Artisan Unfiltered #7: Interest Rates and the Economy – What’s in Store for 2023 according to Artisan’s Expert Panel

 Interest Rates and the Economy – What’s in Store for 2023 according to Artisan’s Expert Panel  

Watch liquidity. Actively manage risk.  Embrace patience, discipline and simplicity.

Words of wisdom from special guest and noted banking and investment expert and educator, Ed Krei, and Artisan Advisors’ Jim Adkins, Jeff Voss and Dave Larson in our latest edition of Artisan Unfiltered. Listen now to hear their unique and insightful POVs on the Fed’s latest interest rate increase and what it means for banks going into the new year.

Transcript

[00:00:00] Jim Adkins: Welcome to, Artisan Unfiltered. I'm Jim Adkins. Joining me from, Artisan Advisors is Jeff Voss, managing partner, as well as Dave Larson, managing director, and we have a special guest today, Ed Krei. I'm give you a little background on Ed before we get into the, discussion.

Uh, Ed joined, First Bankers bank securities in bank management services and sales in 2018. He's got more than 20 years of investment experience, based out of Oklahoma City. Ed is a faculty member at the Southwestern and, Colorado graduate banking schools and has served as a speaker for financial institution, regulatory agencies, and numerous other banking programs.

He's worked for an international accounting firm and was managing director and shareholder. Of an institutional fixed income dealer, and broke. Ed graduated with honors from the University of Mississippi and is a member of that School's Accounting Hall of Fame. He was a gold medalist on the CPA examination in Tennessee.

Ed has served on boards of numerous charitable organizations and is a trustee of the Oklahoma City Community [00:01:00] Foundation and the University of Mississippi Foundation. And, his ties to the University of Mississippi. I'll forgive him since I'm a University of Tennessee. I will forgive him for that. 

So gentlemen, thank you for joining Artisan Unfiltered today. We're gonna be talking about interest rates, uh, the economy and where things are, uh, seem to be shaking out. And maybe take a look into 2023 and, and maybe if our crystal ball is clear enough, look into 2024. To start all this off, I thought I'd just throw it out to the group.

What are your general perceptions of yesterday's fed meeting? That increased our, our, Fed funds rate 50 BPS. What does everyone think about that, Jeff?

[00:01:44] Jeff Voss: Yeah, I mean for, for me it's no surprise. Um, yesterday, no new news from what was expected. 50 BPS. , um, benchmark rate now between four and a quarter and four and a half. Um, [00:02:00] I think the rhetoric is the same as the last time from, uh, Jerome Powell. Um, you know, they're still fighting inflation. Some of the headwinds are still there, but looks like some of the, the macro numbers have improved a.

Uh, seeing, uh, the inflation number fall in November down to 7.1%. Um, you know, uh, again, no surprise from my perspective.

[00:02:31] Jim Adkins: Ed, what's your perception of yesterday's meeting? Anything surprise you at all?

[00:02:37] Ed Krei: No, it didn't surprise me. What I think the $64,000 question is gonna be, how resilient and how and how fixed on the, on the mission of bringing inflation down the Fed will be as we go into 2023. You know, I was, I was, Was thinking the day I went to, I went to the symphony here in Oklahoma City and the new world Sy Divorce Jocks, new World [00:03:00] Symphony.

And the, if you, if anybody's ever heard that, the symphony players just beating the heck out of those, outta those symphony drums. And it made me think. I be being a, an accountant and, and, and bond guy. I was thinking, yeah, we've got two drums being beat. One is the inflation drum and the inflation drum ruled.

It, it was the one that, that, that, that was in control through the 1st of November. The, the, the recession drum started being beat louder in, in November, and we saw intermediate long-term rates back up. We actually saw short-term rates back up even knowing, even in, in anticipation of the fed raising. 50 basis points.

So I, I think the question is, is it recession concern or is it inflation concern that's gonna dominate, you know, the, the dialogue in 2023? Uh, I personally think the Fed's gonna continue to raise rates and wouldn't it all surprise me to see short term rates go up to 5 25, 5 and [00:04:00] a half? I wouldn't at all be surprised to see intermediate long-term rates retrace that 70 basis points that we've, that we've backed up in the last 45 days and go back to 4% or maybe even north of 4%.

That wouldn't surprise me at all. The $64,000 question though, is like catechism. When we go through catechism, there's a question, you know, what does this mean? The question is what it means for us. and the way we develop, the way we articulate, the way we implement the financial strategies and risk strategies in our bank, and, and I met with the, had a meeting with the Fed earlier this week and everything was, everything emanated from interest rate risk.

In interest rate, risk was the number one concern. But then you have the impact, and I'll talk about this later. I'll shut up. The impact of interest rates and the, the, the, the exacerbated increase in interest rates, the impact of interest rate risk on credit quality, particularly commercial real estate portfolios and the impact [00:05:00] of, uh, of, of, of exacerbated rate increases on liquidity within your bank and within the banking system.

