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Market Comment (July 2010)
Economists are seeing continued signs of recovery in the United States as more businesses started hiring, while fewer cut jobs. However, it appears as though the pace of the recovery has slowed since the first quarter. That said, over two-thirds of the experts interviewed felt that the economy will grow by more than 2% during 2010. A key statistic that provides some level of optimism is that 31 percent of businesses are now in a hiring mode, compared to just 6 percent at the same time last year. Putting people back on the payroll could have a snowball effect on hiring at other companies.
During June, unemployment fell in 39 states, but the bulk of the declines were due to workers giving up and leaving the workforce, not because of added jobs. It is estimated that over 600,000 workers gave up looking for employment during the month. This is reflected in the fact that just 21 states added jobs during the month, which is the lowest so far this year. Losing thousands of census positions was one of the factors that contributed to the new job decline.
A key piece of proposed legislation currently being debated is an extension of unemployment benefits. Whether or not additional benefits would be exceedingly helpful or necessary is only a piece of the argument. The more difficult one, as is common in politics, is the source of funding for such a proposal. Democrats are pushing for additional deficit spending, while Conservatives are asking for cuts in other programs in order to vote yes on the extension. Whether or not a deal is made could be a key factor in national spending and consumer confidence figures.
On the international scene, Moody’s made headlines by cutting Ireland’s credit rating to Aa2, while also changing its outlook to stable. One of the primary reasons for the cut was Ireland’s bailout of Anglo Irish Bank last year. Overall, the downgrade was an expected one, and likely not the last in the Eurozone economies.
Banking
The financial regulation overhaul that passed just last week has plenty of opponents, and for good reason. One of the main provisions drawing criticism is the power the Fed has to take over companies it believes are ‘too big to fail.’ This will allow them to control all facets of a company from capital levels to liquidity policies, an idea that should strike fear into employees and owners of said company. In addition, there are some general indications that minimum capital levels will be increased on an international basis, and this will have a direct impact on either shareholder value or customer fees. A combination of both is the most likely scenario, and we may see a situation where many bank customers will be driven out of the market by the institution of new or higher fees.
Also during July, the FDIC made its new $250,000 insurance per depositor limit permanent, replacing the current expiration of December 31, 2013. This was a widely anticipated change, but it gives some certainty to entities who may wish to own bank products maturing past the old expiration date. In addition, the Unlimited Transaction Account Guarantee program was extended another six months to December 31, 2010. However, the maximum rate that can be paid on these accounts was lowered to 0.25% from 0.50%.
Money Markets
Yields on local government investment pools and other money market funds are consistently yielding less than 0.25%. Given the Fed’s continued pronouncements of lower interest rates “for an extended period” it is difficult to imagine a scenario where this will change significantly in the next six months. Fed Chairman Ben Bernanke recently said the economic conditions are ‘Unusually uncertain,’ adding to the difficulty of investment planning. Furthermore, SEC regulations implemented in May that will require Money Market Mutual Funds (often referred to as 2a-7 funds) to hold up to 10% in overnight liquidity and 30% for weekly liquidity will reduce money market account returns even more as these funds will be required to hold more of their portfolios in shorter maturity, lower yielding investments. However, this is not the time to accept diminished returns. With proper planning, local governments have several options that could improve yields by 50 basis points over current money market yields, without increasing overall risk. If you would like to discuss these options please contact Ken Herdeman (262-796-6164), kherdeman@bankersbankusa.com or Brian Mann (651-697-8565), bmann@bankersbankusa.com.
(END)July 2010
Market Comment (June 2010)
On June 25th the Commerce Department reported that the U.S. economy grew at an annual rate of 2.7% for the first quarter. This growth rate was slower than originally projected and was attributed to lower consumer spending and rising imports. Some economists predict slower growth rates in the months ahead as factories scale back production in order to shrink inventories built up in anticipation of increased consumer demand that did not materialize. There is also concern that continued high unemployment, fading federal government stimulus spending and less local government spending along with higher municipal taxes needed to close budget gaps, will put any economic recovery in jeopardy.
When the Commerce Department reported on June 28th that consumer spending in the U.S. rose 0.20% in May, the median estimate of economists surveyed by Bloomberg News called for a 0.10% increase. Michael Feroli, chief U.S. economist for JPMorgan Chase said “The labor market is gradually improving, labor income is picking up and that should continue to support spending.”
Mr. Feroli may be in the minority and give too much credit to a slightly improved, although better than expected, first glance report. On June 23rd the Federal Reserve Bank reported that it will keep short-term interest rates near zero for “an extended period”. Most economists expected this from the Fed as they saw an unemployment rate of 9.7% adding to pressures on consumer spending. The Fed statement went on to say that “Financial conditions have become less supportive of economic growth on balance, largely reflecting developments abroad”. And after stating in April that economic activity “continued to strengthen” the Fed statement in May cautioned the economic recovery was “proceeding” and was “likely to be moderate for some time.”
A little watched Credit Mangers’ Index (the CMI) implies that restrained credit conditions and consumer cash flow will be a further constraint to economic growth. The CMI index dropped from 56.5 in April to 55.9 in May. Although the drop was less than one point, it was the first drop in the index since early 2009. This indicated that credit managers are adopting an even more conservative attitude toward financial management as they wait for the consumer to come to the aid of a slowly growing economy.
Banking
Congressional negotiators agreed on a bill increasing regulation over financial companies and banks, stopping short on some of the more restrictive provisions originally contemplated. This news sent stock prices of financial companies and banks higher as investors were relieved that the regulations will not have significant impact on profitability. The legislation constrains trading in complex derivative instruments but is not as restrictive as first proposed. Rules imposing limitations on commercial banks proprietary trading, the practice of trading solely for the banks’ account in an effort to increase the banks’ profits was also much milder than originally proposed. As first proposed the so called Volker Rule (named after former Fed Chairman Paul Volker) would have effectively banned commercial banks from proprietary trading. Many proponents of stricter financial company regulation fear that it will be business as usual and the legislation as proposed will do little to avert another financial market calamity.
Money Markets
Yields on local government investment pools and other money market funds are consistently yielding less than 0.25%. Given the Feds continued pronouncements of lower interest rates “for an extended period” it is difficult to imagine a scenario where this will change significantly in the next six months, and with legislative and monetary policies remaining uncertain, investment strategies can be difficult to establish. Furthermore, SEC regulations implemented in May that will require Money Market Mutual Funds (often referred to as 2a-7 funds) to hold up to 10% in overnight liquidity and 30% for weekly liquidity will reduce money market account returns even more as these funds will be required to hold more of their portfolios in shorter maturity, lower yielding investments. However, this is not the time to accept diminished returns. With proper planning, local governments have several options that could improve yields by 50 basis points over current money market yields, without increasing overall risk. If you would like to discuss these options please contact Ken Herdeman (262-796-6164), kherdeman@bankersbankusa.com or Brian Mann (651-697-8565), bmann@bankersbankusa.com.
(END)June 2010
Market Comment (May 2010)
European economies, due to concerns about their financial strength and the strength of the banks holding their bonds, roiled stock markets around the world in May. Even as retailers, realtors and auto makers reported improved sales figures, concern over financial market reforms proposed in the U.S. and Europe, along with budget deficits and debt levels in Europe, threaten to bring the modest improvements in the economy over the past year to a screeching halt.
While there are many positive indicators, it remains prudent to be conservative regarding any type of full blown near term recovery. There are still too many bad assets, unemployment remains high, and there is generally too much uncertainty.
Equity markets were rocked in May, with investors trying to weigh economic statistics, earnings announcements, and legislative news regarding financial market regulation both in the U.S. and Europe. Bond markets have seen a lot of activity over the last thirty days, particularly towards the long end of the yield curve. As of this writing, a ten year Treasury was yielding 3.12%. The yield on the same investment in mid-April was nearly 3.87%. The two, three, and five year bonds moved down 36, 54, and 68 basis points in yield, respectively. This type of activity on the longer term issues indicated increased demand as a sign of flight to quality as investors feel positive economic indicators are not as strong as originally perceived and certainly not sustainable. Inflation figures released recently also indicate lower interest rates for the foreseeable future. Investors focusing on near-term maturities will find it extremely difficult to improve returns.
The Federal Reserve Bank also reiterated that interest rates would remain low for an “extended period”. Furthermore, the fed announced its intentions not to “sell any of its securities holdings in the near term, at least until after policy tightening has gotten under way and the economy is clearly in a sustainable recovery”.
The fed owns $1.12 trillion in mortgage-backed securities and $167.6 billion in other agency debt that it acquired at the height of the economic crisis in an effort to inject liquidity into the banking system. The fed conceded “asset sales … would serve to raise short-term interest rates” and “put upward pressure on longer-term interest rates”. The benchmark rate for overnight lending between banks has been frozen between 0.00% and 0.25% since December 2008.
Banking
The Federal Deposit Insurance Corporation (FDIC) reported insured commercial banks and savings institutions earned an aggregate profit of $18.0 billion in the first quarter of 2010, an improvement of $12.5 billion over the first quarter of 2009. Although the percentage of non-current loans and leases rose from 5.38% to 5.45%, it was the smallest quarterly increase in two and a half years. The growth of troubled loans slowed for a fourth consecutive quarter, the FDIC reported.
In a first quarter survey of loan officers at over 80 U.S. banks and U.S. branches of foreign banks, the Federal Reserve Bank reported that most banks did not tighten lending standards in the first quarter. The survey indicated more banks eased standards than tightened for the second quarter in a row, a sign that bank credit is beginning to thaw.
Money Markets
Yields on local government investment pools and other money market funds are consistently yielding less than 0.25%. It is difficult to imagine a scenario where this will change significantly in the next six months, and with legislative and monetary policies remaining uncertain, investment strategies can be difficult to establish. However, this is not the time to accept diminished returns. With proper planning, local governments have several options that could improve yields by 50 basis points over current money market yields, without increasing overall risk. If you would like to discuss these options please contact Ken Herdeman (262-796-6164), kherdeman@bankersbankusa.com or Brian Mann (651-697-8565), bmann@bankersbankusa.com.
(END)May 2010
Market Comment (April 2010)
Sovereign debt struggles continue to make headlines around the world. From Greece to Spain, Portugal to Dubai, both established and emerging economies are reeling in the wake of the global economic slowdown. Greece is perhaps in the most ominous position, and they will be sending representatives to Washington to address the International Monetary Fund. The country will likely be seeking some sort of complementary bailout from the IMF to the one they are currently discussing with the European Union. The agreement with the EU will likely be over $40 billion US, and the extent of the IMF’s involvement will not be known for a few weeks.
Members of the G-7, while not in the dire economic straits of some of the aforementioned, have seen their debt as a percentage of GDP grow to a 50-year high. Unless this trend is stopped or reversed completely, it might not be long before a country like the United States could see its debt rating fall from AAA. The reverberations of such an event would be countless and substantial, as the world has come to accept a U.S. Treasury Bill as a risk-free asset. One potential ramification for local governments would be the credit ratings of their municipal debt. Would we see across the board cuts on bond ratings, or could we find ourselves in a situation where some local governments have a better credit rating than the U.S. government? If so, we could see significant, fundamental changes in the way our state and local governments interact with their counterparts at the federal level.
