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Jim Young and Dallas Wells sit down with Jimmy O'Boyle of Chatham Financial to talk swaps. You'll learn about the 2017 benchmark stats tracked by the Trading Desk, and what they mean for commercial banks.
Ashley: Hey everyone, Ashley here. We're so excited to announce that it's that time of year again. It's time to Bank on Purpose. Bank on Purpose is a conference based on the belief that the path to customer success is built on a customer centric foundation. It brings together the best and the brightest minds in banking in Austin, Texas on April 25th to the 27th. You can use the code podcast 18 to get 10 percent off your registration and to show your pride for the Purposeful Banker podcast. It's time to stop reacting and get back to what makes banking great. It's time to Bank on Purpose.
Jim Young: Hi and welcome to the Purposeful Banker, the podcast brought to you by Precision Lender where we discuss the big topics on the minds of today's best bankers. I'm your host, Jim Young, Director of Communications at Precision Lender and I'm joined again today by Dallas Wells our EVP for International Operations. Today we have a special guest, Jimmy O'Boyle from Chatham Financial. Jimmy is a member of Chatham's hedge advisory team focusing on financial institutions and Chatham Financial, as some of you may know, is a partner we work closely with and they are a platinum sponsor again this year at Bank on Purpose. So Jimmy, why don't you start off first by telling us a little bit about the event that you guys have running that's going to lead into Bank on Purpose this year.
Jimmy O'Boyle: Yeah absolutely and good day to everybody. Thanks for having me. Yeah absolutely, so we're gonna be down at the Bank on Purpose conference here coming up at the end of April and we're gonna be sponsoring a tailgate. So like any great tailgate, it's a good event for people to get together, have a good time before a big event, which is the Bank on Purpose conference. But what we're gonna be doing is spending a little time on April 25th, that Wednesday, and really just open up to whoever wants to attend to learn about interest rate swaps, how they pair up with the CNI and CRE loans, take the interest rate risk off the table. We're gonna be providing some foundational overviews and some real life examples. So we're gonna be fortunate enough to have a couple of bankers with us and capital markets experts, they're actually Chatham clients, gonna be helping lead us through that event and again, we'll be providing some case studies and hopefully it's gonna be a great event and if you can attend, please stop by. Again, that's April the 25th, it's the day before Bank on Purpose kicks off and we're calling it the swaps tailgate.
Jim Young: Yeah, it sounds like a fantastic event and today Jimmy's gonna talk to us about some 2017 benchmark stats that is tracked by the trading desk at Chatham and what they mean for commercial banks, but first Jimmy, we listed your job title just a minute ago in the intro. Can you give us a little more information about what you do at Chatham?
Jimmy O'Boyle: Sure can. I'll try. On paper I'm a Senior Relationship Manager, so what that means is I lead our relationship management team and I kind of really oversee the product deployment to our client base. From an interest rate derivative standpoint we are very fortunate and lucky to have great partnerships with a lot of financial institutions across the country and we really support them from a balance sheet hedging program and derivatives regulatory support, hedge accounting and then what we're gonna talk about here today, with customer hedging programs. So this would be a interest rate swap program where the financial institution wants to offer the borrower directly an interest rate derivative. Again, I'm fortunate enough to work with a great team here at Chatham. No two days are the same, on one day I could be helping a bank management team presenting to their board about the benefits of hedging programs and the very next day being brought in a very complicated, syndicated structure where interest rate swap might be the right tool for that customer. So, have a lot of fun here. Days are long but it's exciting. So, that's what I do.
Jim Young: Great, excited to have you on the podcast to talk about these benchmark stats. So first can you tell us a little bit about what it is your tracking at Chatham with these stats and why?
Jimmy O'Boyle: Absolutely. I'll back up just a second and give a quick disclaimer from a Dodd-Frank perspective. We're required here at Chatham to make sure that we disclose that interest rate derivatives do have risks so we just want to make sure that that was communicated here. From a benchmark stats standpoint, again, so what we're just focusing in on here on this call is interest rate customer facing programs. Again, a financial institution that's offering an interest rate swap to a customer. So, a financial institution issuing a floating rate loan but then at the same time allowing that borrower to fix their debt service by offering a swap to that customer. So that's what we're talking about here. Probably about eight or so years ago, excuse me, we really started to collect a lot of information on our clients and I think initially it was just kind of, "Hey, could this tell a story?" But soon right after that a lot of clients really wanted to see where their peers stacked up and were really interested to see if there were trends in the marketplace so we do track some high level details whether that be deal volume, so the number of trades, deal size and then loan credit spreads that they're lending over Libor on those variable rate loans.
