Economic Update: 2013
S. Scott MacDonald, Ph.D.
President and CEO, SW Graduate School of Banking Foundation
Director, Assemblies for Bank Directors
Adjunct Professor, Dept. of Finance, Cox School of Business
Southern Methodist University
scott@swgsb.org
www.swgsb.org
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The Southwestern Graduate School of Banking
Assemblies for Bank Directors
Southern Methodist University „ Cox School of Business
PO Box 750214 „ Dallas TX 75275
Phone 214-768-2991 „ Fax 214-768-2992
info@swgsb.org „ www.swgsb.org
S. Scott MacDonald, Ph.D.
smacdona@mail.cox.smu.edu
S. Scott MacDonald is president and CEO, SW Graduate School of Banking (SWGSB)
Foundation, director of the Assemblies for Bank Directors, and Adjunct Professor of
Finance, Cox School of Business, Southern Methodist University. He received his B.A.
degree in economics from the University of Alabama and his Ph.D. from Texas A&M
University. Dr. MacDonald joined the Southern Methodist University faculty as a visiting
professor of Finance in 1997 and was named director of the SWGSB Foundation in 1998.
Dr. MacDonald is a frequent speaker at professional programs, banker associations and
banking schools. He is a nationally sought after strategic planning facilitator and
consultant to the financial services industry. He has served as an expert resource
witness before the Texas state Senate and is a former Chairman of the Board of
Directors of a Texas financial institution. Dr. MacDonald is the co-author of the best
selling textbook on banking, Bank Management, and the author of numerous articles in
professional academic journals.
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Will this Economy Ever
Improve?
Seems like forever!
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What Makes this one Different?
• Wealth Destruction
• Deleveraging
• Unemployment
• Housing and Mortgage Markets
• Unprecedented Monetary Policy
• Lack of Fiscal Policy
• Continued Uncertainty
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GDP has improved!
But this economy is built on growth.
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GDP has recovered to pre-recession
levels.
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Investment is down, government
spending is up.
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Household wealth is back to late 80’s early 90’s
Housing and
stock bubble
Tech bubble
What is “normal?”
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Unemployment
Continues to Make this One Different!
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Unemployment has and continues to stay
around like an old shoe that has begun to…
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Unemployment varies by State.
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Prices
The Fed has changed its promise from “keep
rates low until 2015-2016” to keep rates low
until unemployment reaches 6.5 percent as
long as inflation is 2.5 (or maybe 3.0 percent).
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There appears to be “no inflation”
at this time, but check back later!
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Source: dshort.com
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We have, however, seen periods of significant
inflation following accommodating monetary policy.
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The Housing Market
The housing and mortgage markets were
clearly a leading cause of the problems.
But housing is leading us out of this one!!
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Real estate values were inflated.
Normal?
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We took a lot of wealth out of our
homes, then values fell, go figure!
We took “lots”
of money out
of our homes!
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Although consumer spending is important,
single family housing construction is critical
going forward…
The housing bubble,
unprecedented level of spec
homes.
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We are not building new homes fast enough
to replace existing homes wearing out or
destroyed…
Estimated “replacement” level.
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Housing values were clearly inflated.
Some areas more than others…
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Mortgage Markets
Appears to be improving, but with rates at all
time lows and only Fannie and Freddie buying
mortgages, we have significant imbedded
problems in these markets.
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Have mortgage delinquencies
peaked?
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What are we going to do about the
mortgage markets?
When will third parties return?
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Don’t forget we got into this problem by
refinancing 83 percent of all mortgages, now
look at us?
Not sure we learned anything!
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Construction
Is recovering, but not at the levels of the
1990’s or early 2000’s.
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Construction is still slow to recover.
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Source: www.calculatedriskblog.com
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Residential and non-residential are recovering
faster than public construction spending.
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But investment is much lower than the
1980’s and 1990’s.
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Construction employment is slow to
recover.
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The Architecture Billings index
indicates contraction.
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Debt
Too much!
We have been living beyond our means.
Consumers and Business have “sort-of”
learned their lesson, but not Big Government.
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Consumer debt has improved.
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Student loans, however, appear to
be the next “problem child.”
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And, like housing and
unemployment, debt varies by State.
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As does past due debt.
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Even business debt is down…
Non-financial corporate debt
as a share of GDP
Financial corporate debt as a
share of GDP
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Federal Spending is Out
of Control
No Federal budget for over 5 years and Washington
does not have a sense of urgency.
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What if households spent like the
Federal Government?
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Federal spending is a burden on
the economy…not a stimulus!
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And the direction of projected debt
is not good.
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Must deal with entitlements.
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Interest Rates and
Monetary Policy.
There has been an unprecedented use of Federal
Reserve Monetary Policy.
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Most Recently the Fed
Indicated a
“Change in Course.”
A change from a “promise until 2015-2016” to a set of
economic “targets” for rates:
6.5 percent unemployment and 2.5 percent inflation.
Although they still believe rates will stay low until 2015-16,
expect rates to rise well before 2016!
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The Fed Continues to run the
Printing Presses!
The Federal Reserve met market expectations on Wednesday,
December 12, 2012 with another round of easing:
• The New Pledge:
• Keep interest rates low until unemployment falls below 6.5 percent
and inflation tops 2.5 percent.
•
The Plan:
• Buy another $45 billion of Treasury debt and $40 billion of mortgagebacked securities a month. This will escalate the balance sheet to
over $4 trillion in 2013 (a trillion dollars more than today!)
•
The But:
• Bernanke also said that even after the employment and inflation
targets are triggered, that won't lead to an automatic raising of rates.
