speed up that process. Your tax accountant would be pleased, as you’d effectively be deferring the payment of income taxes into future periods. Periods during which, hopefully, industry profitability will remain strong.
So, in summary, community bankers are enjoying the fruits of their efforts. These efforts include sound business practices, wise investing and steadfast advocacy. Here’s hoping for another decade of success for community banking.
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Economic outlook webinar
Craig Dismuke, Chief Economist for ICBA Securities’ exclusive broker Vining Sparks, will present a quarterly Economic Outlook webinar on October 18. He will review recent Fed activity, analyze the key economic indicators and discuss the landscape for interest rates. Visit viningsparks.com or contact your Vining Sparks sales rep to register.
Jim Reber is president and CEO of ICBA Securities and can be reached at (800) 422-6442 or firstname.lastname@example.org.
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