Just to clean up some of my jargon here. I'm calling a deal an individual swap that a bank is offering a customer. So the benchmark stats, I think, it provides really insightful information and it compares banks to their peers. Over the last three or so years ago I think we've done a probably better job of presenting them in a more professional way but they're something that the clients really enjoy and they clamor for at the end of each year. So that's another point I wanna make. We issue them to our clients at the beginning of each year, it's kind of a year in review so that it takes a look at the previous year. So we also will take a look at all of our clients that have a hedging program and give them stats on that and we do try to then also segment those statistics because obviously a two billion dollar bank isn't the same as a 30 or 40 billion dollar bank there.
Another useful tool that we've used this for is striking up a conversation that maybe is a bank that isn't a client or is a bank that's considering using interest rate derivatives and they haven't yet. So before they just dive right in investing into a program, they wanna see what's the return on investment that's gonna made, how will this impact their credit spreads and what can they expect when they get a program up and running? It's basically taking the theoretical with a lot of assumptions made and boiling it down and saying, "No, this is real data that's coming from Chatham's system," and we're fortunate enough to serve a lot of institutions across the United States. So it's pretty powerful. I will say that, with any statistics or analysis, it's not a perfect view. Like I said, we do break it down by region and by asset size, which sometimes can get into, you get into a little bit of a disagreement. Some folks like, "Where does the Midwest end and start?" So sometimes we can get into a debate on where a bank may need to fit from a segmentation standpoint.
Jim Young: That's good. Dallas is our Midwest rep, so he can tell you all about where the Midwest ends and begins.
Dallas Wells: I'm strongly opinionated about where it stops and starts, so we'll get into that later Jimmy.
Jimmy O'Boyle: Yeah, I'm from Illinois so I have definitely have some strong views there too.
Dallas Wells: Jimmy, appreciate you being on and since not everybody will be looking at the same numbers, talking about stats on a podcast, we'll be talking about general trends and as we looked at these numbers that you all sent us, one of the first things that jumped out at me as you guys look at the average transaction volume by segment. So when you guys talk about segment, you're talking about size of the institutions.
Jimmy O'Boyle: Right.
Dallas Wells: And there's quite a bit of disparity between the largest category that you guys track, which would be the above 30 billion and all the rest of them below that. So obviously banks above that size just have a lot more volume but it's always interesting to me to listen to different size banks talk about swaps and how they think about them. So, how do you all see the difference between your smaller community banks and your larger regional banks? Do the little guys use it to compete with the big guys or do the bigger guys, based on having this much more volume, is it really a tool that they're using with maybe some more sophisticated borrowers in a way that the smaller banks can't?
Jimmy O'Boyle: Yeah absolutely. A lot of what you said or maybe what you're thinking of is true. So the short answer is yes and again, these numbers that we put out are coming right out of our system so we don't manipulate 'em. Sometimes they'll tell a story that sometimes even ourselves, we scratch our heads and say, "Well, why is that the case?" But yeah, larger institutions just by nature of being larger can generate just a larger volume of loan originations. Sometimes, or I should say typically, larger institutions also will have folks dedicated, capital market specialists that their entire job is to work on figuring out how swaps could be companions with floating rate loans. So I think those play hand in hand. But it's really interesting though, what I've found over the years here at Chatham is it doesn't ... Yes, that larger institutions typically will do larger volumes of swaps, but there can be definite smaller institutions that per asset size can keep pace, if you will.
We often will think why that's the case. We refer to it as a program mindset. So what I mean by that is, you could have a 30 billion dollar bank that just has a program mindset of being maybe more defensive or opportunistic with a swaps program, whereas maybe a three billion dollar bank or a five billion dollar bank is really programmatic. They have it in their mindset that they wanna lead out with a variable rate loan plus a swap. So just by the nature of their mindset they're gonna try to drive more loans with swaps. I kinda joke here internally at Chatham that when a financial institution signs up with us and wants to start a swap program, I think back to the Forrest Gump movie where Forrest is sitting there on the park bench and, "Life's like a box of chocolates. You never know what you're gonna get."
It really depends on how the financial institution wants to position the swaps program and drivers of that mindset, it's a bank culture, the personnel it has, the interest rate risk or the tolerance of the interest rate risk that the bank wants to take on and a lot of factors that are out of the banks control. Market factors, just an absolute level of interest rates and client behavior. Some borrowers they just want the traditional fixed rate loan. Sometimes that can be a challenge to get a deal done. Long winded answer, Dallas that, yes if you have a large institution that has the same program mindset as a smaller institution, 99 times out of 10 that larger institutions gonna be able to generate more deal volume just by nature of loan volume.