Unemployment figures continue to keep any hopes of real recovery in check, as we just can’t seem to retreat from the nearly 10% level we have seen throughout 2010. The number of people continuing to collect state benefits is at the lowest level in over a year, down to 4.64 million. This decrease, however, is more likely the result of people exhausting state benefits (which typically last 26 weeks) and moving to the 73 weeks of coverage provided by the federal government. The bottom line is, despite GDP growth and strong corporate profits making a return, our recovery will feel shaky and weak without substantial improvement in the unemployment figure.
The housing market showed some positive signs in March, as existing home sales were up 6.8% from February, and 16.1% year over year. Some caveats to consider:
• The first time homebuyer credit will end on April 30th
• Distressed sales accounted for 35% of the activity in March
• Housing inventory rose by 1.5% from February
What might these statistics tell us? For one, it will be a tough test for the market when first time homebuyers are no longer motivated by a cash prize for their purchase. Second, the high percentage of distressed sales is typically not a good thing for home prices, since they are often deeply discounted to move quickly. Third, with an increasing inventory, the real estate market may be in for a double dose of negativity, coupling many first time buyers stepping back from the search and too much inventory available.
Banking
Financial regulation reform is a hot topic in Washington right now, with the debate covering the spectrum from adding additional regulatory bodies to consolidating existing ones. Also, the size of the so-called ‘megabanks’ has become one of the more heated discussions. The argument revolves around whether or not it is the Federal Government’s job to dictate how big a business can be. Obviously, you run into some very philosophical differences on the type of capitalism we should be pursuing in this country. Perhaps a better first step would be the reenactment of the Glass-Steagall Act, the legislation that kept commercial banks separate from investment banks. This would, by design, reduce the size of many of the largest institutions, and if we continued to see problems we could revisit the idea of regulating bank size.
Money Markets
As traditional money funds struggle to add value to municipal investment portfolios, now is not the time to accept diminished returns. With proper planning, local governments have options that could substantially improve yields over current money market returns, without increasing credit risk. To discuss these options, please contact Ken Herdeman (262-796-6164), kherdeman@bankersbankusa.com or Brian Mann (651-697-8565), bmann@bankersbankusa.com.
(END)April 2010
Market Comment (March 2010)
From headlines of Greece and Dubai needing bailouts, to a U.S. economy that continues to lose jobs, to a real estate market that can’t seem to get back on track despite billions of ‘stimulus,’ it is difficult to believe Washington’s assessment that we are in any kind of sustainable recovery. With the scheduled end of the first time homebuyer program just a month away, and the government pledge to begin the process of removing itself from the financial markets, we will find out if our fragile economy is ready to stand on its own. This will be the truest test of our so-called recovery.
Another governing body that will be under a magnifying glass in the coming months is the Federal Reserve. With an unprecedented commitment to low rates in an effort to boost economic growth, the Fed chairmen are now charged with balancing their loose monetary policy with threats of inflation. If they raise rates too soon or too quickly, they run the risk of stifling a meek economy. If they wait too long or raise rates too slowly, inflation could run amok, further deteriorating the dollar’s status as the world reserve currency. The consensus among many U.S. economists is that the Fed will raise rates in six months between a quarter and a half percent.
Real estate markets around the world continue to be at the core of the recession. In the U.S., Fiserv and Moody’s collaborated on a report that predicts home prices will fall another 6% by September 2011. The authors of the report feel that continued foreclosures and the end of government programs currently propping up home purchases will be the primary factors contributing to the decline. Of course, if the private sector starts to experience a recovery and demand more jobs, this could stem the projected decline in real estate prices, as well as the number of foreclosure filings.
Another variable in the financial markets will be the government’s health care proposal. With the administration passing the bill in March, this could be interpreted as a large shift of GDP from the private to the public sector, which will eventually hurt the equity markets. As funds flow from stocks, they will likely be reinvested in short-term fixed income products that could put pressure on rates and keep them low.
Banking
There were 703 problem banks in the U.S. as of 12/31/09, which represents the highest level since 1993. It is obvious that institutions across the country are still working through the troubled assets they accumulated over the last decade, and it is unclear when we will start to see an improvement in this area. On the bright side, the industry as a whole did post a fourth quarter profit of just under $1 billion, a significant improvement from the almost $38 billion that was lost in the fourth quarter of 2008.
That said, we have experienced 37 bank failures through 3/18/10, with four of those occurring in Minnesota and three in Illinois. This is a bad sign compared to this point in 2009 when we had seen just 20 failures with none in Minnesota and three in Illinois. Wisconsin has had only one failure in the last two years.
Bank regulation reform has been a hot topic during the most recent legislative session, despite being vastly overshadowed by healthcare. As is typical on Capitol Hill, there are plenty of skeptics arguing that the bill goes too far. One case where this may be true is the power given to the Treasury that allows them to close a bank or broker/dealer if they believe it could fail. Contrary to other situations where a company’s board or management voluntarily enters a closure, this would force the action upon a company that might not think it is in a position that requires it.
There are some good pieces in the bill regarding consumer protection, activist shareholder power, and excessive risk-taking. The biggest debate will likely revolve around who shall be responsible for the various components, as well as how much power will remain with the Federal Reserve. Many in Washington don’t like the lack of any accountability of the Fed to lawmakers, which could greatly influence votes.
Money Markets
As traditional money funds struggle to add value to municipal investment portfolios, now is not the time to accept diminished returns. With proper planning, local governments have options that could substantially improve yields over current money market returns, without increasing credit risk. If you would like to discuss these options, please contact Ken Herdeman (262-796-6164), kherdeman@bankersbankusa.com or Brian Mann (651-697-8565), bmann@bankersbankusa.com.
(END)March 2010
Market Comment (February 2010)
Through 2008 most global economies were feeling the same pain, although the severity varied. From the U.S. to Europe to China and other Asian economies, credit was hard to come by, demand shriveled, output plunged and global economic growth slowed sharply.
Since the 3rd quarter of 2009 signs of recovery began to appear in isolated areas around the world. The U.S. economy is recovering at a faster pace than European and Asian economies, but sustaining this pace will depend largely on if, and how, other nations modify monetary and fiscal policy. Greece, Spain and Ireland continue to struggle, which has an impact on every euro based economy. As this reflects on the currency, exports are affected, which slows output and growth. Furthermore, job losses in Europe are similar to those in the U.S. so domestic demand increases are not anticipated.
In the U.S., much of the recent recovery is due to stimulus spending. Much of this spending will end by mid-2010. As states struggle to balance budgets, they are making cuts at a furious pace as tax revenues decline due to high unemployment and sluggish consumer demand. And although the House has passed billions in job creating stimulus legislation, the Senate has yet to take up the torch.
Global economies are intertwined to the point that the pace of recovery is just as important as degree. Currency and commodity price fluctuations could be significant enough to actually dampen a recovery. Oil prices have increased to the point where the average price of a gallon of gas is nearly 40% higher than it was a year ago.
Global economies are growing at different rates but they must also grow in different ways. Countries like China, Japan and Germany must put more emphasis on domestic demand while borrowers like the U.S. cut budget deficits in order to create jobs and sustain economic growth.
Banking
Although President Obama has stated that “Never again will the American taxpayer be held hostage by a bank that is too big to fail,” it may be hard to achieve and may have a disproportionate impact on smaller financial institutions.
The President’s comments are aimed primarily at the largest U.S. based financial institutions with global operations. To solidify his intentions the President has proposed the following;
• Imposing a “Financial Crisis Responsibility Fee” aimed to recover $117 billion from approximately 50 banks and insurers over a ten year period.
• New regulations that would require banks to increase capital ratios and submit to tighter regulatory control.
• Tighter controls on financial institutions’ compensation packages.
Using history as our guide, we should be prepared for unintended consequences. Regulation Q, implemented in the 1930’s restricting interest rates banks could pay on deposits, was intended to discourage banks from risky behavior by discouraging competition for deposits. With deposit rates held artificially low, savers moved deposits to foreign markets where banks were free to set deposit rates, thus the development of the Euro market in London, and the flight to money market funds, which were not limited on the rates they were allowed to pay.
Likewise, if financial institutions are required to keep larger capital cushions to guard against future crisis, they may make fewer loans in order to keep capital levels intact. Increased capital levels alone could squeeze smaller banks disproportionately as they do not have the same access to capital markets as the larger banks do.
Tighter regulation of the financial industry is needed, but the form and degree of that regulation could create problems the regulation was intended to prevent.
Money Markets
As traditional money funds struggle to add value to municipal investment portfolios, now is not the time to accept diminished returns. With proper planning, local governments have options that could substantially improve yields over current money market returns, without increasing credit risk. If you would like to discuss these options, please contact Ken Herdeman (262-796-6164), kherdeman@bankersbankusa.com or Brian Mann (651-697-8565), bmann@bankersbankusa.com.
(END)February 2010
Market Comment (January 2010)
Happy New Year! At the very least, we can hope for a happier one than 2009 economically speaking. As the economy begins to show signs of improvement, questions are being raised about when central banks will begin to withdraw some of the emergency measures enacted during the fall of 2008. These programs injected unprecedented amounts of liquidity into the world economies in an effort to minimize the effects of a global banking crisis, and at some point they will need to be retracted.
The timing and magnitude of the unwinding process could potentially impact the recovery currently under way, weak as it is. Central banks want to avoid any market distortions that could create asset bubbles and minimize increases in inflation and interest rates.
The concern of central banks is how to unwind, through monetary policy or fiscal policy. Governments injected liquidity into the banking system by purchasing financial assets from the private sector, driving down interest rates. As world economies seem to be on the mend, any large scale securities sales by central banks could drive up interest rates crippling a world economy learning how to walk again. The case of Norway and Australia may be a harbinger of things to come as central banks in both countries raised their benchmark rates late last fall. However, other major central banks publically indicated no hurry to follow suit.
Fiscal policy could have the same effect. Political commitments must be credible. It is too easy for politicians to renege on pledges under electoral pressure. Also, a rush to implement fiscal policy could be counterproductive sending the economy back to a recession. Japan’s 1997 increase in the consumption tax is thought to have stymied recovery.
2008 was the year of the banking system meltdown and 2009 was the year of government intervention and stimulus. 2010 may be the year of the exit strategy. Consumers and investors will have to determine what the economy will look like without government support. Many governments hope they can get through 2010 without withdrawing that support but market forces could leave them with little choice. And it will not be a question of too little too late but too much too soon.
Banking
The first hearing of the Financial Crisis Inquiry Commission was held on January 13, 2010, and the chief executives of the nation’s largest financial firms were the panel’s first guests. Although somewhat contrite about the role their firms played in the crisis, they were not altogether apologetic. Admitting to behavior that in retrospect was risky and suggesting they may have become complacent, the chief executives offered no apologies for intentions to pay 2009 performance bonuses.
Lloyd Blankfein, chief executive of Goldman Sachs, was criticized for his firm’s practice of selling mortgage-backed securities to investors, then selling these same securities short, effectively betting the value of the securities would fall. He admitted that the “behavior was improper” and regretted that “people lost money,” but rationalized the practice as “an exercise in risk management.”
Brian Moynihan, chief executive of Bank of America, seemed most remorseful when he said “we as an industry caused a lot of the damage” then added he was “grateful for the taxpayer assistance we received”.
M&I Bank reported a loss of $259.5 million for the quarter that ended December 31, their fifth consecutive quarterly loss. However, M&I suggested their fortunes are beginning to turn around citing improvements in delinquencies, nonperforming loans and write-offs of soured loans. But chief executive Mark Furlong added “We are most likely at a turning point in credit quality, though another quarter or two is needed to validate that condition”. M&I has yet to repay the $1.7 billion it received in government TARP funds and has paid over $100 million in TARP dividends over the last year.