So we can talk about those later if you wish, but, uh, that, that, that's kind of how I see where we are, where we are.

[00:05:15] Jim Adkins: Uh, Dave, what's your, what's your take on yesterday's fed action and, and what you've

[00:05:20] Dave Larson: I think, I think, uh, you know, Ed and Jeff make some excellent points. I would say. Uh, obviously it was no surprise. Of course, the, the funny thing is why the market was surprised or reacting. Uh, but, but I think largely it's, it's, it's higher the theme I hear, you know, higher for. And, and I would add one point, I would add it is early, there's a lag effect with, with policy actions that the Fed has taken.

You know, you think about it, it was just back in March, just March of this year, we're talking, you know, 9, 8, 9 months ago we were near zero. Okay. And now we're up four and a half and now it's, we're, it's natural we're finally starting to begin, I think, to see the teeth in the tighten. And so, but it, it, [00:06:00] it's, I think we're, so, I think the reality's sinking in now and then, and then obviously the, you know, there's a retail number this morning or whatever that's weak and beginning to see some impacts and so on.

But, but employment's obviously very low. And people, some people say, well, employment's low. It's, it's, everything's fine. Well, no, there's a lag effect. And, and so, uh, I think you'll, you're gonna, we'll learn a lot in the next six months. And then as, as Ed indicated, the big question will be, You know what, uh, uh, you know, I think the, there's no doubt the Fed has committed to, to, to, you know, tackling inflation.

If they stick to that message, then I think a recession is certainly likely, but very difficult to

[00:06:35] Jim Adkins: Yeah, I, I think I read in, uh, comments yesterday, uh, that, uh, the Fed's looking at, you know, 0.5% gdp. for 2023. I think that's down from a 1.2% number that they had in September. So, I mean, they're recognizing the fact that things are gonna slow down substantially. I mean, that's a, that's a big move from 1.2 to 0.5, you know, and, uh, you know, it's [00:07:00] just minimal growth.

So, you know, to edge's point about recession and inflation it to. They're, they're still beating that inflation drum. But, uh, recognizing the fact that, that, you know, that recession side is, is, you know, it's, it's here. We're gonna, 2023 is gonna be an interesting year, may not be that great of a year.

[00:07:22] Jeff Voss: Yeah, Ed, I think you're right, I love the analogy to the company. I mean, I think that's absolutely correct.

 [00:07:30] Jeff Voss: I, I mean, I think the, the, the, the Fed start trying, trying to do is orchestrate this soft landing, uh, as, as much as they can. Those numbers, Jim, I think are gonna bear out in, in smaller rate, increases down the road here.

But, but I do think as, as Ed said, I think we're gonna see the, at that benchmark rate, up, up, you know, well above five, probably 5, 5, 5 and a quarter, five and a half percent. [00:08:00] And, and I think, you know, the impact is, you said, uh, on banks is credit and it's gonna be impact on, on ability to. On the lending side, uh, deals no longer make sense.

You know, when you're, when you're looking at opportunities that are out there. Um, and then the, the big impact that I see too, Ed, we're seeing from our client base is liquidity concerns. And it's, it's being driven through the, through the examination, uh, today, you know, process that the Fed walks in the door today or the F D I C walks in the door.

First question out of the box is they wanna see your liquidity policy, your liquidity, stress testing, your capital planning, all of that stuff. And, um, I know, we'll, we'll spend some time on that as we get into this discussion, but the, the, the consumer makes up 65% of the economy today. Right? So [00:09:00] the spending that's, that's happening to me with the headwinds that, that we're all facing as consumers still amazes.

You know, it, it, it, it's gotta manifest itself in higher debt. They've gotta be used. Credit card debt must be rising significantly, irrespective of what people, uh, you know, the impact that they're gonna see. That the sticker shock when, when they get their bills, uh, coming through on the, the, the, these changing interest rates for credit cards is gonna be.

And I, and I do think you're gonna see the fall out of that from a credit perspective here in 2023 and maybe beyond.

[00:09:44] Jim Adkins: I just, you know, in our client base, uh, you know, looking at a lot of loan portfolios, Dave can, can jump in there as well. But, you know, there were a lot of deals written. For the last few years, few years at four and a half, four quarter, and, uh, those deals are gonna renew. And now [00:10:00] we're looking at, you know, rates seven and a half, 8%.

And you know, when you, a lot of banks shock as they should, they individually shock a credit and say, okay, what happens to this credit if it goes up 2%? Well, the shock rates, uh, you know, a year and a half ago were at six. You know, uh, if you shock something and you're writing a deal at, uh, seven and a half, 8%, you, and you throw another couple percent on your other shock to see what interest rate sensitivity it has, those deals may not work.

