Addressing A Flat Yield Curve

How to Invest with a Flat Curve

Economists, financial professionals and business owners use the yield curve to predict economic outcomes and gauge the behavior of the market. The yield curve percentage is the rate at which debt interest rates change from shorter to longer maturities and is the spread between the Treasury 2-year and 10-year bond yields.  The curve shows three different scenarios: an upward slop, a flat curve and a downward slope (inverted). 

Upward Curve: Represents that the long-term bond rates are higher than short-term bond rates.

Flat Curve: Represents that short- and long- term bond rates are the same.

Inverted Curve: Represents that short-term bond rates are incurring more interest than long-term bond rates. The inverted curve typically shows indicates a recession is occurring, but it is important to remember that is not always the case.

For the past few years, the yield curve has been remaining flat.  As one could predict, a flat curve makes banks question how they should invest their excess liquidity? Do they stay short or go long? Should they stop loaning money?  As with any situation, it is advised to get ahead of the ‘curve.’  Instead of trying to predict where the economy is headed, learn from the past experiences and prepare for the future and develop a plan.

Strategies When Investing in a Flat Curve

Invest in Yields that are not Flat: Find a curve that has better yields in this rate environment. One opportunity to invest in is Bank Owned Life Insurance (BOLI).  BOLI is immediately accretive to earnings and improves Non-Interest Income and Shareholder Value.  Earnings from BOLI are income tax-free and backed by highly rated insurance companies.  With BOLI, a bank can receive better yields with stronger financial strength.

Assess your asset liability management model: Look at different scenarios in your bank simulation models. Consider how asset-sensitive your bank wants to be. It is important to understand that what may look good from an investment strategy in one model, may not work when other factors are folded in, such as loans and deposits.  Handling the bank’s interest risk now with potentially lower rates is easier to do with investments than loans.

Review Credit Risk: In preparation of an economic downturn, understand the bank’s balance sheet and recognize the long-term deals on it to ensure the bank’s credit profile looks clean.  In addition, be mindful to not buy low-rated bonds or sectors with credit-risk such as asset- backed securities and corporate bonds in a downward slope.

Although, the economy is unknown, there is still a lot of potential for banks to continue to invest in a flat curve.  The flat curve could continue for another few years without continuing to change.  It is not a time to stop investing, but to ensure all bases are covered when considering a purchase. Be mindful of reviewing the bank’s balance sheet and how a new investment will blend in on it and understand all of the benefits of the investment.