Money Markets
As traditional money funds struggle to add value to municipal investment portfolios, now is not the time to accept diminished returns. With proper planning, local governments have options that could substantially improve yields over current money market returns, without increasing credit risk. If you would like to discuss these options, please contact Ken Herdeman (262-796-6164), kherdeman@bankersbankusa.com or Brian Mann (651-697-8565), bmann@bankersbankusa.com.
(END)January 2010
Market Comment (December 2009)
Apparently low interest rates are good news for equity investors and are probably the main reason the stock market rally, now in its 9th month, has been sustainable. Low interest rates have driven investors to put cash to work in equities and other asset classes (translated; riskier) in search of higher returns. But analysts’ predictions for economic recovery and higher corporate profits may also be a contributing factor.
The Federal Reserve Bank still targets the fed funds rate between 0% and 0.25%, why? Do they believe the economy will remain weak and predictions for improved corporate profits will disappoint? Do they fear a stronger than expected recovery causing higher inflation, which could result in rapidly rising interest rates?
A recent Morgan Stanley report stated that earnings at non-financial companies in the S&P 500 beat 3rd quarter estimates by 9%. But the report went on to say that sales were approximately 1% lower than forecast. It seems companies are taking advantage of the economic crisis to improve profit margins by reducing labor costs. Operating costs, mainly labor; have decreased over 30% from the 3rd quarter 2008.
Lower labor costs translate to lower consumer confidence and lower consumer debt levels. Although October retail sales were stronger than expected due mainly to auto industry incentives, consumers continue to reduce overall consumption and pay down debt.
Can companies continue to improve profit margins by reducing costs as sales decline? Cost cuts at one company improve margins but contribute to lower sales at another. Recent corporate profit improvements have not translated into an increase in capital spending. Instead companies are choosing to build up cash reserves and pay down debt, the same strategies many consumers are employing. And as companies reduce debt many banks find themselves flush with cash leaving them with little choice but to buy treasury securities driving down interest rates further.
Unless and until corporate profits improve due to increased sales and higher payrolls, look for small gains or possibly declines in equity markets and low interest rates for the foreseeable future.
Banking
As Americans largest banks; Bank of America, JP Morgan Chase, Citigroup and finally Wells Fargo, pay back government funds received under the Troubled Asset Relief Program (TARP), defaults on commercial property loans may prevent many regional and community banks from doing likewise. Regional and community banks have large concentrations of commercial real estate loans. As owners and developers of these projects continue to struggle it remains unlikely that regulators will allow regional and community banks to exit the TARP program.
This leaves larger banks with many competitive advantages. Free of extraordinary government regulation but with the government’s label as “to big to fail” the largest banks can now move into business that had been limited such as consumer lending, capital markets and asset management. However, there is fear that without government control the larger banks will once again engage in the risky behaviors that precipitated the current economic crisis.
Paul Volcker, former Federal Reserve Board Chairman and current head of President Obama’s Economic Recovery Advisory Board, has been traveling the world meeting with central bankers in an effort to persuade them to strengthen regulations that would prevent a crisis in the future. He has been warning bankers and regulators that they “have not come anywhere close to responding with the necessary vigor”.
Money Markets
The yield on the Wisconsin local government investment pool fell to 0.22% for November. The average yield for November in the Illinois Funds was 0.117%, while the 7 day yield as of December 14, 2009 on the Minnesota 4M Fund stood at 0.11%. As these money funds struggle to add value to municipal investment portfolios, now is not the time to accept diminished returns. With proper planning, local governments have options that could substantially improve yields over current money market returns, without increasing credit risk. If you would like to discuss these options, please contact Ken Herdeman (262-796-6164), kherdeman@bankersbankusa.com or Brian Mann (651-697-8565), bmann@bankersbankusa.com.
(END)December 2009
Market Comment (November 2009)
In late October, in a bid to add stimulus to a sagging economy, the Federal Reserve Bank lowered the Fed funds target rate, the rate banks charge other banks for overnight loans, to 1.00%.
Tight credit, in the Feds view, remains the biggest issue for the economy. Tight credit is not just a domestic issue, it is a global issue. The Fed’s recent fifty basis point cut comes on the heels of a fifty basis cut in early October that was coordinated with central banks in Europe and Asia.
By lowering the fed funds rate the Federal Reserve Bank hopes to stimulate the economy by injecting funds into the credit markets and instilling confidence in lenders that they will be paid back. However, as residential real estate values continue to fall, foreclosures continue to rise, and consumer confidence levels remain low, the Fed has indicated that further rate cuts may be necessary to keep the economy from falling deeper into a recession.
When the CEOs of Ford, GM and Chrysler went in front of congress to ask for $25 billion in federal bailout funds, it did nothing to help the situation. Congress is walking a fine line in considering the auto makers’ request. Legislatures are increasingly wary of bailing out yet another industry at taxpayers’ expense. As congressional hearings ended and it became clear the auto makers’ loan request would not be granted, General Motors indicated it would consider filing for bankruptcy.
Consumer confidence slipped to historical lows. Although the rapid decline in oil and gas prices has provided some lift, unemployment figures continue to rise with some economists predicating unemployment could reach 9% by the end of 2009. Retailers are expecting the worst holiday shopping season since 2000/2001.
Ben Bernanke, the Federal Reserve chairman, has strongly suggested additional stimulus programs. Congress is considering a $300 billion program that would provide funds for postponed Federal road projects that proponents say would create jobs. The program would also provide more state aid and expanded unemployment benefits, measures that some feel would have an immediate impact because the funds would flow directly into the economy.
Also, the Federal Reserve Bank has pledged to pump an additional $800 billion into stressed credit markets by buying up to $600 billion of debt backed or issued by Fannie Mae and Freddie Mac and other $200 billion to finance student, auto and other consumer debt.
Bank News
In the latest banking news, Citigroup was the recipient of another $20 billion injection of government funds, on top of the $25 billion that they received in October. In addition, the FDIC and the Federal Reserve Bank will guarantee roughly 15% of Citi’s assets, nearly $306 billion. This balance is composed exclusively of securities and loans backed by residential and commercial real estate.
Not all banks have been able to secure the capital that Citi has, and through November, the U.S. has experienced 22 bank failures. Even though 22 is a relatively small number, it may be prudent for municipalities to closely examine their banking relationships. One of the services provided by Community Investment Partners is a Bank Evaluation. We put this together by analyzing a bank’s publically available Uniform Bank Performance Report, and pulling out key ratios and financial data in order to provide a summary of a financial institution’s general overall strength and condition. We also can provide a third party rating for an additional objective view.
Given the current economic uncertainty, it is critical for public entities to employ investment strategies that provide safety and liquidity for their funds. If you would like additional information or explanation regarding the Emergency Economic Stability Act, FDIC changes, bank evaluations or investment opportunities, contact Ken Herdeman at 262-796-6164, kherdeman@bankersbankusa.com, or Brian Mann at 651-697-8568, bmann@bankersbankusa.com.
(END)November 2009
Market Comment (October 2009)
Are credit markets throwing water on America’s struggling economy? If credit markets are still tight is it due to lenders not lending or borrowers not borrowing? Could it be both?
Usage of the Federal Reserve Bank’s special liquidity facilities is declining while the Fed gradually winds down its purchases of distressed assets. Credit-card debt and car loans are being securitized at volumes nearing levels prior to the current economic crisis. And as loan losses continue to climb, large public firms are finding it relatively easy to obtain credit, and investment grade companies are issuing corporate bonds at a record pace.
However, large parts of the economy remain in a real credit squeeze. Only a quarter of publicly listed companies have the wherewithal to tap the bond markets while an even larger number of small and medium-sized companies, who employ almost half of all American workers, and rely heavily on bank loans, still find it extremely difficult to obtain credit. Although banks hold Fed reserves at record levels and have money to lend, smaller banks continue to tighten lending standards as they see additional losses in commercial-property and construction loans. It certainly doesn’t help that CIT, American’s largest small-business lender, slips toward bankruptcy as it struggles with problem loans.
On the other side, borrowers are cutting back too. Unemployment remains high and is predicted to go higher, and regardless of some positive signs in the manufacturing sector, households are saving more and spending less. With household debt at 129% of disposable income consumers will continue to pay down debt for the foreseeable future. Companies are also asking for fewer loans. Demand for commercial and industrial loans has fallen in every quarter since the middle of 2006 as companies consider every capital purchase and hiring decision with a more critical eye. Then again, a survey conducted by the National Federation of Independent Business found that small business is hampered more by a lack of customers than by a lack of credit. The survey also revealed that economic uncertainty is keeping capital-spending plans at a 35-year low.
When recovery seems more assured companies will want to ramp up inventory levels and buy new equipment and banks will be there ready to lend. Unfortunately, many see loan losses unlikely to peak until the 3rd or 4th quarter of 2010. If banks continue to fail at their current pace, the credit crunch, for borrowers and lenders alike, could be just beginning.
Banking
In an effort to encourage banks to limit the type of risk-taking that precipitated the struggles of the financial sector, the Federal Reserve Bank, along with the Treasury Department, is proposing a plan that would require banks to submit their compensation plans for approval. The plan would not set compensation levels but rather review pay policies and veto those it found rewarded excessive risk-taking. The Fed believes that such a requirement would correct a pay system that rewards traders and lenders who engage in the type of high risk bets that were a large contributor to the current financial crisis. Most banks, large and small, would be required to submit compensation plans and face additional supervision.
As bank deposits have grown by more than 7% nationally in 2009, the Milwaukee Journal Sentinel reported that deposits in Wisconsin banks grew by more than 9%. As investors exit the equity markets or cannot find competitive yields in the Treasury or Agency markets, bank deposits may continue to grow. Even as banks continue to fail (Wisconsin experienced its first bank failure this year when Racine’s Bank of Elmwood was taken over by regulators on October 23rd) depositors feel comfortable putting money into the banking system. However as deposits continue to grow and banks find fewer lending opportunities depositors may find that banks are unwilling to pay rates much higher than current Treasury yields.
Money Markets
Yields on local government investment pools and other money market funds continue to decline, many yielding less than .25%. Many analysts and economists expect interest rates to remain at these low levels for quite some time. However, this is not the time to accept diminished returns. With proper planning, local governments have options that could substantially improve yields over current money market returns, without increasing credit risk. If you would like to discuss these options, please contact Ken Herdeman (262-796-6164, kherdeman@bankersbankusa.com) or Brian Mann (651-697-8565, bmann@bankersbankusa.com).
(END)October 2009
Market Comment (September 2009)
For yet another meeting of the Federal Open Market Committee, members elected to keep interest rates at record lows, which means banks will continue to lend overnight to each other at a target rate between zero and 0.25 percent. In addition, the Fed has decided to slow the volume of dollars it is using to purchase mortgage-backed securities. Initially, the goal was to buy $1.45 trillion by the end of 2009, and we now know that target has been lengthened by at least a quarter. That strategy is most likely an indication that rates will continue to remain at record lows into the first half of next year. At that point, we should start to see a recall of a select number of government programs which will test the resiliency of the debt and equity markets.