It probably won't work in a lot of cases. So I, I do think there's a lot of credit issues. That are going to, uh, uh, raise, uh, raise their ugly, raise its ugly head when, uh, we get into 2023, um, you know, you can already see some slowdown in our client base in construction. And um, uh, you know, I think that's gonna continue.

Deals just aren't gonna work like they did when it was three 3.75. A lot of deals work at 3.75 and 4%. And, uh, we'll, we'll have to see that. The other thing [00:11:00] I want to, you know, we talked about inflation. and I just, what strikes me about, you know, the increase in rates and that, that, that, you know, um, trying to soft land and, and, and bring inflation down, it just seems like that 2% target inflation that the Fed has is a long way off.

And I'm just wondering if it's gonna take, you know, the Fed says, okay, we're going to have a G D P next year 0.5, you know, maybe that recession that they're trying to soft land needs to. Greater to drive, you know, to stop some of the demand in the economy to get back to 2%. It just seems like a long way off.

Five points is, I don't know how we're gonna get there, but that's just a, a, a reaction that I have.

[00:11:48] Ed Krei: I couldn't agree more with that. I think it's going to, I think inflation is going to be frustratingly persistent because so much of it is not gonna be impacted. [00:12:00] by the Feds raising short-term interest rates. I don't see that their raising short-term rates is going to bring down wage growth, labor growth.

I don't think it's gonna bring, it's gonna impact productivity. Uh, like they would maybe be, think or hope. It is, I would expect inflation to remain, like I said, stubbornly high through 2023. And again, I think, as I said before, the question is, how persistent will the fed remain? On bringing or establishing a path, a track for inflation to go back down to the 2% range that they talk about.

[00:12:44] Jeff Voss: A question I have is, what other tools do they have other than rate increases today to drive inflation down? I mean, they've already started the, the tightening by not buying more, you know, shrinking their balance [00:13:00] sheet. Um, what other tools, uh, do, do you think are out there for them to use other than this rate increase to drive inflation?

[00:13:17] Dave Larson: Oh, bank reserve policies, I think, right? Potentially. Um, but. Um, I think that Jeff, I think you hit on the major ones. Those obviously, and, and ones that I've, they're, they're, they're kind of stuck with too. I think the quantitative tightening aspect is particularly challenging for them, given the size of that balance sheet.

And even if, from what I've read, even what they're doing right now is that that's significant relative to how much they have.

[00:13:40] Jim Adkins: Yeah.

[00:13:41] Dave Larson: Um, but, um, but Ed, you're probably more familiar with, with, with that impact on the, on the markets. Uh, but I, because the other piece here too, we got this back. is, is the fiscal side.

Right. You know, and, and the, and the government , you know, you know, they're, you know, crowding, potentially crowding out from the government, having [00:14:00] to, to fund its deficits and its large. You know, we obviously Covid dramatically altered, um, you know, the, the fiscal aspects and, and I don't hear a lot of talk of that, but I think that's, that's a factor too, as it as these, all these higher rate costs flow through the federal.

Deficits. And, you know, think about it, we borrowed, we had money near zero. It's pretty cheap to carry these, these trillion, you know, deficits or trillion dollars of debt. And now as those rates go up, the government is gonna, they're gonna have to, that's gonna have to be in the budget, you know, so, and plus they're in the market funding their debt.

So how will that, will that have a, you continue, you know, how will that impact the tightening?

[00:14:41] Jim Adkins: Well, I think, uh, what the Fed Balance sheet is something like 9 trillion something. I think that's the last,

[00:14:48] Ed Krei: Mayybe a little bit smaller. Yeah. Yeah. But, but.

[00:14:51] Jim Adkins: still substantial and they've been, you know, they've been getting that as well. But, uh, you know, it's still, I, I agree with you. Uh, David. [00:15:00] One thing I always think about is, okay, you've got certain financial tools on this inflation that you can use, some of which we've talked about tightening, and then of course, you know, interest rate increases and things.

But I don't know, it, it seems like this inflation's more structural, you know, it's, you know, more policy driven, more structural. So maybe all the, all the financial things that the Fed can do don't have the same impact that, you know, maybe they would in the past. I, I've never seen a supply chain issue.

There's still supply chain issues now that I would never, ever think would be around. I mean, my, we, my wife and I ordered some stuff and, uh, I think it's a new bed, and I said, when's it coming in February? You know, and I said, wow. Really? February. Wow. And they, you know, they just can't get stuff. So it just seems like the structural.

Uh, inflation factor, uh, is, is a monster. And, you know, some of our monetary [00:16:00] policy may not be enough to, to get that handled as quickly as maybe they would like.

[00:16:07] Ed Krei: I would agree with that. I think China continues to be a big uncertainty if you look at what's happening there with, you know, with their common prosperity goals and their. Uh, and, and their bubble, their real estate bubble that they're trying to live through, and they're, they're, while they're relaxing their, their zero covid policy, the impact that that's had on their, on their economy and their, and on their participation in the global supply chain. 

