Robert Perry is a Principal at ALM First, joining the firm in 2010. Mr. Perry leads ALM First’s ALM and Investment Strategy Groups and is responsible for the development of asset liability and investment portfolio themes for the firm. Mr. Perry has more than 30 years of experience in the banking and bank-consulting businesses. Before joining ALM First, Mr. Perry previously served as Chief Investment Officer for First Coastal Bank in Manhattan Beach and was a Principal and Product Portfolio Manager at Smith Breeden Associates, Inc.
Robert Perry is a Principal at ALM First, joining the firm in 2010. Mr. Perry leads ALM First’s ALM and Investment Strategy Groups and is responsible for the development of asset liability and investment portfolio themes for the firm. Mr. Perry has more than 30 years of experience in the banking and bank-consulting businesses. Before joining ALM First, Mr. Perry previously served as Chief Investment Officer for First Coastal Bank in Manhattan Beach and was a Principal and Product Portfolio Manager at Smith Breeden Associates, Inc.
And at the time I was at a crossroads of either going back to business school or moving on to something a little bit more challenging. And at the time I met Doug Breeden, who was a professor of finance at Duke University and Doug owned and ran a bank and thrift consulting firm in Chapel Hill. Ultimately, I did move to Chapel Hill, even though I was a wolf pack guy...
Mike Ensweiler:Welcome everyone to the second episode of In Your Best Interest an ALM First Podcast, a show that will explore common depository challenges, give you an insider's view of the latest market trends, and share stories and insights from industry leaders. I'm your host- Mike Ensweiler. This week's episode will focus on balance sheet management in volatile markets. 2020 has been an interesting year to say the least. Rates have been up. Rates have been down. We've seen consumer confidence index reach it's all time high, and it's all time low within a two month period. Who better to speak about managing depository balance sheets in volatile markets than Robert Perry. Robert is a principal at ALM First joining the firm in 2010. Mr. Perry leads ALM First's ALM and Investment Strategy groups and is responsible for the development of asset liability and investment portfolio themes for the firm. He provides strategic focus for financial institution client portfolios that are primarily invested in the high credit quality sectors and is instrumental in balance sheet hedging strategy development. Mr. Perry has more than 30 years of experience in banking and bank consulting businesses. And with that, I am very pleased to welcome Robert Perry. Robert, thank you so much for joining us for our second episode. You know you have deep roots in finance and fixed income and in consulting with depositories, how did you get interested in these disciplines?
Robert Perry:You know, Mike, that's a great question. You know, I grew up in Southern California and was always a smart kid, had great grades. I skipped the eighth grade and I always liked building things. So I had a lot of skateboards, had a lot of bicycles. Built a lot of things, built a lot of cars over my life. And I just always liked the way things worked. I had that inquiring or inquisitive type of mind. So when I got to NC state, I started as an accounting major actually. Uh, I think lot of us probably did and that wasn't going to work after a while. So I, uh, I was always good in math. I like the challenge. The finance side of it just really was attractive to me. And I started down that path and never really looked back. Finished up and then had a long career so far in banking and finance and bank consulting.
Mike Ensweiler:The things that people who know you closely know this, but I think it'd be really interesting to share with the rest of the group. Obviously you have a great math mind and people who are really into math are also into music. And so being an old rock and roller, you know, I know that that music has always been a passion for you as well, playing the guitar and that kind of stuff.
Robert Perry:Yeah, that's correct Mike. Jacob and I were just talking about that before we got started. I took guitar lessons in kindergarten for a couple of years and then again in junior high, and I have a whole closet full of guitars back here. Played some rock guitar, gave guitar lessons in high school And also first couple of years of college. If I wasn't making money shooting pool, I was making money, giving guitar lessons. And really stuck with it. You know, I don't play as much as I used to, but, I have a lot of friends that are in the music business. I still like go into a lot of shows. I like live music. I have a turntable here with a bunch of old vinyl and, uh, I've always really enjoyed music. Definitely.
Mike Ensweiler:So you're into math, you're into finance. Tell us about the path that led you to ALM First.