Job losses and continuing claims of unemployment continue to make headlines, with 42 states losing jobs in August. Many analysts expect the national unemployment rate to surpass the psychologically significant ten percent mark. One positive sign is that the rate of job loss is falling, which some say bodes well for the coming quarters. We are more conservative in our estimates, and feel that any job losses at all indicate an economy that has not yet turned the corner. The elephant in the room remains the market reaction to our government withdrawing the many backstops it has created. Time will tell whether or not financial markets are ready to stand on their own once again.
How does this news affect you? For one, we will likely see yields on short term investment vehicles, be it money markets, Treasuries, or Agencies, continue to be slim. In searching for some light in the tunnel, we have seen rates tick up slightly on some of the longer term investments, most notably, the five year maturity. Over the course of the most recent G20 summit in Pittsburgh, many foreign leaders were very frank regarding their concern about the borrowing levels of some of the world’s biggest economies. We believe this sentiment is reflected in the lower demand for certain U.S. Treasuries, as this drives up yield. It goes beyond the borrowing habits of the government, however. A recent report from Moody’s shows that consumer credit card defaults are at an all time high. Logic would say this is a poor indication of future spending, since most people will be working to pay down outstanding debts rather than purchasing goods and services.
Banking
The biggest news coming out of the banking sector this month is the recapitalization efforts of the FDIC. As a result of the failures the sector has experienced this year, many have called for a strengthening of the insurance reserve in order to maintain confidence in the system. A myriad of fundraising options are under consideration, ranging from the traditional assessment on FDIC insured banks, to more exotic tools such as borrowing directly from some of its largest participants. Borrowing from the Fed is an option as well, albeit one the FDIC would like to avoid due to the stigma and political implications with which it is associated. Regardless of which route the organization pursues, it’s safe to say they will have no trouble raising funds, and there is no reason to doubt the solvency of the FDIC.
Within our market of Wisconsin, Minnesota, and Illinois, we experienced four failures during September. In Illinois, InBank, Platinum Community Bank, and Corus Bank were each shut down, Minnesota lost Brickwell Community Bank, and Wisconsin did not see any closures.
Money Markets
Yields on local government investment pools and other money market funds continue to decline, many yielding less than .25%. Many analysts and economists expect interest rates to remain at these low levels for quite some time. However, this is not the time to accept diminished returns. With proper planning, local governments have options that could substantially improve yields over current money market returns, without increasing credit risk. If you would like to discuss these options please contact Ken Herdeman (262-796-6164, kherdeman@bankersbankusa.com) or Brian Mann (651-697-8565, bmann@bankersbankusa.com).
(END)September 2009
Market Comment (August 2009)
A recently published study by the International Monetary Fund estimates that by mid-2010 the gross public debt of the ten richest countries will reach 106% of their collective Gross Domestic Product (GDP). The global recession has drained tax revenues and policymakers have been borrowing, and spending, unheard of sums to support their economies and banks. These ten richest countries have amassed $9 trillion (that’s Trillion, with a “T”) of additional debt in just the last three years.
Even with some positive economic signs that the recession is a least “bottoming out”, there is more borrowing and debt to come. Economic growth is likely to remain weak for several years, especially in the United States and Western Europe, where unemployment remains high and over extended consumers, who’s spending makes up as much as 70% of GDP, rebuild their savings.
This combination will equate to larger and larger government deficits. The same IMF study predicts that government debt as a percentage of GDP will reach 114% by 2014 but could be as high as 150% if economic growth is slower than expected and continued government borrowing drives up interest rates.
Although this magnitude of government borrowing is unprecedented in peacetime and huge government debt will impact the world economy for a decade, most of the additional borrowing was the correct course given the situation. Without government stimulus, the private shift to saving would have caused an even larger recession, tax revenues would fall even further and banks would be in worse shape.
The flight from riskier investments that made government intervention necessary in the first place has also minimized its cost. As investors have loaded up on government bonds public borrowers have found they can issue debt very cheaply.
But many uncertainties remain, especially in the medium term. What impact will all this borrowing have on economic growth and governments’ creditworthiness? Will governments be able to contain their debt burdens through budgetary discipline or will they inflate their way out of debt or worse, default? But perhaps the biggest question of all is when governments will stop borrowing and hope not to strangle a recovering economy? These are just a few of the concerns that must be considered and planned for.
Banking
According to a Bloomberg.com article published August 14th, more than 150 publicly traded U.S. financial institutions “have nonperforming loans that equal 5% or more” of their total loans. The article quoted former regulators that suggested levels that high “could wipe out a bank’s equity and threaten its survival”. Ratios this high, brought on by missed payments by consumers, builders and small business have contributed to over 72 bank failures so far this year.
A high ratio does not necessarily predict a bank failure however. Banks keep capital reserves to mitigate bad loans. Banks with larger loan loss reserves and higher ratios of equity to total assets may have the capacity to withstand such losses.
For a bank to be considered “well capitalized” by regulators they must have an equity-to-assets ratio of at least 10%. If this ratio is at or above 10% the likelihood of a bank failure is lessened even if the ratio of nonperforming loans exceeds 5%. For example, the Bloomberg.com article stated that although M&I Marshall & Ilsley had nonperforming loans at 5.01% at the end of July their equity-to-asset ratio was 11%. This is just one example of a tool public depositors can use to assess the stability of their depository relationships
Money Markets
Yields on local government investment pools and other money market funds continue to decline, many yielding less than .25%. In his semiannual report to Congress recently, Fed Chairman Bernanke said that he expects the central bank would keep interest rates at “exceptionally low levels for an extended period”. However, this is not the time to accept diminished returns. With proper planning, local governments have options that could improve yields 50 basis points over current money market returns, without increasing overall risk. If you would like to discuss these options please contact Ken Herdeman (262-796-6164, kherdeman@bankersbankusa.com) or Brian Mann (651-697-8565, bmann@bankersbankusa.com).
(END)August 2009
Market Comment (July 2009)
With most of the less-bad-than-expected economic and corporate earnings news reported recently, the focus has turned to the nature of the impending economic recovery. The optimists see a strong recovery as unemployment wanes, confidence returns, pent-up demand is unleashed and government stimulus programs work their way through the economy. Pessimists however see a much less vigorous, and slower, recovery as consumers cut debt and increase savings and output remains weak while unemployment continues to rise.
The optimists point to Sweden in support of their argument. Sweden’s productivity growth rate, the pace at which Gross Domestic Product (GDP) expands without affecting unemployment and inflation, accelerated in the early 1990’s, in the aftermath of that country’s banking crisis, due in large part to the government’s swift action to inject liquidity into the financial system.
The pessimists will argue that American’s new found thriftiness and massive increases in government debt will crowd out private investment, resulting in higher interest rates, further constraining growth. As evidence, pessimists will point to the fact that although interest rates are off 40 to 50 basis points from their June highs, they are still almost 100 basis points higher than they were in January.
The general consensus however is that America is headed for an era of slow growth. In his semiannual report to Congress recently, Federal Reserve Bank Chairman Ben Bernanke suggested that the U.S. economy would begin to recover during the second half of 2009, grow gradually in 2010 and accelerate in 2011. He further reiterated that growth would be constrained by high unemployment, declining home values and tight credit markets.
The circumstances affecting economic growth can be mitigated by good policies, or exaggerated by bad ones. Ill conceived polices to support declining industries and mismanaged companies, or to dictate lending decisions, could potentially do more harm than good.
Banking
Many banks have taken their lumps, watching earnings deteriorate as residential real estate values have fallen. The other shoe is dropping as many banks are now facing serious losses from commercial real estate such as shopping malls and office buildings.
Prospects for the commercial real estate market are bad, with the potential to get much worse. As loans continue to sour, lenders must set aside more in loan-loss reserves, directly impacting earnings. Prospects for the overall economy are dim unless the banking system strengthens. And a strong bank system is difficult to envision until real estate markets, both residential and commercial, improve.
There are some exceptions among individual banks. Financial institutions that limited their exposure to commercial real estate are in a fairly strong position. However, even these banks are having difficulty finding qualified lending opportunities. Local government officials should make a point of finding out their bank’s exposure to commercial real estate.
Money Markets
Yields on local government investment pools and other money market funds continue to decline, many yielding less than .25%. In his semiannual report to Congress recently, Fed Chairman Bernanke said that he expects the central bank would keep interest rates at “exceptionally low levels for an extended period”. However, this is not the time to accept diminished returns. With proper planning, local governments have options that could improve yields 50 basis points over current money market returns, without increasing overall risk. If you would like to discuss these options please contact Ken Herdeman (262-796-6164, kherdeman@bankersbankusa.com) or Brian Mann (651-697-8565, bmann@bankersbankusa.com).
(End)July 2009
Market Comment (June 2009)
With unemployment slowing its recent torrid pace, some positive news coming out on real estate, and many big banks starting to pay back TARP funds, it’s easy to feel just a little optimistic about the United States economy. While it is true these are all positive indicators, it remains prudent to be conservative regarding any type of full blown V-shaped recovery. There are still too many bad assets out there, too many jobs being lost, and too much uncertainty surrounding the ultimate effects of an unprecedented amount of government intervention in the private sector.
Equity markets have been relatively quiet during June, with investors trying to weigh economic statistics, earnings announcements, and legislative news. Bond markets have seen a lot of activity over the last thirty days, particularly towards the long end of the yield curve. Last month, a ten year Treasury was yielding 3.19%. The same investment in mid-June paid right around 3.80%. The two, three, and five year bonds moved up 40, 55, and 80 basis points, respectively. This type of activity on the longer term issues indicated a declining demand, which could be tied to market concerns regarding monetary policy. Obviously, if money is simply printed to pay back obligations in the future, investors will lose money on a ‘real’ basis, which is why many buyers are focusing on near-term maturities.
However, during the week of June 22nd, the Treasury auctioned a record $104 billion in notes and bonds. The $40 billion in two year notes sold on June 23rd to yield 1.15%, a much stronger showing than even the optimists were projecting. Second, $37 billion in five year notes sold on June 24th to yield 2.70%, which was also much stronger than expected. And third, $27 billion in seven year notes sold on June 25th to yield 3.25%, rounding out a week of solid interest in the Treasury markets. All of these events would seem to indicate that investors have plenty of faith in the ‘full faith and credit’ guarantee of the United States. A better test will be the next 30 year auction, which is tentatively scheduled for the first part of July.
Banking
A total of $68 billion in TARP funds was approved for repayment this month from ten participating institutions. The Treasury considered the requests and made their own determination about whether or not each bank was ready to return the funds. In the end, the successful bid by these companies to repay is an important step in reversing the trend of governmental dependence, something that would drastically alter the financial landscape. In addition, management will once again be free to operate as they see fit, including determining their own pay scales and lending practices, functions critical to any bank’s success.
On a negative note, we’ve seen four more banks fail this month, one each in Illinois, Kansas, North Carolina, and Georgia. The relatively torrent pace of failures we have seen this year should start to slow, as many local banks have built substantial loan loss reserves. The tightrope we need to walk as a country is increasing lending, but doing so in a responsible way. A large push by Fannie Mae or Freddie Mac to “make credit available” would likely reinflate any kind of real estate bubble. It is important to stick to the tighter, sounder lending practices of the last six months, and not make loans for the sake of making loans.
Money Markets
Yields on local government investment pools and other money market funds are consistently yielding under .50%. It is difficult to imagine a scenario where this will change significantly in the next six months, and with legislative and monetary policies remaining uncertain, investment strategies can be difficult to establish. However, this is not the time to accept diminished returns. With proper planning, local governments have several options that could improve yields by 50 basis points over current money market yields, without increasing overall risk. If you would like to discuss these options please contact Ken Herdeman (262-796-6164, kherdeman@bankersbankusa.com) or Brian Mann (651-697-8565, bmann@bankersbankusa.com).
