Winthrop Bank (EOC Q&A 9 Page 445/454 Reading 15 Book 2)

Development: “More opportunities exist for expanding net interest margins with low risk in Winthrop’s loan portfolio than in its securities portfolio.” Effect: “The development suggests taking less risk in its securities portfolio.” I need some coffee because I am not seeing the connection here. I’d agree if they said “make more loans instead of buying treasuries” or something; but in isolation, this development does not change anything in the securities portfolio. Does it?

I believe that the point is that the bank’s overall risk tolerance hasn’t changed. Thus, if it takes more risk in its loans, there’s correspondingly less risk available to take in its portfolio.

My take is this:

Banks are primarily in the business of making loans therefore you can think of the net margin as the defining aspect of their equity while the securities portfolio serves to adjust their exposure to the net margin.

I agree, given the greater opportunities they should increase loans. Adding more loans increases the duration mismatch between assets and liabilities. Their net margin would thus be more sensitive to interest rates, therefore to take advantage of the loan opportunities (something they know more about), the securities portfolio should become less risky in order to adjust the increased exposure to interest rates.

It’s very similar to that pension reading at the end of the book, just reallocating risk to something they know more about.

Thanks Going and S2000.

I thought that “expanding net interest margins with low risk” should imply that there isn’t more risk in loans even after making more loans. Apparently “low risk” can still mean “more risk” since they can’t wish away the fact that a higher margin is still more susceptible to interest rate risk.

My take was more low risk loans were being made requiring more capital so less risk needs to be taken in securities book.

Just to revidsit this as it seems tough to understand. Does securities portfolio always act as a counter weight to the loan book?

A) So loan book has longer duration >>>> securities have lower duration (b/c risk tol unchanged)

B) Higher credit standards / investment grade debt >>>> liabilities more secured so can take more risk w/ securities

C) sell mortgages which lowers liabilities >>>> less liquidity needs

D) higher net margins in loans (which would come from lesser credit quality or longer duration) >>>> need to take less risk with securities.

Yep, my takeaway is that the securities portfolio does not exist to make money but to mitigate the differences between the loans (assets) and the deposits (liabilities).

I still don’t understand this, could anyone please elaborate? Thanks