Robert Perry:So, you know, Mike, when I got out of school, I went to NC state during the Jim Valvano years, so a ways back. And, you know, North Carolina is a pretty big banking state. So once I had my degree, I was interviewing my senior year with a lot of financial institutions in North Carolina. Mostly the big banks, um, Nations Bank, First Union Wachovia. There were a lot of banks in North Carolina at the time, and I enjoyed that side of my education. So I interviewed with all the banks and took a job with a small regional bank in Rocky Mount, North Carolina. It was Planters Bank. And when I got there, I went into a training program with a lot of other graduates at the time. It was a smaller institution so there was 10 of us in training. And they asked me where I wanted to be ultimately. And I had my choice between the outer banks, Nags Head working in retail banking or in Rocky Mount at the headquarters. And I had met the guy that ran funds management for the institution and him and I would go to the gym every now and then we played some racquetball. He was a great guy, Stan Jones. And he asked me one day, if I would come to work for him as an analyst in the funds management area and run asset liability management reporting and analytics and software. That was a pretty new thing at the time. You know, if you really look at asset liability management, risk management, balance sheet consulting reporting, it really has evolved with technology. So those early days, I graduated from college and never had a computer. And the first one I ever had was on the job, you know, working in running ALM reports and working for Stan. That institution ultimately merged with another local bank People's Bank. And I did all the analytical work to put the two balance sheets together when I was 22 years old or 23 years old. That ultimately became Centura Bank and was sold to RBC. And it became RBC Southeast Regional Bank that they've sold now to PNC. And that was the genesis of it all was in little Rocky Mount, North Carolina.
Mike Ensweiler:So how'd you get into consulting with banks? So now you've worked at a bank. How did that lead ultimately to consulting and working with different, you know, treasury finance, CFO types?
Robert Perry:So, you know, after a couple of years, Mike, after the merger was done there in Rocky Mount to create Centura Bank. I was working in funds management are doing asset liability management, reporting analytics, and the securities portfolio was their liquidity, risk management, pretty typical funds management. And at the time I was at a crossroads of either going back to business school or moving on to something a little bit more challenging. And at the time I met Doug Breeden, who was a professor of finance at Duke University and Doug owned and ran a bank and thrift consulting firm in Chapel Hill. Ultimately I did move to Chapel Hill, even though I was a wolf pack guy. And I went to work for Smith Breeden Associates as an analyst when I was 24. And I worked there for 15 years. At first I was an analyst. I became an associate after three or four years. And then I became a partner in 1998 and I ran the bank consulting group there, which was all asset liability management, mortgage analytics, and hedging. Smith Breeden also had a separate account business. We ran mutual funds and I also, so in the end there, I was overseeing all the short duration strategies, our equity overlay strategies. And I worked in the CDO business with a couple of CDOs that we put together a pre-crisis. And after 15 years at Smith Breeden, the firm had really moved to be a much more traditional asset management firm and it moved away from its roots in bank consulting and bank advisory work. So I left Smith Breeden in 2006, after 15 years. Moved to Scottsdale Arizona and I ran a bank in Manhattan Beach, California with a friend of mine, Don Griffith. First Coastal Bank, which is a little community bank there in El Segundo. We ran that bank for about two years and while we were doing it, we put together, a firm like ALM First. It was inside of data tech and it was an asset liability management consulting and investment advisory firm that we were building while we were running that bank before Don sold it. We ultimately partnered that group that I put together with Wells Fargo. John Shrewsberry is Wells Fargo's Chief Financial Officer, and he's a good friend of mine from high school. We put together a consulting group and partnered it with Wells Fargo for distribution. What I didn't want to do is work... the distribution and sales side of it is very difficult sometimes. So for me to build the product and then have the correspondent banking group inside of Wells be distribution seemed like a pretty good idea to us. So we got that all accomplished and we were an approved outside provider of investment advisory work and asset liability management reporting for Wells Fargo. I spent about a year and a half on sales calls and training all the correspondent bankers, and then the financial crisis came and we shut everything down. And that's how I got to ALM First.
Mike Ensweiler:And luckily you were able to parlay some of that experience into what you're doing now, which is running the Investment Management Group and ALM Strategy Group for ALM First. Those groups are relatively new, you know, we centralized those functions about five years now. Um, and I got to believe that that experience you had in the past was interesting, instrumental in putting that together.