(END)June 2009
Market Comment (May 2009)
During the first quarter of 2009, equity investors witnessed the biggest percentage increases in equity indexes in over 60 years. But while the stock markets were popping champagne corks, the corporate bond market experienced 35 defaults, the largest number in one month in the last 60 years. Is this mere coincidence? One year ago the default rate was around 1.5%, and today it’s at 7%. Rating agencies predict it will double by year’s end.
Why the difference between the stock and bond markets? Does the rebound in stock prices indicate the recession is over, or least bottoming out? Do higher equity prices foreshadow better days for the bond markets?
Stock prices fell so far so fast that about the only place prices could go was up. Also, when stock prices fall as far as they did, price rebounds occur when short-sellers close their positions and take profits. Plus, rallies such as this are not unprecedented. Between 1930 and 1932, the worst bear market in history, the stock market experienced five rallies of 20% or more.
Skeptics abound, however. Although there has been a slight rebound in manufacturing activity, it is still at its lowest level in the past 25 years. Freight rates, one measure of global trade activity, have increased recently, but are still over 80% lower than they were a year ago. And commodity prices show no signs of rebounding anytime soon. Although the Dow Jones commodity index bottomed in early March, it is still 50% lower than it was a year ago.
All that said, there are signs of recovery. The sense of extreme panic, marked by fixed income investors who were willing to accept a 0% return, is waning. And, although there have been no net inflows in money market mutual funds, investors have been buying some corporate bonds, evidenced by the recent narrowing in the spread between corporate and treasury issues. Finally, as governments have used every combination of low interest rates and fiscal stimulus they can think of to combat the crisis, the perception is that some of the measures are taking root.
However, if more bad news comes forth in terms of lower than expected corporate profits, additional job losses or further real estate de-valuations, recent gains could be short lived.
Banking
In response to the government’s stress test results, Bank of America, Wells Fargo and Morgan Stanley issued new stock and bonds in order to raise capital. However, Morgan Stanley, along with Goldman Sachs and JP Morgan Chase, has applied to pay back a combined $45 million in TARP funds. The pay back must be approved by the Federal Reserve Bank. The banks want to pay back the funds as quickly as possible in order to escape restrictions on executive compensation and hiring that were imposed by the Fed when the money was taken.
In Wisconsin, M&I Bank plans to sell $350 million in new stock for general corporate purposes but indicated that some of the proceeds may be used to repurchase some of the preferred shares M&I sold to the U.S. Treasury last November. On the other side, three more Wisconsin banks, Boscobel Bancorp Inc., Deerfield Financial Corp., and Brogan Bankshares Inc., all accepted capital infusions from the U.S. Treasury.
Money Markets
Yields on local government investment pools and other money market funds that are permissible investments for municipalities continue to yield less than 1%. Yields will remain low for the foreseeable future as the Federal Reserve Bank and U.S. Treasury strive to keep interest rates low in an effort to stimulate the economy. However, this is not the time to accept diminished returns. With proper planning, local governments have several options that could improve yields by 50 basis points over current money market yields, without increasing overall risk If you would like to discuss these options please contact Ken Herdeman (262-796-6164, kherdeman@bankersbankusa.com) or Brian Mann (651-697-8565, bmann@bankersbankusa.com).
(END)May 2009
Market Comment (April 2009)
Manufacturing has been the economic mainstay in the Upper Midwest for decades. Manufacturing employment as a percentage of total employment in the eight states that make up the region; Minnesota, Wisconsin, Illinois, Michigan, Indiana, Ohio, Iowa and Kentucky, is higher than the rest of the nation. Wisconsin, Indiana, Michigan and Ohio have the highest concentrations of manufacturing employment in the country.
Over the last 20 years much of the regions manufacturing base has been lost to foreign and domestic competition. Technology improvements that have led to higher productivity levels require fewer low-skilled workers. While overall U.S. economic growth strengthened after the 2001 recession, the manufacturing sector has not rebounded to pre-2001 levels. These developments magnify the effects of the current level of job loss and unemployment in the Upper Midwest. How?
The Upper Midwest did not experience the home price appreciation of the housing boom to the same degree as other regions; however, residential real estate markets are suffering nonetheless. Home sales declined by a third from their 2005 peak and half of the states in the region are experiencing foreclosure rates at or slightly higher than the national average.
Weak housing markets have affected construction employment. While construction employment grew by more than 10% from 2003 to 2006 nationwide, it was stagnant in the Upper Midwest. And since 2006 the construction sector in the region has lost 96,000 jobs.
Employment in the Upper Midwest has experienced significant deterioration during the current downturn, and the near-term outlook is not encouraging. As Chrysler and GM struggle to avoid bankruptcy, studies indicate hundreds of thousands of jobs are at risk not only in the auto industry but in many support industries as well. While market share and job losses in domestic car makers create opportunities for foreign car makers with U.S. operations, any new hiring would not fully absorb jobs shed by domestic automakers.
Federal government programs aimed at stimulating the economy in general and the auto industry in particular will have a significant impact on how the Upper Midwest weathers the current economic crisis. Provisions in the American Recovery and Reinvestment Act are intended to maintain existing jobs but most of the affected jobs will be outside the manufacturing sector. In the long term, emerging and expanding industries such as energy and health care are more likely to contribute to job growth.
Banking
Although some large money center banks such as Bank of America, U.S. Bancorp, Wells Fargo, J.P. Morgan Chase and PNC Bank reported first quarter profits, preliminary results of U.S. government stress tests could indicate that “bad assets” at the nation’s largest banks almost tripled on average in the past year.
The stress tests performed on the nation’s 19 largest banks are expected to reveal, in part, that lenders may need to raise nearly $1 trillion (that’s trillion, with a “t”) in capital in order to cushion against future losses. This information, coupled with indications that commercial loans in default or foreclosure jumped nearly 43% in the first quarter, will make investors extremely leery of making commitments to the financial sector to the magnitude required.
Money Markets
Yields on local government investment pools and other money market funds that are permissible investments for municipalities continue to yield less than 1%. Yields will remain low for the foreseeable future as the Federal Reserve Bank and U.S. Treasury strive to keep interest rates low in an effort to stimulate the economy. However, this is not the time to accept diminished returns. With proper planning, local governments have several options that could improve yields by 50 basis points over current money market yields, without increasing overall risk. If you would like to discuss these options please contact Ken Herdeman (262-796-6164, kherdeman@bankersbankusa.com) or Brian Mann (651-697-8565, bmann@bankersbankusa.com).
(END)April 2009
Market Comment (March 2009)
In December, when the Fed announced its intention to reduce the fed funds target rate to near zero, it signaled its willingness to employ drastic measures to promote economic recovery. The recently announced plan to purchase over $1 trillion in mortgage securities, agency debt and Treasury securities is just the latest sign of the measures the Fed is willing to take to aggressively manage its recovery efforts. The Fed said the majority of these bond purchases will be concentrated on the two – and 10 – year portion of the market. Almost immediately yields on treasury securities fell over 20 basis points.
Shortly after the Fed announced its plans, the Treasury revived a plan, first proposed then abandoned by the Bush administration, to purchase up to $1 trillion of illiquid real-estate assets from the nation’s banks. The theory is that removing these loans and securities from banks’ balance sheets will breathe life into the economy by giving banks the capacity and ability to start lending again.
After nearly a decade of deflation, falling interest rates and nearly non-existent economic growth, the Bank of Japan enacted a similar plan in 2001. Although Japan’s economy began to recover before the latest crisis hit the world’s financial markets, mainly due to increased export activity, the jury is still out as to whether the Bank of Japan’s actions made a significant difference.
With over $2 trillion of new government spending, on top of the billions already committed, where is the money coming from? If the Fed prints money to buy its way out of this economic crisis, will there be inflation consequences later? It was only a year ago, as energy costs were spiraling upward, that inflation was a major concern facing the economy. But as economic activity slowed, unemployment increased and financial markets slumped, deflation replaced inflation as a real prospect. However, price data released recently shows prices increasing. Consumer prices increased 0.4% in February following a 0.3% increase in January, led by a 3.3% increase in energy prices.
But few expect inflation to be a major concern, at least for the near term. Payrolls continue to dwindle as the number of mass layoffs surged in February and recent actions by the Fed are an indication of its intention to keep long term interest rates low for an extended period of time.
Banking
Public dissatisfaction is growing with the government’s bailout efforts as media outlets report bonuses paid to executives of banks and insurance companies that received bail-out funds. Many banks, especially community-based financial institutions, are overtly critical of the Federal Reserve Bank, U.S. Treasury and FDIC as requirements for receiving bail-out funds are being changed after-the-fact and FDIC assessments are increased. Several community-based financial institutions have turned down bail-out funds due to high costs and onerous oversight requirements. Minnesota based T CF Bank returned bail-out funds it received it November. Smaller banks are finding FDIC assessments increasing 50% or more. These banks feel they are being penalized for the mistakes larger money center banks made with their investments in the sub-prime mortgage and derivative markets. Some say these higher costs will be passed along to bank customers, either in the form of lower deposit rates or higher account fees.
Money Markets
For the first time since June 2004, the Wisconsin Local Government Investment Pool fell below 1.00% when it returned 0.87% in February. The Wisconsin LGIP joined the ranks of similar type funds around the Midwest. The Illinois Funds Money Market Fund fell below 1.00% in October 2008 and the Prime Fund followed in December. These Funds returned 0.46% and 0.51%, respectively, in February. The story is much the same in Minnesota with the Minnesota Municipal Money Market Fund (4M Fund) currently yielding 0.51%. Government money market mutual funds managed by the large brokerage firms’ yield even less due to higher expense ratios. Yields on money market funds will remain low for the foreseeable future as the Federal Reserve Bank and U.S. Treasury strive to keep interest rates low in an effort to stimulate the economy.
(END)March 2009
Market Comment (February 2009)
With the trends seen in interest rates lately local government investors are struggling to find yield without taking significant risk. However, the counter effect of this situation is that we have started to see the mortgage industry pick up, primarily in the form of refinance applications. This is important for a couple of reasons. First, jobs are being saved in an industry that was devastated by the housing bust. Second, individuals are setting themselves up to pay less each month via lower rates, in contrast to longer terms or adjustable-rate loans. In the long run, this should help lower losses to banks and investors. This should encourage people to start taking acceptable levels of risk again and lower the demand for ultra-safe treasuries and CD’s, which will increase their yield.
While it’s unknown what effect the stimulus package will have on the credit and financial markets, we can be sure we will continue to see volatility. Provisions of the American Recovery and Reinvestment Act and the second half of the Troubled Asset Relief Program are vague in some areas, and until we see some tangible results, uncertainly will undoubtedly prevail. One potentially key provision is the final amount allocated to the states. With deficits forecasted across the country, local government aid is in question along with the credit ratings of many municipalities. We are already seeing cities and villages dipping into reserves to make debt payments and pay operating expenses.