Dallas Wells: Yeah, that makes sense. The other interesting thing that jumped out at me, just because it lined up with some of our data that we see is that of the two larger categories that you guys track which were above 20 billion or above 30 billion, there were slight drops in swap volume but the 10 to 20 billion category had a 25 percent or so increase. We actually saw that same category of banks pretty aggressively growing in traditional lending volume as well. I think some of that is probably clearing that 10 billion mark and then trying to put as much distance behind them as they can, that's sort of the regulatory issues there are part of that. Is that something that you guys see? Are those banks in that size, do you see them as being a little more aggressive than the sizes around them?
Jimmy O'Boyle: Yeah, I would definitely, when we were getting ready to jump on this call, love to hear your take on it too because we see the exact same trend and from our standpoint we don't see or we didn't see, I guess from a 2017 standpoint those 10 to 20 billion dollar banks being more aggressive per se. I think it's just a kind of some of the things that you just touched on. I think just CRE concentrations sometimes. Last year was a hot button for regulators so maybe banks that were just growing over 10 maybe didn't have that concentration limit but overall, if you look at all asset size banks that we serve, deal volume was down around 10 percent and we think because those large institutions did take the foot off the pedal or weren't able to generate the loans that they'd done in the past. I know there's a lot, in the press, there were a lot of reasons or theories why commercial lending was down in 2017. So I think that just played out into our benchmark stats as well.
Dallas Wells: Yeah. Moving from volume into some of the terms 'cause I think that speaks to what some of the bankers are seeing in the marketplace and what the competition looks like, so I think that's interesting. The first one I wanna look at is just term stats, so tenner, the length of these swaps and we've seen deals and the duration really move around as rates have started to change over the last couple years and we've seen a lot of community banks really extend out on the yield curve and now we're seeing some of them start to rethink that and pull back a little bit now that rates have ticked up. But you guys actually split this out by the regions as well, so east, Midwest, and west and there's some differences by regions. So, first of all, you guys break them out that way so I assume there's some thought as to why. What's the reasoning for dividing by region when you start looking at terms?
Jimmy O'Boyle: That really just came down from a client request. Financial institutions wanna hone in on their markets.
Dallas Wells: Yeah, other banks like us, right?
Jimmy O'Boyle: Yeah, exactly. I think they wanna see across the country that that's great perspective initially but then they really wanna hone down and say, "Really, what are my competitors doing?" So a way to try to narrow that view on the stats is kinda break it up by region. We'd love to keep improving how we present these to maybe make it a little bit more granular than even just the segments that we have. So hopefully we can do that but it really was just an attempt to try to narrow it down. What you see or what you can see from our stats and what you're saying you see from your stats and benchmarks are that from a swap perspective, swap loan perspective, we definitely did see the tenner grow and it has been growing, particularly in the institutions that are larger than 10 billion in assets. We think here that the reason or what the reason is is because of central clearing. So if you're a financial institution greater than 10 billion in assets you are required to essentially clear a derivative or an interest rates swap, I should say.
But being able to do that allows you to go a lot longer out with a dealer counterparty. The clearing house is willing to take that longer trade on, so financial institutions, once they cross that 10 billion dollar threshold really can take advantage of doing a longer termed swap as long as the bank is comfortable with extending that loan also equally as long. So, we definitely have financial institutions that, whereas four or five years ago they wouldn't go any past 10 years in duration and now definitely we see 15, 20 and sometimes even longer term swaps that are companions with floating rate loans.
Dallas Wells: Yeah, and I think that will actually be really interesting as this credit cycle starts to get a little long in the tooth. There are some pockets of concern for credit markets in general. It's been really good for a really long time and typically what you start to see at the end of these cycles are things like that, where terms start to get stretched and people's risk tolerance goes way up right at the end. So it'll be interesting to see if that continues and if that's what we're seeing here or if we've still got some smooth sailing ahead.
Jim Young: Absolutely.
Dallas Wells: So, last part we wanted to touch on and I think this is maybe the most important one from a bankers perspective, is credit spreads. Everybody that we talk to, of course, still says basically it's insanity out there, that spreads get ever tighter, especially on the very best deals. That you have to get uncomfortably skinny to win these. So again, this is something you guys break out by several different ways, you break it out by term and you break it out by region. So a couple things that were interesting in looking at credit spread, so the spread over the floating piece of your swap, those spreads tended to get smaller with longer deals. I assume that has something to do with credit quality, as you're doing deals with better borrowers that you're willing to go longer with, those are probably tighter spreads. So that one made some sense but looking at the differences between the regions, there's a pretty big difference between the east, the Midwest and the west as far as just the average spread. Those range from 217 in the west to 236 in the Midwest, so almost 20 basis points difference which is, in my mind, pretty significant.