Robert Perry:Yeah. I think, you know, Mike, when I got to ALM First, which is 10 years ago now, which is hard to believe. One thing that was very clear to me is that in any consulting business, like the one that we're in, consistent messaging and scale becomes a very difficult thing for a firm as you continue to get larger and larger. So centralizing theme development, making the product more consistent across clients, became really something that I at the time was talking with Emily Hollis about that, you know, for us to continue to move the firm forward that was a, a model that I thought was appropriate for ALM First. And it's a model that I had come out of and we ultimately got there and I think we're doing a pretty good job at it. And you're right, Mike, it's a new thing for ALM First four or five years now, probably half the time I've been there, we've been working toward this, but it it's the right way. And if you look at it today, it really functions well that way. We have a lot of clients that are getting our best ideas downstream now. A lot of the portfolios are really performing well. You know, we manage the...we're the underlying asset manager for the Callahan Mutual Funds. Also, we had a mutual fund board meeting this morning and assets there have grown significantly. The performance has been solid and it really comes down to just a dedication to building a framework in which a company analyzes assets and makes decisions and consults institutions, where you kind of take the guesswork out of it because you impose a quantitative framework around the way you evaluate things so that you level the playing field and you're not throwing darts at a board. You're not guessing whether which one's the right bond to buy or which one's the right asset to do. You put in quantitative pricing, a profitability type analysis and then you kind of impose that framework around the firm and people can consult and our directors and advisors and people in the firm. They all start singing from the same sheet of music and talking the same way about how you make decisions. And ultimately we should be able to sit down together and look at 25 different things that we're working on and come to very similar conclusions because we've built a framework that we know works. Now, you always have to tune it up. You have to continue to do your research. You can't get lazy at those things. Which we do, we have a pretty big commitment to, you know, analytics and research in the firm. And we continue to tune those models to help the decision making process. But the framework itself is the right way to do it.
Mike Ensweiler:You know, I know your team spends a lot of time on mortgage research. Why so heavy on the residential mortgage side?
Robert Perry:You know, Mike, there's a couple of reasons why that asset class really floats to the surface, when you look at what we do. One the residential mortgage market is very big. So the mortgage backed security market is a big market. The mortgage market itself in the whole loan space is a big market. So there's a lot of opportunities there and there's a lot of size there so that as we continue to grow, there's ample assets there to fulfill the needs that we have. The other one is and I think this is one that, you know, a lot people don't think about is that mortgages are a varied sort and understanding mortgage risk and modeling mortgages successfully, and hedging mortgages successfully is very difficult. There is a tremendous amount of research going on constantly through Wall Street and through asset management firms. That was Smith Breeden's early background, you know, just mortgage analytics and mortgage math and mortgage hedging, understanding mortgage prepayment risk and mortgage analytics is pretty difficult. And it's an area where if you think you're good at it and you can put your best foot forward there, you can differentiate yourself from the rest of the pack by being good at it. So it's an area where we can show a specialization in mortgage analytics and mortgage hedging, and it's a way for us to, to show how good we are at what we do by really drilling down and getting, you know, under the hood when it comes to mortgage risk management and mortgage analytics. It's an area that you can really shine if you can do good work there, but it's not easy.
Mike Ensweiler:Yeah, given that so many of our clients... their balance sheets are composed of, or comprised of residential mortgages, that seems to make a whole lot of sense.
Robert Perry:I see that also, and also in the securities portfolios agency mortgage backed securities, that's a very large market. And it's a spread asset. So generating excess returns, constructing and building a reasonably or well-diversified MBS portfolios is something that we're also very good at and the same math and the same analytics and the same discipline required to do that as it is to build a balance sheet or has mortgages in your core business.
Mike Ensweiler:So let's just stay on that topic of mortgages for a little bit. You know, when being in a sales role, I talked to depositories all the time and they state that they're searching for yield in the bond portfolio. And yet we see when we see these portfolios, they have very undiversified portfolios. They'll have the same position on over and over and over again and they think that they're diversifying, but essentially it all comes down to the same trade. So, you know, to those who say, Hey, look, I've just portfolio to whole bunch of, of residential whole loans. I don't want to add any more mortgages to my bond portfolio. You know, what's your response to that kind of a comment.