Banking
With the Federal Reserve exhausting the first half of the $700 billion Troubled Asset Relief Program, the new administration released the second half as one of its first acts in power. The Fed is finding that many smaller community banks are refusing to accept TARP funds due to the relatively high interest rate associated with the money. Banks are required to pay 7.7% annually for the first five years, at which point the rate jumps to 14%. Despite the cost, there is a growing list of banks in WI and MN that have accepted funds to-date. The institutions participating so far are outlined in the chart below:
Date Bank State Amount(Millions)
10/28/08 Wells Fargo CA, MN, WI $25,000
11/14/08 M&I Corp WI $ 1,715.0
11/14/08 US Bancorp MN $ 6,599.0
11/21/08 Associated Banc-Corp WI $525.0
11/14/08 TCF Financial MN $ 361.2
12/23/08 HMN Financial MN $ 26.0
12/23/08 Nicolet Bancshares WI $ 15.0
1/9/09 Redwood Financial MN $ 3.0
1/16/09 Baraboo Bancorp WI $ 20.7
1/16/09 First Manitowoc WI $ 12.0
1/23/09 Crosstown Holding MN $ 10.7
1/30/09 Anchor Bancorp WI $ 110.0
1/30/09 Legacy Bancorp WI $ 5.5
It’s important to note that on February 17th, banks started making dividend payments to the treasury. US Bancorp, for example, paid $83.3 million, while Wells Fargo paid $371.5 million. This should be a positive sign for taxpayers, as it’s an indication that not only could the treasury recoup its entire investment, they may stand to make a profit for the public.
Money Markets
In late January we saw an important change in the Liquid Government Investment Pool in Wisconsin. Financial Security Assurance, Inc., the insurer for the fund, has withdrawn its backing of the LGIP. Because of the current market environment, any commercial paper and negotiable CD’s purchased for the fund after 2/15/09 will be uninsured against credit loss. In substitute of the insurance, the LGIP is looking to obtain a rating from S&P, and we will keep you updated as that process moves forward.
(END) February 2009
Market Comment (January 2009)
In a sign that credit markets may be thawing, the premium banks pay over comparable U.S. Treasuries contracted to its narrowest margin in the last 5 months. The difference between the 3 month London interbank offered rate, or LIBOR, and the yield on the 3 month Treasury bill, the so called TED spread, narrowed to 98 basis points, or less than 1%. The last time the spread was this narrow was August of last year.
Central banks worldwide have tried to get banks lending by cutting interest rates and lending massive amounts of cash directly to banks. Narrowing spreads and lower borrowing costs for banks are beginning to entice some companies back into the credit markets. New corporate debt issued the first week of January totaled $82 billion, the highest weekly amount since May, 2008.
Congress unveiled an $825 billion economic-stimulus plan that would provide funds for new government spending along with a tax cut for families and businesses. The plan calls for infrastructure spending, additional state aid, additional unemployment benefits and funds for college grants. Proposed tax cuts of nearly $275 billion include credits for workers worth nearly $1,000 per family and $500 for individuals.
Some economists believe that due to the ongoing impact of the trillion dollar government stimulus provisions, and other factors such as improving consumer confidence, the economy could begin to improve by the 3rd quarter of this year. Other economists warn, however, that job losses could exceed 3 million in 2009, on top of the 2 million jobs lost in 2008. They also think that not enough of the aid provided by the government is reaching those individuals that truly need it, such as those that have lost jobs or homes due to foreclosure.
In further efforts to provide liquidity and normalize credit markets, GMAC, a consumer lender partly owned by General Motors, was granted regulatory approval to become a bank holding company. As a bank holding company GMAC will be eligible to participate in the government assisted funding sources thereby allowing GMAC to provide auto and mortgage financing. GMAC had been unable to access credit markets in recent months due to a cut in its credit rating after it was forced to restructure $60 billion in debt to avert a bankruptcy filing.
Bank News
Amid speculation about a government takeover of Citigroup, the second largest U.S. bank, FDIC Chairman Sheila Bair said she would be “very surprised” if the government took over any large U.S. banks. Furthermore, Bair suggested that the FDIC may need to borrow directly from the U.S. Treasury in order to maintain its insurance fund. Although the FDIC can access a $30 billion line of credit at the Treasury and can borrow up to $40 billion from the Federal Financing Bank, in December it doubled fees financial institutions must pay to insure customer deposits in a further move to replenish the insurance fund.
Bank of America and Citigroup, the two largest U.S. banks, and Marshall & Ilsley, the largest Wisconsin based bank, all reported 4th quarter losses. Bank of America was given $138 billion in government bailout funds, Citigroup announced plans to sell control of its brokerage, consumer lending and life insurance businesses, and M&I added $850 million to its loan loss provisions. Furthermore, many community banks are finding it difficult to attract low-cost, stable deposits while market competition is forcing many to seek alternative funding sources.
One lesson the current financial crisis presents to public depositors is understanding the risks, from a safety-and-soundness perspective, of the products banks are marketing to consumers and businesses. Given the current economic uncertainty, it is critical for public entities to employ investment strategies that provide safety and liquidity for their funds. If you would like additional information or explanation regarding the Emergency Economic Stability Act, FDIC changes, bank evaluations or investment opportunities contact Ken Herdeman at BBE Community Investment Partners, LLC, 262-796-6164 kherdeman@bankersbankusa.com or Brian Mann at 651-697-8568, bmann@bankersbankusa.com.
(End) January 2009
Market Comment (December 2008)
On December 1st the National Bureau of Economic Research (NBER) officially declared that the U.S. economy is in recession, which began December 2007. The U.S. economy has not experienced a recession since November 2001 when a 9 month downturn came to an end. Since the NBER determined the recession began in December 2007 the U.S. was the first country in recession, the Euro zone and Japanese economy’s slumping in the first quarter of 2008. This is the first time since World War II that the U.S., Europe and Japan have been in a recession at the same time and with the world’s three largest economies in recession simultaneously data predict a mounting pattern of job losses and corporate defaults across the globe.
As the Institute for Supply Management reported that manufacturing contracted in November at the steepest rate in 26 years, and the number of U.S. workers receiving jobless benefits rose to its highest level in a quarter century, Federal Reserve Chairman Ben Bernanke said the economy “will probably remain weak for a time” and that the Fed may buy treasury securities in an effort to spur growth by pumping funds into the banking system. James Poterba, an economics professor at the Massachusetts Institute of Technology and president of NBER suggested that “It is not terribly surprising you might get a longer-than-average downturn.”
The NBER defines a recession as a “significant” decrease in activity over a sustained period of time. The decline would be visible in gross domestic product, payrolls, industrial production, sales and incomes. According to the NBER the biggest factor in determining the starting point of the U.S. recession was the loss of 1.2 million jobs so far this year.
Although the Federal Reserve Bank promised to use every tool at its disposal to end this downturn, banks continue to hoard cash; businesses continue to struggle to refinance debt and consumers can’t get loans. According to the American Bankruptcy Institute personal bankruptcies rose 34% in the third quarter of 2008, compared to the same period in 2007. Moody’s Investors Service predicts corporate defaults in the U.S. will surge threefold in the next year.
As predictions of a prolonged recession multiplied, investors continued to flock to the safety of U.S. treasury securities. On December 8th the Treasury sold three-month bills at a discount rate of 0.005 percent. By December 9th, the three-month bill traded at a negative discount rate of 0.01 percent which means that if an investor purchased $1,000 par value of this bill it would cost $1,000.03 and the investor would receive $1,000.00 at maturity.
When the Federal Reserve Bank lowered the target fed funds rate on December 16th to between 0.00 and 0.25 percent, yields on 30-year treasuries dropped to as low as 2.68%. Treasury bill rates at or near zero reflect the intense demand for cash and reluctance of banks to lend.
BBE Community Investment Partners currently manages over $25 million for its clients. In November the average weighted yield to maturity on portfolios managed by BBE CIP exceeded the Wisconsin LGIP by 0.53% with an average weighted maturity of 176 days.
Bank News
The Federal Reserve Bank and the U.S. Treasury are taking steps to make it easier for banks to lend. The Treasury’s $700 billion Troubled Assets Relief Program (TARP) is providing much needed capital to banks. However, some analysts and investors feel that TARP does not address inherent shortcomings in banks’ management of their balance sheets.
Despite these efforts the Fed reported in November that businesses faced the tightest lending standards on record and that about 85% of domestic banks tightened lending standards on commercial and industrial loans to large and mid-size firms. James McKillop, CEO of Independent Bankers’ Bank of Lake Mary, Florida suggested, “There isn’t a community banker in America who doesn’t want to make good loans. But finding loans that they feel are going to be good is becoming more and more difficult.”
Given the current economic uncertainty, it is critical for public entities to employ investment strategies that provide safety and liquidity for their funds. If you would like additional information or explanation regarding the Emergency Economic Stability Act, FDIC changes, bank evaluations or investment opportunities contact Ken Herdeman at BBE Community Investment Partners, LLC, 262-796-6164 kherdeman@bankersbankusa.com or Brian Mann at 651-697-8568, bmann@bankersbankusa.com.
(END) December, 2008
Happy Holidays
Market Comment (November 2008)
In late October, in a bid to add stimulus to a sagging economy, the Federal Reserve Bank lowered the Fed funds target rate, the rate banks charge other banks for overnight loans, to 1.00%.
Tight credit, in the Feds view, remains the biggest issue for the economy. Tight credit is not just a domestic issue, it is a global issue. The Fed’s recent fifty basis point cut comes on the heels of a fifty basis cut in early October that was coordinated with central banks in Europe and Asia.
By lowering the fed funds rate the Federal Reserve Bank hopes to stimulate the economy by injecting funds into the credit markets and instilling confidence in lenders that they will be paid back. However, as residential real estate values continue to fall, foreclosures continue to rise, and consumer confidence levels remain low, the Fed has indicated that further rate cuts may be necessary to keep the economy from falling deeper into a recession.
When the CEO’s of Ford, GM and Chrysler went in front of congress to ask for $25 billion in federal bailout funds, it did nothing to help the situation. Congress is walking a fine line in considering auto makers request. Legislatures are increasingly wary of bailing out yet another industry at taxpayers’ expense. As congressional hearings ended and it became clear the auto makers’ loan request would not be granted, General Motors indicated it would consider filing for bankruptcy.
Consumer confidence slipped to historical lows. Although the rapid decline in oil and gas prices has provided some lift, unemployment figures continue to rise with some economists predicating unemployment could reach 9% by the end of 2009. Retailers are expecting the worst holiday shopping season since 2000/2001.
Ben Bernanke, the Federal Reserve chairman, has strongly suggested additional stimulus programs. Congress is considering a $300 billion program that would provide funds for postponed Federal road projects that proponents say would create jobs. The program would also provide more state aid and expanded unemployment benefits, measures that some feel would have an immediate impact because the funds would flow directly into the economy.
Also, the Federal Reserve Bank has pledged to pump an additional $800 billion into stressed credit markets by buying up to $600 billion of debt backed or issued by Fannie Mae and Freddie Mac and other $200 billion to finance student, auto and other consumer debt.
Bank News
In the latest banking news, Citigroup was the recipient of another $20 billion injection of government funds, on top of the $25 billion that they received in October. In addition, the FDIC and the Federal Reserve Bank will guarantee roughly 15% of Citi’s assets, nearly $306 billion. This balance is composed exclusively of securities and loans backed by residential and commercial real estate.
Not all banks have been able to secure the capital that Citi has, and through November, the U.S. has experienced 22 bank failures. Even though 22 is a relatively small number, it may be prudent for municipalities to closely examine their banking relationships. One of the services provided by Community Investment Partners is a Bank Evaluation. We put this together by analyzing a bank’s publically available Uniform Bank Performance Report, and pulling out key ratios and financial data in order to provide a summary of a financial institutions general overall strength and condition. We also can provide a third party rating for an additional objective view.
