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  • Writer's pictureDarnell Canada

Not the Dreaded "D" Word

“I am really concerned about these long assets!”

- At least one member on your Board

Not the Dreaded D Word

ALCO | ALM Strategy | Interest Rates

The year was 1996 and I was in an ALCO meeting early in my career. The topic of the conversation was interest rate risk and someone shared a graph, illustrating historical trends for the 30-year mortgage rate, which at the time was approaching a 30-year low of 7%. Thirty-year US treasury bonds yielded 7.5%.

The objective with this illustration was to help rationalize their decision to not follow a strategy recommendation we had made in the two previous ALCO meetings, which was to purchase GSE mortgage collateralized investments funded with short-term borrowings. Despite managing a balance sheet that was clearly asset sensitive and demanded long-duration assets, their view was that purchasing long-duration assets was an unwise strategy given rates were near the historical low. “You’re too young to remember when mortgages were at 15%. It wasn’t pretty.” I can hear it like it was yesterday. At the time, some form of this statement was expressed on more than a few occasions early in my career – clearly intended to suggest that I was uninformed to historical context and too inexperienced to properly help navigate through the prevailing economic environment. To this day, even after spending 25-years advising the industry in asset/liability management, I continue to fight an uphill battle to convince financial institutions when added duration is a worthwhile consideration as part of their balance sheet strategy.

Given short-term market rates are effectively at their lower bound level and long-term rates remain at levels not observed since before the 1960s, it is undeniable that long-duration assets should be viewed with skepticism and cynicism. However, risk is a relative term and should be examined accordingly.