So I think that's gonna be, be a challenge. You know, the Fed could, could reestablish, uh, uh, or, or, or increase margin requirements on stocks. They could, they could look at reserve requirements on deposits, you know, the, if they chose to do that. Those are things that go beyond the quantitative tightening, the shrinking of their balance sheet, uh, in.

in the, in my [00:17:00] opinion, the uncertainty that that's causing within, within the securities management of community banks is what effect is that gonna have on mortgage backed securities and what's effect is it gonna have on agency spreads and, and, and what's it effect is, should it have on how I look at, at duration of a securities portfolio.

There's so many things that, that manifest in these, you know, in this, in. uncertainty as to what, you know, what the Fed's actions will be.

[00:17:30] Jim Adkins: Right, right.

[00:17:32] Ed Krei: so

[00:17:33] Jim Adkins: Well, and you get the, you got the AOCI issue, right? 

[00:17:37] Jeff Voss: Yeah. Well,

[00:17:38] Jim Adkins: you know,

[00:17:38] Jeff Voss: I'm, I'm sure Ed, you've, Ed, you've seen that at your, your banks too. Um, that's a huge issue with our clients. Uh, we've, we've recently been engaged to work with clients on liquidity, stress testing, and you know, while, while there may not be credit risk in their portfolio, the [00:18:00] concern is some type of a deposit run at a bank that would cause liquidity concerns and having to sell bonds.

And, um, while it may be unfounded, uh, it's still a regulatory concern that's been created by these, these shock to the shock to the interest rate cycle here that the Fed has put through. and it's, it's definitely causing management stress, um, at these institutions. I don't know if it's causing real financial stress yet, but definitely management stress

[00:18:39] Ed Krei: Uh, you know, I think it's, I think if it's not causing financial stress, it's right on the verge of it. Uh, and I say that because if you look, if you look at the institutions that have committed. A large portion of their gap capital, their equity capital to interest rate [00:19:00] risk, and, and I'm, and I'm saying interest rate risk as measured by that, that accumulated other, you know, that loss in the, the unrealized loss in the securities portfolio, if you're taking that level of risk, And from a strategy standpoint, from a macro strategy standpoint, in that institution, the question is, well, how much other risk can I take in my loan portfolio?

How much other risk can I be taking elsewhere in my balance sheet in the, in the way I make, make, uh, my, my strategic financial decisions going into 2023 and 2024. Have, I burned my capital within an interest rate risk and now I can't take it in credit risk? If I were a bank today, I would be asking, and I had a, had a large unrealized loss.

Relative to the size of equity that one of the first things I would do is I would say, give me, give me, let me, let me look at my top 25 biggest loans, and I'm gonna go in and I'm gonna stress them. I'm gonna look at them, I'm gonna look at them qualitatively, and I'm gonna look at them. As you [00:20:00] said earlier, someone said earlier, I'm gonna stress those.

And I would take, I would take prime rate up to 8.5 or 9%, and I'd say, how do those loans, how will those loans perform? What's my coverage ratios going to be? With interest rates at 9%, what happens to my collateral evaluation and my capitalization rates? If capitalization rates go from 2.5% or 3% up to 9%, and, and, and, and I have to focus on, on that risk in my institution.

That's the reason I said. Credit portfolio. Loan portfolio credit risk will, will emanate from interest rate risk to a, to a fairly significant degree, I think. And last thing, liquidity risk. You can't sell bonds that have big losses because all you're doing is converting an realized loss to a real lost loss that you're, most banks are not gonna do that.

So they're gonna look at at at their borrowing capacity. and the consternation there is, or at least one element of consternation, is that the Federal Home Loan Bank has [00:21:00] said, or their, their supervisor has said, our bank system, federal home loan bank system will not lend to a bank that has negative tangible equity.

And there's push to have them remove that requirement, um, to eliminate that requirement for, for, for, for lending. And, uh, banks, banks may not have all the liquidity sources that they had six months or a year ago because of those unrealized loss. And, uh, and that's why I said liquidity risk will increase as a result of the interest rate risk.

And it is, it will. And, and we know last point. We know that when interest rates rise, liability durations, shorten deposit durations, shorten. because more customers are looking to take advantage of higher rates and they redeem CDs and they, they move outta money markets into other products. We know liability, duration, shorten, and when interest rates rise, asset, durations, lengthen.

We know that. And, and, and, and, and that creates an even more focus. [00:22:00] More focused, concern about, about, about liquidity and, and, and interest rate risk management at an institution and, and the alcoves of the, these banks. They need to be able to understand that and they need to understand optionality better than they ever had, negative convexity, better than they ever had because that has contributed to a large degree to the unrealized losses. I think the unrealized losses and securities.

[00:22:28] Dave Larson: I was, I was, I was gonna say that ALCO is no longer a boring committee at the bank.