Given the current economic uncertainty, it is critical for public entities to employ investment strategies that provide safety and liquidity for their funds. If you would like additional information or explanation regarding the Emergency Economic Stability Act, FDIC changes, bank evaluations or investment opportunities, contact Ken Herdeman at BBE Community Investment Partners, LLC, 262-796-6164 kherdeman@bankersbankusa.com or Brian Mann at 651-697-8568, bmann@bankersbankusa.com.
(End) November, 2008
Market Comment (October 2008)
Financial systems across the globe continue to suffer as a result of both the subprime mortgage crisis and the subsequent banking issues. A testament to the severity of the situation lies in the passing of the $700 billion Emergency Economic Stabilization Act. With the powers granted in the Act, the U.S. Treasury is now able to purchase troubled mortgages through a reverse auction process. This will help clean up the balance sheets of the participating banks, as well as provide them with the liquidity needed to begin lending again, ideally in a more responsible manner. The Treasury will also be able to purchase preferred stock in U.S. banks, making them a direct owner of a portion of the banking system.
Banks will not be required to participate in the program, and many will opt not to for a variety of reasons. First, many large banks (i.e. JP Morgan, Citi, etc.) have already written down a large portion of their mortgage portfolios, some to as little as 22 cents on the dollar. This is not the case with many community banks, and as a result, they may not want to accept the relatively low prices that will be offered by the government. They would have to recognize the loss on their income statements, which would negatively affect capital levels in a time when capital concerns are at extremely high levels. Second, the preferred stock will have some strict caveats embedded, the most daunting coming in the form of a relatively high dividend. In addition, banks that participate will be required to limit any dividends paid to common shareholders.
The Treasury has already contacted many of the country’s largest financial institutions and pressured them to participate, as they believe this will remove some of the negativity surrounding the program. It was recently announced that Marshall & Ilsley Corporation, Wisconsin’s largest bank, wants to participate. Treasury Secretary Henry Paulson has made it very clear that this is an investment by the government, not an expense, and there is no reason to expect any loss to taxpayers.
FDIC
In addition to the Stabilization Act, the FDIC also made some key changes in an effort to restore confidence in the banking system. The insurance coverage on interest-bearing accounts was raised from $100,000 to $250,000, while the limit on non-interest bearing accounts is now unlimited. At first glance, this sounds like a great opportunity to protect large amounts of money for local governments, but there are a couple of important clauses to note.
First, the new limits are only temporary, as they are designed to relieve the current pressure on the deposit bases of member banks. As of December 31, 2009, the increased coverage is set to revert back to the old figures unless permanent changes are made before then. Second, the cost of this coverage will be borne by banks in the form of increased FDIC assessments, cost which most likely will be passed along to depositors.
How the National Reform May Affect You
The new FDIC coverage levels provide an opportunity for local governments to deposit a large amount of money in a fully protected account, as long as the investor is willing to accept a 0% return on any balances over $250,000. U.S. Treasuries, on the other hand, offer excellent safety in addition to a market-driven rate of return. If FDIC insurance is paramount, it might also be responsible to explore the option of using multiple banks in order to keep all investments working for you, rather than sitting idle.
Given the current economic uncertainty, it is critical for public entities to employ investment strategies that provide safety and liquidity for their funds. If you would like additional information or explanation regarding the Emergency Economic Stability Act, FDIC changes, or other investment opportunities, contact Ken Herdeman at BBE Community Investment Partners, LLC, 262-796-6164 or kherdeman@bankersbankusa.com.
(End) October, 2008
Market Comment(September 2008)
The collapse of the sub-prime mortgage market that began last summer continues to reverberate, wreaking havoc on financial systems worldwide. Since our last issue the federal government has taken control of the Federal Home Loan Mortgage Corporation (Freddie Mac) and the Federal National Mortgage Association (Fannie Mae). Equity owners of the two firms will probably lose their investment. However, with the government takeover, the debt securities of the two firms virtually become direct obligations of the U.S. Government.
A week after taking control of Freddie Mac and Fannie Mae the government refused to intervene with a Bear Sterns type bailout and allowed Lehman Brothers Holdings, Inc, an investment bank with a 158 year history, to file for bankruptcy. Shortly thereafter the treasury announced it would lend AIG Group, the world’s largest insurer, $85 billion in order to keep it solvent. Lehman’s bankruptcy filing had a ripple effect when the net asset value of one large money market mutual fund went below $1 a share, mainly due to a loss of value in Lehman Brothers commercial paper held by the fund. This triggered a run on money market mutual funds when redemptions exceeded $80 billion for the week ended September 12.
Investors moved a large portion of their money market mutual fund holdings and stock market holdings into short term U.S. Treasury securities causing some treasury yields to fall to 0.00%, a sign that investors were willing to forgo any investment income in return for safety of principal. Banks, in an effort to preserve capital and their own uncertainty of financial market developments, stopped lending to each other, temporarily driving up the fed funds rate to 6% and LIBOR well over 3%.
Then on Friday, September 19, President Bush, flanked by Treasury Secretary Henry Paulson and Federal Reserve Chairman Ben Bernanke, announced a government plan to purchase, by some estimates, as much as $700 billion of illiquid mortgage related debt and securities. This plan is generally not seen as
(End) September 2008
Market Comment (August 2008)
The Labor Department reported the consumer price index climbed 0.8% in July, twice as much as anticipated. Inflation remains a factor that reduces the Feds willingness to cut interest rates further even though unemployment rolls continue to rise, property values continue to fall and foreclosure actions continue to rise, developments indicating general economic conditions continue to deteriorate providing evidence to Federal Reserve Bank officials to ease interest rates. The odds of the Fed cutting interest rates are negligible while inflation concerns make a rate increase more likely.
However, without Fed intervention, inflation may ease in the coming months due to the same factors restraining the Fed from increasing rates. The prices for commodities such as oil, coal, and copper have been falling. Oil, which traded over $147 a barrel on July 11, is now under $115. Renee Haugerud, founder of a $2.5 billion commodity hedge fund predicts oil will be $80 a barrel within the next 12 months. Commodity and other prices are likely to fall further as consumer demand continues to wane world wide due to rising unemployment and declining property values.
This creates an opportunity for public investors to take advantage of a positive sloping yield curve. Short term rates remain low. The Wisconsin Liquid Government Investment Pool paid 2.23% in June and July, the lowest rate since January 2005 and the first time it’s paid the same rate for 2 consecutive months since February and March 2004. Banks are aggressively courting deposits, some paying 4% or more on 1 year Certificates of Deposit.
Banks?
The state of the banking industry has been a recurring theme in this letter. Banks have been a recurring theme in virtually every media outlet. Kenneth Rogoff, former chief economist for the International Monetary Fund believes that the worst is yet to come and that there is the likelihood of at least one large bank failing. Eight federally regulated banks or thrifts have failed this year and 100 others are on government watch lists so to shore up faith in the banking industry the Federal Deposit Insurance Corporation has increased efforts to make depositors aware of FDIC deposit insurance requirements and reassuring depositors of the FDIC’s mission to protect deposits. As FDIC Chairman Shelia Bair stated in the Summer 2008 edition of FDIC Consumer News, “The overwhelming majority of banks in this country are safe and sound, and the chances that your own bank could fail are remote. However, if that does happen, the FDIC will be there – as always – to protect your insured deposits. No one has ever lost so much as a penny of FDIC-insured deposits – not a single penny”. Kathleen Nagle, FDIC Associate Director for Consumer Protection added, “The bottom line is that bank customers who keep all of their deposits within the federal insurance limits can rest assured with the knowledge that their deposits – principal and interest – are 100 percent safe”. (Emphasis added.)
Many public depositors far exceed FDIC insured deposit limits and either fail to adequately collateralize deposits with proper documentation or do not ask their depository for collateral or a surety bond at all. FDIC officials commented that although unlikely, bank failures do occur and depositors have not lost “insured deposits’.
In these volatile times it is imperative local governments adhere to investment strategies that insure their funds are safe and liquid. If you would like assistance evaluating your depository relationships or need help in reviewing your investment strategy contact Ken Herdeman at BBE Community Investment Partners, LLC, 262-796-6164 or kherdeman@bankersbankusa.com.
(End) August 2008
Market Comment (July 2008)
Freddie Mac (Federal Home Loan Mortgage Corporation) and Fannie Mae (Federal National Mortgage Association), the debt securities of which are permissible investments for local governments, are struggling to maintain sufficient capital as the sub-prime mortgage crisis shows no signs of ending soon and residential property values decline. The good news is that lenders to these privately owned government sponsored enterprises will not suffer loses as the U.S. Treasury asked Congress for the authority to provide expanded credit lines and additional capital. In a show of confidence in the Treasury’s plan, investor demand was greater-than-average for Freddie Mac’s auction of $3 billion short-term notes held on July 14. Although stockholders may not be as fortunate, the Treasury’s plan, which was signed into law July 30, also authorizes the Treasury to buy the stock of the Government Sponsored Agencies.
Unlike U.S. Treasury securities, which carry the explicit guarantee of the “full faith and credit” of the U.S. Government, securities of Government Sponsored Agencies (GSE’s) are not backed by the full faith and credit guarantee but are perceived to have an implicit guarantee. Investors generally believe the U.S. Government would not allow a GSE to default on any debt. With the legislation signed on July 30 this implicit guarantee virtually becomes explicit.
Wisconsin Banks Sound
Experts believe Wisconsin banks are well positioned to weather the current economic downturn and do not foresee any state banks failing, despite the fact the FDIC closed two banks in California and one in Nevada in July.
Although Wisconsin banks have not been immune to lower earnings and falling stock prices they have generally stayed away from sub-prime mortgage lending. In addition, Wisconsin property values and the real estate market in general have remained relatively stable. Also state regulators, several years ago when Wisconsin banks were posting healthy profits, encouraged banks to increase loan-loss reserves to soften the impact of future downturns.
Most of Wisconsin’s community-based financial institutions are traditional mortgage lenders adhering to traditional lending standards and practices. In addition, most of the states community-based financial institutions are privately owned and are therefore not under pressure from Wall Street to increase earnings by making riskier loans.
The last bank failure in Wisconsin was 2003, and the president of that bank was eventually convicted of fraud. Before that, Wisconsin had not witnessed a bank failure for 17 years.
In these volatile times it is imperative local governments adhere to investment strategies that insure their funds are safe and liquid. If you would like assistance evaluating your depository relationships or need help in reviewing your investment strategy contact Ken Herdeman at BBE Community Investment Partners, LLC, 262-796-6164 or kherdeman@bankersbankusa.com.
(End) July 2008
Market Comment (June 2008)
As Memorial Day approached, oil reached nearly $140 a barrel and a gallon of gas broke the $4 level. At this point the Fed was wondering what the biggest enemy was, inflation or recession. Market signals at the beginning of June pointed to inflation. There are indications that not only has the Fed put the brakes on cutting rates but that they may take actions to raise rates before year end.
In the first days of June the fed-funds futures market, where traders bet on Federal Reserve Bank policy initiatives, was indicating a 50% chance the fed would raise rates by this fall and nearly a 100% chance of a rate increase by January 2009. The only thing standing in the way may be reality.