Any thoughts on where that comes from and is that something that's held true for a couple years or does that number move around quite a bit?
Jimmy O'Boyle: I guess for the last two or three years it's been fairly consistent and for your listeners, when you initially think of going out on longer term deals, I guess just maybe in my mind, you would think that spreads should typically increase, right? You're gonna have that money out the door for longer but once you stop and think about it and you just mentioned, the better rated credits, being willing to offer that longer term financing for that but in our statistics you can see that as the tenner increases, so when you go out from the three to five or five to seven and then the seven to ten, that credit spread, like you said, it drops across the board, in all regions really. I think that just what you just open up with is, I think, the number one reason. It is so competitive out there for longer term financing that our clients and financial institutions across the country they just have to get skinny to win that deal and it kinda shows up in the numbers.
In terms of just the differences between regions, that's one of the things that we wish we had better insight into. We, again these numbers are coming right out of our system and I would say many times or often is the case, we don't know where these spreads or how they're being determined. Are they being determined by competition that's driving them down? Is it the risk waiting or the risk level that the bank is using? Again, these numbers are just coming right out of our system but what it shows across the board is it's just so competitive and then as you pointed out, it's just in the east especially, east which obviously is the east coast and the northeast, it's extremely, extremely competitive compared to the rest of the country.
Dallas Wells: Well, the interesting thing about that and our CEO, Carl, has a running gag about but every bank that we talked to, they actually happen to be in the most competitive market in the country. They just have to ask them to know and they'll tell you that.
Jimmy O'Boyle: So it might get me in some hot water with my Midwest brother, when I say it's more competitive in the east coast, it's all relative, don't worry.
Dallas Wells: Yeah, it's not easy anywhere. So, Jimmy I saved my most important question for last. So mentioned the tailgate, you mentioned what you were gonna talk about, what's the food and drink menu? That's really what we gotta know before we know if we're showing up or not.
Jim Young: And bear in mind Jimmy that I'm from the south where tailgating is a very serious thing so I'll be listening very carefully to this answer.
Jimmy O'Boyle: Okay, okay. Nah, I think we're gonna have your traditional tailgate food. I think we're gonna have some good barbecue, I think we're gonna have some burgers and hopefully some, maybe some adult beverages there, perhaps. So, no please come by. It's gonna be ... They're not letting me go, which I'm gonna take up with my higher in command here but no, we've got some great folks from Chatham. We've got a couple of really good clients that enjoy meeting folks and talking about how swaps can be used so we hope people come out.
Dallas Wells: Yeah, you had me at barbecue, so I'm in.
Jim Young: Actually, I was gonna say barbecue almost opened the door to another 45 minute podcast which we could debate that but I'm gonna leave that part alone. But thanks so much for coming on the show Jimmy and breaking down all of these swap stats for us.
Jimmy O'Boyle: Oh absolutely. Anytime, we enjoy the partnership with Precision Lender and hope we can help out.
Jim Young: And I just wanna check on this to be sure that we're, because this podcast is coming out on the Monday before the week of Bank on Purpose. So can people, if they're listening to this and they're going to Bank on Purpose and they say, "Wow, that swaps tailgate sounds great," could they still register at that time or is there a window of opportunity where that closes?
Jimmy O'Boyle: Oh no, yeah you can definitely register. You can contact a Chatham if you're interested but no, it's still open so again, it's Wednesday, it's the day before and it's gonna be at the same location. So it's gonna be at the Hilton there where Bank on Purpose is being. So, either contact your rep at Precision Lender or contact Chatham and we'll be glad to give you more details.
Jim Young: Right, exactly, so if you're, again, if you're listening and you're coming in for Bank on Purpose and you're planning to be there for the kick off party on Wednesday night, we encourage you to just maybe arrive a little bit earlier and go to the Chatham swaps tailgate. Well, that'll do it for this weeks show. A reminder if you wanna listen to more podcast or check out more of our content you can visit our resource page at PrecisionLender.com or you can just head over to our homepage to learn more about the company behind this content. Finally, if you like what you've been hearing, make sure to subscribe to the feed in iTunes, SoundCloud, Google Play or Stitcher. We love to get ratings and feedback on any of those platforms. Until next time, this has been Jim Young for Dallas Wells and Jimmy O'Boyle and you've been listening to The Purposeful Banker.
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