[00:22:34] Dave Larson: after, after, after that, after that decade of, you know, low rates and you go in there and you did all, I've been, you know, we've all been through these meetings, you know, there's. Whatever rates go up 200 basis points.

Oh my God. It's, you know, how do you ever fathom that or whatever. And we have all these charts and graphs

[00:22:47] Jim Adkins: Yeah.

[00:22:48] Dave Larson: so on, and, and you take a, and you take a position whether you're, you know, hopefully

[00:22:53] Dave Larson: possibly gaped are, are good shape. But, but now, now, absolutely. It's, it's not just capital, but I think the [00:23:00] other piece too here is net interest margins.

Uh, you know, and, and obviously initially rates go out, Hey, we're gonna, we're gonna bank that, you know, we, we raise our, our loan rates. So on, try to bank that deposit and you look at deposit betas and how they're gonna run. But I saw something from S&P the other day, and it said that the national average of, uh, the high yield savings accounts are 0.12%.

Okay? And that's the national average. The top 10 digital banks, high yield savings, comparable. I exceeded 3%. I think it'll, it's gonna be very interesting to see, and the banks are already, you know, they, they, again, trying to, everybody's gonna try to hold on to those, those costs. But how at the higher the Fed goes, again, the, the more economic sense it makes for people to go after yield. And also this time around there, you have an extensive digital offering that continues to grow of people that it's very easy to open an account and get that higher rate wasn't [00:24:00] there historically, there wasn't so much the trust in that. And I think it's gonna be, it's gonna be tougher this time I think for, for banks to, to preserve those funding costs given, given the competition and just given the magnitude of how much you can make if you, so, so, so net interest spreads, you know, there again, it depends how you're gapped and, and, and I think some banks will do well, but with it, uh, also depend on much.

Your funding also is core or BDA and so, But if you're, if you're exposed there, then you're gonna lose a lot of value. And in that sense, I think it's these combination of things that obviously bank stocks have have sold off. Both spread, spread concerns. And then obviously credit quality, you could really get hit on two ends,

 [00:24:40] Ed Krei: The biggest uncertainties and variables in bank's performance next year. And I know, and I, and I see this as banks are talking about their 2023 budgets, it's gonna be their funding costs, you know, not, and, and how, how their funding mix may change as they move through 2023. [00:25:00] and, and, and, and, and we could very well see that, that the rise in asset yields, particularly loan yields, has kind of stalls out, kind of caps out, but the upward pressure on your funding costs is gonna continue.

We've benefited from this, you know, from this, this rise in short-term interest rates as we drug our feet to, to move our, our deposit rates. But at some point we're gonna have to ask within my competitive area, you know, how, how am I gonna have to take my rates upward, to retain the deposits that I've enjoyed the last two or three or four years.

[00:25:34] Jim Adkins: Right. And of course that puts more stress on, you know, your, your, your rate on the asset side, your rates, you know, your loan rates. You can't rely now on mortgage origination income - that's gone. You know, that it puts a lot of bank. We're in the, we're in the budgeting process with a number of our clients and, uh, that, that line item is, is gone.

I mean, uh, I just got some data the other day. As of this [00:26:00] week, uh, mortgage apps, uh, for purchase were down 38% from a year ago. And Refi mortgage applications were down 85% from a year ago. So that income stream is gone and that puts more pressure on margin activities. Right. And, uh, you know, the banks are, are, are, you know, gonna be under a lot of pressure not to take on too much credit.

Um, and you know, that whole stress process, Dave, you do a lot of credit risk management. That whole stress stressing and, and making sure that, you know, there's rainy day solutions for loans that are, are, you know, possibly subject to interest rate increases.

[00:26:40] Dave Larson: Right. Buzz is that indicated, you know, stress testing it, it is one, one aspect to, it's also being very engaged in your portfolio, knowing what. What risk you have, you know, operationally within these businesses or in in markets, and making sure you understand what, you know, what options are available to strengthen those, those credits, or to [00:27:00] take action as you can to trim exposures.

And, um, it's, markets are still flowing. I mean, the banks obviously are still lending now. They certainly in sector wise, CRE, office, retail, other, you know, they, those are tough, but, But I think you, you could see some slowing click in the warehouse side. Uh, you know, because we built a lot of warehouse in support of the whole, you know, during the whole Covid period.

Uh, but, but once the banks, I think it'll, it'll be interesting to watch. I think you watch the banks on the credit side because they tend to move together, uh, in, in pulling back. And then when the, when the banks pull back, that'll be, in my mind, that's a big signal of the downturn because it's then, There's less and less options for people that are borrowing or, or obviously that that flow of credit slows and that definitely has an impact.

And obviously the Fed wants to, that's part of the Fed's plan when you raise rates. If you slow the economy, then you're gonna, banks are getting more conservative and pull people back, but they tend to just think of the past. They tend to be pretty heavy [00:28:00] breaks in the banking business where one day we're kind of in and the next day it's, Nope, we're not doing that.