MacDonald’s bet is, shortly after…
•
Five of 19 the Fed officials said the first interest rate increase
would be warranted in 2014 or sooner, while 13 said it would
occur in 2015. One called for an increase in 2016.
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The Fed’s New Message
• On Thursday January 3, 2013, however, the
Fed “surprised” the market somewhat by the
statement:
“Several (officials) thought that it would probably
be appropriate to slow or to stop purchases well
before the end of 2013, citing concerns about
financial stability or the size of the balance
sheet" --the Fed minutes.
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The Simple Math
•
•
•
The Fed has expanded its balance sheet by printing money
some 3.5 times the level in 2008.
That means, prices will have to increase 3.5 times to keep all
in balance!
$10 a gallon milk?
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Lloyd Blankfein (Goldman) is worried that
investors think low interest rates will last forever.
•
•
•
•
•
"One of the big risks that's looming is complacency. People are
once again complacent about the low level of interest rates.”
“As a result, there could be losses for investors with portfolios
heavy with low interest loans.”
"At some point growth will come back. I think its going to come
back sooner than people think.”
“Now what's going to happen when growth comes back, interest
rates rise?"
"That will have an effect on portfolios and people will have
losses.“
Blankfein said that Goldman is advising all its corporate clients to
borrow "as much as they're going to need for as long as they think
they could need it" because of the low interest rate environment.
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What goes down, often goes back up again.
History indicates much higher interest rates
going forward.
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Source: dshort.com
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Daily rates since 2007
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Source: dshort.com
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Most impact on the stock market,
but even QE3 had little impact.
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Source: dshort.com
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So, what does 2013 look like in the
bond markets.
• In 2011-2012, everything went right for fixed income
•
•
•
•
•
returns.
2013 and 2014, however, will be more challenging.
At a minimum, we should expect lower total returns,
much closer to the single digits returns from income.
Price appreciation will be much more challenging, at
a minimum, and the potential for losses increases.
It is difficult to see a strong case for significant capital
gains, when it will be so difficult for the Fed to
continue to lower rates significantly.
We must continue to face the potential of rising
interest rates.
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What will happen when rates begin to rise?
•
If rates increase 1% on a 10 year Treasury, their value will
fall by 8.25 %:
Expected Change in Yield
Percentage Change in Price
Current
Rate
0%
1%
2%
•
30 year
3%Coupon
3.14%
0.00% -17.15% -30.50%
10 year
3%Coupon
1.93%
0.00%
-8.25% -15.70%
2 year
3%Coupon
2.79%
0.00%
-1.89%
-3.73%
Since 10 year Treasuries pay about 1.9 percent, seems like
a lot of risk for a small return.
"A reversion of risk premiums to historical averages of 6%
nominal rates (3% real rates and 3% inflation) would suggest
estimated losses in portfolios with bond durations of 5 years of
25% or more," equity strategist Robert D. Boroujerdi (Goldman).
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Credit Markets
•Credit standards tighten during sub-optimal conditions
•Liquidity is at a premium
•Some bank’s business models have or will change
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Loan growth has been negative over the past 4
years and construction and development loans
saw the greatest decline.
But We See Improvement Today!
12-Month Loan Growth Rate Has Been Positive for the Last Four Quarters
12‐Month Loan Growth Rate (percent)
40
One time change in accounting for consumer loans.
30
20
10
0
‐10
‐20
‐30
Secured by 1‐4 Family Residential Properties
Construction & Development
Nonfarm Nonresidential Real Estate
C&I Loans
Loans to Individuals
Total Loans & Leases
‐40
Source: FDIC Quarterly Banking Profile
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Loan Losses Have Improved.
Net Charge-offs as a Percent of Average Loans and Leases
By Asset Concentration Group
3.50%
3.00%
2.50%
International Banks
Agricultural Banks
Mortgage Lenders
Consumer Lenders
Loans < 40% Assets < $1 Billion
No Concentration < $1 Billion
No Concentration > $1 Billion
2.00%
1.50%
1.00%
0.50%
0.00%
Source: FDIC Quarterly Banking Profile
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Factors affecting the availability of
credit going forward.
•
•
•
•
•
•
•
New higher capital requirements in the financial services industry.
• Basel III
Less tolerance for growth from regulators
• Financial institutions will be more “selective” in the loans they do
accept.
Less tolerance for loan concentrations (real estate) from regulators.
Less tolerance for funding the bank with borrowed funds.
More pressure on bank’s margins and profit sources (credit card
rules, FDIC insurance assessments, overdraft programs, etc.) means
lower profitability, hence less risk taking (a.k.a., fewer loans).
Anti business Federal Government, large government, anti business
taxation, etc.
Finally, potential future inflation and the exit of Fannie and Freddie
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So, what about our future?
•
The economy is stronger than many think. This could lead to:
• Higher interest rates, and sooner than many predict
• Higher inflation, and sooner than many predict
• The imbedded interest rate risk is much greater than many think
• Rates will rise, and losses will occur, with a resulting negative effect on the
economy.
•
Increased regulatory burden (it is already here!):
• Consumer protection
• Higher minimum size needed to compete
• Negative impact upon lending, liquidity and economic growth
•
Higher capital and liquidity requirements (already here!):
• Reduces bank’s franchise value and their ability to lend
•
Slower growth ahead
• Be prepared for slower growth
• No “big” driver for growth right now.
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Economic Update: 2013
S. Scott MacDonald, Ph.D.
President and CEO, SW Graduate School of Banking Foundation
Director, Assemblies for Bank Directors
Adjunct Professor, Dept. of Finance, Cox School of Business
Southern Methodist University
scott@swgsb.org
www.swgsb.org
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