CONFAB: Performance Trust

Bankers urged to look beyond rates when managing investments."Economists are extremely bad at predicting turning points," former Federal Reserve Board Chair Ben Bernanke is purported to have said. At least one investment expert agrees. "Economists' predictions for the direction of rates have been poor to flat out wrong the majority of the time," said Kurt Fritz, managing director at Performance Trust Capital Partners, Chicago. Fritz spoke to 20 bankers, CFOs and controllers attending an Oct. 21-23 session of the Performance Trust University conducted in Minneapolis..Last April, all 67 economists polled by the Wall Street Journal were wrong about the direction of rates, Fritz said. In 2008, "the average prediction was off by 129 basis points," he said. WSJ economist predictions have been off by more than 60 bps more than 60 percent of the time since 2005, Fritz said. "Ignore the noise about rates," Fritz said..Bankers often stay short on their investments when rates are expected to rise. Banks, however, can end up losing out on earnings when they invest in short term assets without analyzing the decision using bond math. "It is about analyzing the total return of the options available to you based on the math behind your investments," Fritz said..Bankers attended Performance Trust's seminar to learn the math behind their investments. For example, the seminar showed bankers how to calculate total return incorporating falling or rising rates. "There are scenarios in a rates up environment in which a five-year Treasury bond is a better investment than a three-year Treasury bond from an earnings perspective," Fritz said..Fritz reviewed a case study from 1993 in which a banker bought a $5 million, five-year U.S. Treasury bond. The banker gambled that rates were going to fall. By 1996 rates were up 200 bps and the banker had a $65,000 loss when he compared the bond to the market..The investment, however, turned out to be the correct decision from an economic viewpoint. "He made the right decision for the wrong reasons," Fritz said. "The three-year Treasury bond offered in 1993 would not have had a $65,000 loss, but it would only have earned him $717,301. The five-year he purchased earned $825,214. The five-year earned $107,913 more than the three-year. So, even if he decided to sell the asset and take the $65,000 loss, he still would have made $42,913 more than the three-year. In fact, the bank could have taken a $106,000 loss and still beaten the three-year investment."."Managing the investment portfolio to find return isn't about guessing; it's about analyzing the total return available in the market," Fritz said. Total return, a concept that includes fluctuations in market value, is a more appropriate tool than yield for measuring the performance of an investment portfolio, he said, quoting the FDIC..Fritz echoed Nigel Johnson, director of the Performance Trust University, who said, "We are tempted as bankers to choose the options that satisfy the regulator." Performance in the investment portfolio can make a big difference for banks' bottom line, Johnson said. "Our data shows banks in the 80th percentile earn about 173 basis points more per $100 million in assets on their investments than banks in the 20th percentile," he said. "Where else in the bank is there this kind of potential?"."When I showed this to regulators in 1994," Johnson continued, "what do you think they said was the reason some banks perform while others under-perform? They said that the higher performers were lucky. We disagree." He said expertise comes from knowledge and discipline..Fritz gave bankers a few tips for helping directors understand investments made with the total return approach. "These are people who may spend very little time or know very little about securities," he said. "Don't give them a 50-page packet of numbers to explain your decisions. Give them graphs and diagrams which are easy to understand and illustrate the performance of the bank's investments as rates change."