And because nobody else is,

 [00:28:07] Dave Larson: It's hard to be a maverick.

[00:28:09] Jim Adkins: Yeah. And you know, we're kind of like lemmings in the banking business. You know, a lot of, a lot of things kind of happen in, in lockstep, but you know, back to the Fed and, and you know, their actions are they signaling are, are they, you know, you want a signal from the Fed, right?

You everyone knew that yesterday we were gonna have 50 BPS. It wasn't a big secret, but you know, are they signaling their intentions? Correctly to give people, give business people an idea of where they're going. It seems like they, you know, as Ed was saying earlier, in doing the, the drum analogy about the inflation efforts and the, uh, uh, economic performance efforts, you know, are they, are they giving us a clear signal as to what they're trying to accomplish, or is it [00:29:00] still messy?

[00:29:04] Jeff Voss: Well, I, I, I think the. The signal to me yesterday was pretty clear as I think as Ed said, it's will, will the Fed be as tenacious about it, you know, over the next year? Or are they gonna have to back off trying to create this soft landing in some way, shape or form? Um, you know, they've, they've indicated benchmark numbers that they want to get to, and until they get there, they're gonna continue with their, their strategy, their overall.

Um, I, you know, one, one thing that's I guess that's positive that came this past month was, uh, we, we now have, I think, a more clear direction of inaction on the part of Congress, right? So between the, the, the two houses, I don't think we're gonna see a lot of new economic legislation coming out that would be [00:30:00] harmful to the economy from a monetary per.

Um, but you know, Ed, you may, you may have some thoughts on that too with the change in political climate, uh, with, you know, Republicans taking control of the House and you still have the Democrats and Control on the Senate side. Uh, Biden's front-end loaded agenda, uh, of spending, I think is probably gonna come to an end here for the next couple years.

[00:30:31] Ed Krei: I'm, I'm fairly apolitical, but I believe that the Democrats will push hard to get a spending bill done before, before the end of the year while they still, they still call the shots in the House. Uh, I think they'll make a real push and we'll see the degree to. and, and, and, and who on the Republican side will capitulate to that?

I know that the ha the Republican leadership is urging resistance to that and wait until 2023 when the Republicans control the House. But, but we'll just have to see what happens. I'm, I'm, I'm not a, I'm certainly not a political, a political person at all.

 [00:31:18] Ed Krei: that is, that is a big uncertainty. You're exactly right.

[00:31:21] Jim Adkins: yeah, and you know, we're still correct me, I mean, we we're still under the, you know, the, the Trump tax cuts, right? The Trump. Trump tax policy is pretty much untouched, right? I mean, there hasn't been any major changes to some things that he did. So, um, you know, that revenue is coming in according to those policies and, and the spending seems to have ratcheted up so much that, um, you know, it's a lot more deficits.

You know, more deficits are coming. I, I, I'm not a big, I, I don't have a lot of, um, uh, What's what [00:32:00] I'm trying to say? Uh, you know, uh, I don't think we're gonna get a lot done. How about that? Over the next couple years in, in Congress

[00:32:07] Jeff Voss: So is that, is that good for business though, Jim? I mean, I think having, having, well uncertainty creates problems for business and, even if, even if we knew nothing was gonna happen, at least business can take some actions over the course of the next two years. It's the,

[00:32:26] Jim Adkins: Yeah. Well, I think from a tax, if you're, if you're planning for your tax, you know, your company's tax position, you know, they're certainty there. Right. I don't think there's gonna be any major changes in, in that regard. Um, and uh, as you know, we've been talking about, I, you know, the economy interest rates are, are moving up, you know, maybe if we can get some more certainty, uh, in regard to the, uh, interest rates, um, you know, people will feel a little bit better, but, um, I just don't have a lot of confidence that anything's gonna happen in Congress over the next two years.

I just, you [00:33:00] know, so we're just gonna be kind of stuck here in the mud and fighting political fights and spending money, I think is, is pretty much what we're gonna do it in the, in the money that is gonna be spent. I don't know how much it's gonna really help the average person and the average bank, you know, or the average businessman.

So I, I just see more spending and more deficits.

[00:33:23] Dave Larson: Well, I, I would, I would just go, go ahead. was gonna just say, I think, I think, I think the Fed has been clear, if you're listening, I think the Fed has been clear. Um, I think that, uh, two, as it relates to Congress, I think you have a, it's divided. So, yeah, you wouldn't expect a lot of legislation, although I continue to believe that the impact of the deficits and the cost to, to fund the, the treasury debt amidst, amidst a, a declining economy, that's gonna be the, the, the main focus of discussion and, and how that all drops out. Uh, because I just, I, you know, [00:34:00] they're just these, we, you know, the, thankfully the modern monetary theory concept I think is dead. You, you can't continually just print money and, spend your way out of, out of deficit. So, but I think, so I think it comes home to us the next couple years. We'll see how people deal with it from a policy standpoint, but part of it's out of their hands now because the, the, the money's been spent, the deficits are out there, the feds continues to tighten.