As certain economic indicators in the spring showed a full fledged recession may be avoided, more bad news was reported. Reports in late may showed non-farm payrolls have fallen 0.2% since January and personal income was down 0.1%. Citigroup reported it will have substantial second quarter write downs related to its mortgage investments. Although they said the write-downs would be less than the $15 billion in the first quarter, analysts believe Citigroup could face write-downs approaching $10 billion in the second quarter. Other large money center and regional banks face similar situations as the economy slows and the credit crunch contributes to rising defaults on consumer and business loans, mainly commercial development loans and companies drawing on previously unused lines of credit.
The Conference Board’s confidence index fell to 50.4 in June from 57.2 in May. The index, a measure of American consumer confidence, dropped to the lowest level since 1992. Although S&P/Case-Shiller reported that home prices in 20 major metropolitan areas fell an average 15.3% in April, 2008 from April, 2007 eight of those metropolitan areas showed price increases. The drop in the confidence level was attributed to the erosion in the jobs market. Continued mortgage defaults and home foreclosures added to housing inventories while stricter loan requirements are making it difficult for buyers to get financing. Former Federal Reserve Bank Chairman Alan Greenspan believes the U.S. is “on the brink” of a recession with little chance of improvement until sometime in 2009.
What About Banks?
This month the Federal Deposit Insurance Corporation suggested bank supervisors pay special attention to a lending practice that allows real-estate developers to delay paying interest on construction loans. The terms of these loans allow the bank to calculate the interest that would be owed on the loan and to put that amount into “interest reserves”. The bank then “pays itself” out of the reserves until the loan is due or the underlying project generates cash flow. The FDIC is concerned about this practice because many projects financed by construction loans may not be completed, or if completed may not be sold or rented, as the housing slump deepens. Where large banks have exposure to the sub-prime mortgage market due to investments in collateralized debt obligations and structured investment vehicles, small banks are more exposed to the $280 billion of overall construction loans outstanding. If a bank shows a low percentage of delinquent construction loans in one period then show an increase in non-accruing loans the following period this could be a sign that interest reserves may be hiding problem loans.
In these volatile times it is imperative local governments keep a close watch on their depository relationships and investment strategies to insure their funds are safe and liquid. If you would like assistance evaluating your depository relationships or need help in reviewing your investment strategy contact Ken Herdeman at BBE Community Investment Partners, LLC, 262-796-6164 or kherdeman@bankersbankusa.com.
(End) June 2008
Market Comment (May 2008)
Somewhat unexpectedly the Fed cut the target fed funds rate on April 30 to 2.00%. Unexpectedly because 3 weeks prior to the Fed meeting to consider this rate cut market expectations were for a 0.50% cut instead of the 0.25% cut that was finally agreed upon. What made the fed reconsider the magnitude of this rate cut?
First, prior Federal Reserve Bank actions seem to be having a positive effect on the financial markets. Investors are more willing now to consider securities that were perceived as poison just 8 weeks ago. Evidence of this is the 78 basis point rise in the 30 day Treasury bill since March 17 and the 14 basis point decline in 30 day prime rated commercial paper in the same time period. Another example of this newfound risk taking is the nearly 6.5% rise in the Dow Jones Industrial Average since the bail out of Bear Stearns in March. In addition, the economy is not deteriorating to the degree as originally expected. Industrial production fell in January and February but rebounded in March. And although the pace of existing home sales fell slightly in March they were generally stable over the first quarter as a whole.
Going forward, expectations of further rate cuts seem unlikely. Why? Depending on the inflation measure used, real short-term interest rates are at or below zero. Commodity prices continue to rise, a barrel of oil now exceeding $120, and food prices are rising worldwide. Inflation concerns are probably the best arguments against further rate cuts. Additionally, Federal Open Market Committee minutes, as well as Fed Governor comments, indicate a wait and see attitude.
This feeling that the financial markets are improving, investment rates are stabilizing and in some cases rising and some of the risk subsiding could prompt local government investors to consider some “riskier” investments to improve yields. However, investment policies state Safety as the first priority, Liquidity a close second and Yield a distant third. With the financial markets improving local governments can improve their investment performance without sacrificing safety by closely monitoring their cash requirements by employing a comprehensive cass forecast and using that forecast to craft an investment portfolio with strategically placed maturities of US Treasury and US Agency securities and certificates of deposit.
If you have questions on developing a cash flow forecast or need help in reviewing your investment strategy contact Ken Herdeman at BBE Community Investment Partners, LLC, 262-796-6164 or kherdeman@bankersbankusa.com.
So, Where Are We Headed?
As noted above, there are some that believe the current financial crisis has run its course and may be coming to an end. Since mid-March equities have risen and investors are selling “safe haven” securities such as US Treasury Obligations and buying prime rated commercial paper. Unemployment figures have decreased slightly, industrial output stabilized in March and real estate valuations in some markets are leveling off.
However, recent consumer readings are at there lowest levels in almost 3 decades and there are reports that the Memorial Day weekend could be the most dismal in years due to high fuel costs, with a gallon of gas approaching or exceeding $4.00. Factory output in April fell 0.7% and foreclosure actions in Wisconsin were up 45% in April, 2008 compared to April, 2007. Federal Reserve Bank Chairman Ben Bernanke, speaking at a conference in Chicago said he was “encouraged” by bank’s ability to raise capital but went on to say that they need to be proactive in building “generous” cushions to get them through the current crisis and suggesting that financial markets remain fragile. In an interview on Bloomberg Radio, economics Nobel Laureate Myron Sholes said the current financial market crisis “may even rival the worst crisis we’ve seen since the end of the Second World War”. Sholes wonders “Are there other shoes to drop and new events or new shocks that will come to the fore?”
Though these comments and reports may not be particularly comforting, local government and municipal investors can take solace in the fact statutes, which should be incorporated into investment policies, allow only the safest investments. Although any investor desires to earn the best return possible local government and municipal investors are bound to the reality that Yield is a distant third to Safety.
If you would like suggestions on building a safe investment portfolio that earns a market rate of return contact Ken Herdeman at BBE Community Investment Partners, LLC, 262-796-6164 or kherdeman@bankersbankusa.com.
(End) May 2008
Market Comment (April 2008)
Welcome to the inaugural edition of the BBE Community Investment Partners, LLC Market Comment. In these monthly commentaries our desire is to provide useful and timely information to our readers to keep their investments Safe, Liquid and earning a competitive Return.
It is nearly impossible today to open a newspaper, watch television or view any on-line news source without reading or hearing about the turmoil in the financial markets brought on by the collapse of the sub-prime mortgage market. Financial markets and the banking system have not been under such stress since the unraveling of the savings and loan industry in the 1980’s. Banks have written off billions (that’s with a B) as they revalue mortgage-backed securities held in their portfolios.
In an effort to stave off a recession the Federal Reserve Bank has slashed the target Fed Funds rate, the rate banks charge each other for short-term loans, 6 times since September 2007. An unexpected development has been bank’s unwillingness to lend to each other for fear of borrowers exposure to sub-prime mortgages. Despite the Feds best efforts to add liquidity to the banking system, a “credit crunch” has developed with lenders becoming extremely cautious in all situations, not simply mortgages. And little can be added here to emphasize the seriousness of the situation when Bear Stearns, the 5th largest investment bank, was purchased (with assistance from the Federal Reserve Bank) by JP Morgan Chase Bank for $2.00 per share (later increased to $10.00 per share) to forestall a bankruptcy filing by Bear Stearns.
For fixed income investors, especially short-term investors, this has translated into a rapid decline in interest earnings. The Wisconsin LGIP declined from 5.21% in July, 2007 to 3.12% in March, 2008. An investor with $1,000,000 in the LGIP in July, 2007 earned $4,424.93 and in March, 2008 that same $1,000,000 earned $2,642.62, a decline in interesting earnings of over 40%.
Now we know what has happened. What should municipal investors do today to limit their risks in these volatile times and still earn a competitive return? Fortunately state statutes offer guidance by allowing only low risk, high credit quality fixed income investments. Still municipalities should take additional precautious.
- Decrease custodial credit risk.
• As much as possible increase FDIC coverage by spreading deposits among financial institutions.
• Secure high quality collateral for deposits that exceed FDIC insurance limits.
• Monitor your financial institutions closely. Request and review your depository banks financial statements.
- If you don’t have one, develop an annual cash flow forecast.
• Interest rates will probably decline further. Knowing your liquidity requirements for the foreseeable future will allow you to take advantage of appropriate investment opportunities.
- Review your investment strategy.
• As stated earlier, interest rates will probably decline further. Some certificate of deposit yields are attractive, especially for maturities 90 days to one year. If your liquidity situation allows consider re-allocating funds from short-term money market type accounts.
In these times of market volatility and financial uncertainty it is incumbent for municipal investors and public depositors to remain diligent in an effort to keep their cash assets safe. If you have questions on developing a cash flow forecast or need help in reviewing your investment strategy contact Ken Herdeman at BBE Community Investment Partners, LLC, 262-796-6164 or kherdeman@bankersbankusa.com.
FDIC Considers Increasing Deposit Insurance Coverage for Municipalities and Other Units of Local Governments
The 2005 Federal Deposit Insurance Reform Conforming Amendments Act required the Federal Deposit Insurance Corporation (FDIC) to study the feasibility and consequences of several issues, one of which was increasing the limit on deposit insurance coverage for municipalities and other units of general local government.
The FDIC’s recent report to Congress did acknowledge arguments for increasing municipal deposit coverage;
- Public deposits could remain in local institutions where they could be used to meet local needs.
- Bank operations could become more efficient and less costly by lessening the need for public depositories to provide collateral.
- Provide a higher degree of safety and additional protection for taxpayers.
- Permit small financial institutions to compete more effectively for public deposits.
However, the FDIC also suggests three main arguments against increasing municipal deposit insurance coverage;
- Increasing coverage for one class of depositor is inconsistent with the traditional goals of deposit insurance, which are to;
a. Promote financial market stability by maintaining depositor confidence in the banking system.
b. Protect the nation’s economy from the disruptive effects of bank failures.
c. Protect the deposits of small savers.
- Increasing coverage for one class of depositor could adversely affect moral hazard and market discipline. In the FDIC’s “definition” moral hazard implies public depositors would be less likely to monitor the risk behavior of their depository institutions if they know the FDIC is providing additional insurance coverage.
- Additional coverage is likely to increase deposit insurance assessments possibly increasing banking costs.
In its summary, the FDIC did concede that increased federal coverage for public deposits could benefit local governments by lowering bank costs and increasing security for taxpayers. But the report pointed out that increased federal coverage would be a departure from the traditional goals of federal deposit insurance by increasing coverage for one class of depositor and would likely increase moral hazard and deposit insurance assessments. Finally, the report suggested credible private sector alternatives to increased federal coverage such as surety bonds and deposit-placement services. Review the FDIC’s entire article regarding increased insurance coverage for municipalities at www.fdic.gov/bank/analytical/quartely/index.html.
The FDIC is considering several options for structuring increased insurance coverage; however, Congressional authorization is required for the FDIC to provide this coverage to municipalities. If you would like to review options currently available to secure your bank deposits, please contact Ken Herdeman at BBE Community Investments Partners, LLC at 262-796-6164 or kherdeman@bankersbankusa.com.
(End) April 2008
Information obtained is from sources we believe to be reliable but we do not guarantee accuracy. Neither the information, nor any opinion expressed, constitutes a solicitation by us of the purchase or sale of any security. Yields, rates and prices are subject to change and availability. Past performance does not guarantee future results.
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