You're gonna have to pay for that. Uh, and so it'll be interesting to see what that, how that affects their decisions or if whether it forces fiscal discipline on the government to deal with those deficits.

[00:34:34] Jim Adkins: Right.

[00:34:36] Dave Larson: Your thoughts, you know, from a market standpoint, I mean, the, as long as people wanna finance your debt, no problem.

You can, you can, you know, if, if people wanna hold your currency and, and rates are low, you can, you can do all those things. But if, if people have alternatives, uh, particular nationally, if alternative, you know, like Russia or China, other powers, uh, that, you know, focused on really commodities as revenue [00:35:00] focused on other, you know, places to hold their, their, their currency. You have some real issues.

[00:35:10] Jim Adkins: Well, I know that, you know, when you look at around the world, and I'm, I'm certainly not a, uh, a world economist by any stretch of the imagination. You know, some of the other economies aren't as, you know, they're, they're having their issues too, you know, and so, uh, maybe that'll hold borrowing costs to, to some level here in the US as we finance our $32 trillion, deficit.

But, it comes down to where, where else do investors go to, right? I mean, we're still the shining hill, shining, uh, you know, shining star. And so, you know, that is an advantage. But, um, it's, it's, it's gonna be a tough slog, I think in 2023.

[00:35:55] Ed Krei: And even if we know, even if, if, if, if we, if we signed a pact with the [00:36:00] devil or whomever and we knew that interest rates, the, the terminal Fed funds rate was gonna be five and a half percent, that's where it is. Even if we know that, that's not going to change the fact that we have such significant uncertainty as it relates to OPAC and energy costs, as it relates to the strength of the EU economy and, and, and, and their ability to deal with, you know, with, with disrupted energy supplies that we don't know what's going to happen in, in, in China and their, you know, and their real estate bubble.

And, and, and the, the impact of the, as I said, the common prosperity and the zero code policy. We don't know that. So I think, I think the, the, the, the, the, as we move into 2023 and 2024, what if somebody were to ask me and what, and I'm, I'm an old bond guy and. Somebody, what, what, what does this mean for us? [00:37:00] Well, I would say, I'd say there's three things that you wanna keep, keep in mind.

Number one, always remember that you're, that, that, that, uh, that, that the securities and, and your institution has to have liquidity to operate. Banks fail because of bad loans, but they're closed because of no liquidity. So don't ever forget that. So I would say today, three things. Patience, discipline, and simplicity. You know, be patient because the uncertainty is gonna persist certainly into 2023 and maybe 2024. Discipline. Don't go out and try to, to, to, to buy. This is not a time to be out buying 15 to 20 duration securities and doubling down on your duration risk and exposing your bank to more, you know, accumulated comprehensive income law.

That's not how to do that. Simplicity, take risk outta your securities portfolio and make sure that you're taking the right kind of risks and you're, and you're being compensated for the risks. I would suggest low optionality risk in securities portfolios. I would suggest short duration securities, insecurities, portfolios.

I've already touched on what I would do with the, with your real estate loans and stress, testing your biggest credits first and making sure that you're managing credit risk. But, but that's what I would tell a bank today. You manage your balance sheet, you stay in control of your risk management practices and not try to do double reverses and end rounds.

You know, this is, this is block and tackling time.

[00:38:38] Jim Adkins: Uh, David, along that line, what would you tell a bank, you know, that, you know, you're advising to manage the overall risk of their, their organization going into 2023. What are some of the things that you, that would, that would you would want to share with them?

[00:38:53] Dave Larson: Well, um, I think, you know, certainly I don't have Ed's background on the, on the security side or bond side, but I would, I wouldn't say, I think, you know, it makes a lot of sense to stay, to manage your risk. I think laddering, laddering strategies, effective laddering strategies should get you through this.

Uh, if, if you, you know, if you weren't too heavily weighted, that's the whole idea of laddering is, is to be short and long and then, and, and you roll into the higher rates and, and go through it. Uh, I, I think, uh, uh, you know, certainly on the, uh, the, and, and then I think very much understanding, you know, to a certain extent, Whether you were positively gapped or negatively gapped, that's kind of baked in now.

So that's you, you, if you were excessive one way or another. It's not easy to move that overnight, but I think you certainly need to understand that, uh, and, and, and continue, and continue to think about that, not how best to, to manage this. That said, to staying shorter as you can going forward to take away that duration risk where you can, but on and on the risk management side, yeah, it's absolutely time to. And I've talked a [00:40:00] lot about this, but absolutely. Um, you know, you have your tools of reporting with whether, whether it's for tools and Nalco that tell you about your make, make sure you're getting the right tools, that are telling you what's going on in your portfolio, where your risk is. And, and the same thing on and on the credit side, obviously that you're giving.

You have the right reporting with regard to, uh, risk ratings, uh, uh, deterioration, migration, if there's issues, migration, credit quality. You're, and you're not getting lost in the, the weeds of what's going on, but seen at a higher level of the trends in your portfolios. And then, uh, an effective risk management system that moves throughout the organization so that the people are upstreaming the issues, upstreaming, the, the performance of the portfolio to the right people to make the right decisions.

And that's staying engaged with your customers, uh, and, and taking, taking action. Certainly not hope is never a, never a strategy. Hope that rates will go down or it'll get better. I mean, you've got, if you've got a, a construction project that's out of balance now because the interest reserve is out, uh, and, uh, you know, [00:41:00] higher rates, I mean, you've, you've gotta take action to deal with that.

And it's best to take action earlier when people, borrowers are in a position to do something. Right now banks are all still lending. You can sell exposures. You may take a hit on certain exposures, uh, but there's an opportunity still to do. Or, or we're asking borrowers to put an accurate, to do things they might be willing to do.

Now that once you shift into recession, then it's, it's all bets rough. Other, the liquidity evaporates from other banks taking you out. Uh, and borrowers themselves pull back and say, Nope, I gotta conserve my capital. I can't put that into this project now. Uh, so I be very vigilant right now. It doesn't mean you gotta stand by your customers, but it, it just, it very much means under understanding your risk in, in what you.

Where you're exposed and, and then, uh, making sure you have the reporting so that people at a high level, at the board level understand that.

[00:41:51] Jim Adkins: Before I ask Jeff the same question, I wanted to just comment on what you were talked about in terms of customers. You know, some customers handle, uh, stressed [00:42:00] economies better than others, and one, and one of the, you know, it's more of an art than sometimes a science. But, uh, sometimes you have to go in, look at your portfolio and understand which segments or which customers or which segments are gonna have more difficulty with economic situations. And sometimes, you know, you have to trim the tree, uh, trim the grass. Sometimes you have to say, well, you know what, we're, we're not comfortable with this type of business or this particular business. And you have to be able to do that while there's still meat on the bone.

While there are still options for those borrowers to go to some other place that maybe has a different, uh, risk tolerance or view of risk. And that's a real art form, especially as you get into these, these economic situations. Um, you know, sometimes good customers can, you know, be more susceptible to problems and you have to have tough conversations and, uh, uh, I would just make that point.

Uh, it's, [00:43:00] it's more of an art form, art form. Uh, than a science. Uh, Jeff, your, your words to banks that are, are trying to figure out, you know, the next year or so, what do you think?

[00:43:10] Jeff Voss: Yeah, I mean, I, I, I think liquidity, stress testing. Contingency funding planning. Um, I, I think all banks should be focused on that right now. Um, they should be, uh, looking at their various sources of liquidity, looking at their deposit durations, looking at, um, what will happen if, if there is movement within their deposits, they may not lose, they may not lose the actual deposits, but they may have to reprice them significantly in order to keep them. And what that, what the impact is on earnings ultimately gets back to capital, uh, stress testing your capital. And obviously the, the credit piece of that is [00:44:00] extremely important as, as Dave talked about.

But I, I think Ed had it hit, hit it on the head. I mean, you know, we've, we've gotta focus. At least for the next year, on blocking and tackling. Uh, this isn't a time to become aggressive when it comes to growth in an organization. Um, I, I've heard a number of organizations talk, you know, in, in discussions with their bond firms talking about leverage strategies.

And I shudder to think what that means. And every bank's balance sheet is different. So the strategies could all be different right now. You know, my, my focus would be on conserving liquidity. Uh, keeping as high of an on balance sheet liquidity ratio as possible because honestly you're getting paid for it these days.

Um, and then, and then, you know, figure out what happens if you start to see movement in your [00:45:00] deposits out of the organization. What do you need to do to respond. You need to test those, those sources of liquidity because obviously, you know, when things get tough, many of those sources of institutional liquidity dry up and they're not there.

So to the extent that you can firm up those relationships in any way, shape, or form by pledging, pledging a certain assets. You know, I, I'd suggest that you do it so that you have some real sources of liquidity. I can tell you, the examiners are gonna pay, uh, focused attention on that this next time around.

[00:45:42] Jim Adkins: Well, I see by the old clock on the wall that we're out of time. Uh, I want to thank, uh, of course Jeff and, and Dave from Artisan, uh, to, for joining us today. And certainly I want to definitely thank Ed, if you, if you wanna reach out to [00:46:00] Ed or see what First Bankers Bank Securities can do to help your, your bank thrive and, and prosper.

I would suggest you go to their website, www.fbbsinc.com, and you can learn more, uh, about what they do. And also, uh, if you need to reach out to Ed, you can do it through that website. So gentlemen, I appreciate everybody joining us today and, uh, we'll see you next time on Artisan Unfiltered.