Robert Perry:Yeah. You know, it kind of comes back to the same thing Mike. You know, mortgages are a varied sort, and most of the time when you see a portfolio constructed that has the same type of risk profile bond after bond, it comes from policy constraints that forced the portfolio manager into doing the same trade over and over again. So we talk about this a lot and well-developed investment process. Institutions manage risk at a portfolio level, not at an individual security level and at the risk of this, the next asset asset number of 10 or 12 or whatever, the risk of that asset by itself doesn't matter as much as its contribution to the riskiness of the portfolio. And that's a pretty textbook way to think about that, but it's the right way to think about it. So if you expand your policy constraints away from the bond level policy constraint and put it at a portfolio level, it allows you then to mix assets together in a portfolio that have uncorrelated returns. And what you end up with then is a portfolio that's less risky than the sum of all of its parts, because it has diversification benefit at the individual asset level. A perfect example of that is putting, LIBOR or Fed funds floating rate mortgage assets in a portfolio together with fixed rate mortgages, par coupon mortgages, and higher coupon mortgages. And what you're doing there is you're covering your bases along the yield curve where, you know, the total returns, if you regress them over time for floaters are very uncorrelated with fixed rate mortgages. So they have a nice diversifying benefit when you put them together in a portfolio. And that's the right way to think about portfolio construction is in that type of context. And that portfolio may have, it has a very different risk profile than your whole loan book. In the whole loan book is typically where institutions take mortgage credit risk in their whole loan book. And that's a whole different animal than managing interest rate, risk, yield, curve risk, and spread risk, and other types of risks that you have in your bond portfolio.
Mike Ensweiler:Speaking of yield curve risk. We've seen a lot of volatility in the markets this year. Couple of questions come out of that. You know, the one that I know you get all the time that probably drives you crazy is where are rates headed?
Robert Perry:Yeah, we hear that. We hear that a lot. I wish I knew Mike. We'd make a lot of money If we actually knew the answer to that. I think what you see going on in the markets today, obviously that the Fed has been pretty clear about they're pretty dedicated and committed to managing the yield curve right now. So, you know, rates are fairly low and the curve is fairly flat and spreads have tightened a bit and rate falls down a lot. But that idea that we don't position portfolios for interest rate moves, we build portfolios and recommend this to all of our clients with duration targets in a risk management framework. So if your core balance sheet is using more of the duration budget that you have, then your bond portfolio may run a little lower interest rate risk profile even down to an enhanced liquidity or more aggressive cash strategies if you're really loaning and using a lot of duration in the core balance sheet, but your average bond portfolio for a bank or a credit union is about a two or three year kind of duration. And how you get to that number though, there's a lot of ways to mix up the pieces and get a two and a half or three duration. And it's not just by buying a bunch of three year assets, it's buying longer duration assets, floating rate assets, amortizing assets. There's lots of ways to put it together, but ultimately trying to maximize that portfolio's expected return or spread over benchmark rates like treasury rates or swap rates is our approach. We take a risk adjusted spread type analysis or an OAS type analysis to compare individual assets, and you know, OAS type analysis, it levels the playing field when you're looking at assets with different risk profiles. So how do you compare 30 year fixed rate mortgages with agency commercial MBS with floaters? Well, they all have a different risk profile, but in an OAS model, what comes out of it is a risk adjusted spread. And then you can compare them to one another and then you can mix the pieces together into a portfolio that has a high probability of succeeding over time.
Mike Ensweiler:Right. Instead of just looking at top line yields and that kind of thing.
Robert Perry:That's correct. Exactly. So we hear a lot of, you know, I hear this from clients and it's not abnormal, but how do you compare a fixed rate asset with a floating rate asset? They're just not even comparable, right. Have to have more of these or less of those or whatever. If you put them into a framework where it removes that guesswork and boils to what's my risk adjusted spread, and then can I mix the pieces together so that I keep the portfolios duration on top of the targeted duration? That's a disciplined framework that really works over the long haul and it takes the guesswork out of it.
Mike Ensweiler:Well, right. Because there's hundreds and hundreds of little decisions that people have to make every day. And so being a long run investor like depositories are, you're in this for the long haul and you want to make the right decisions and make it a repeatable process. And so that's really what I'm hearing you say is, you know, develop that kind of a process and stick to it. In good times or in bad.
Robert Perry:Yeah, I think that's very true, Mike. I've said this many times that in the depository space, especially, you know, if you were, what if you had to manage a portfolio with a two-ish year duration, but you had to run it for 50 years. What do you do? You think about how much that portfolio turns over over time with reinvestment in decision making, if you didn't have a solid framework around how you assemble the pieces, it would you make thousands of decisions over years. How do you know how you're really doing in the end? So that's the approach that we take. It really is a quantitative approach with a heavy dose of risk management. And then ultimately we look at ex-post performance with a very critical eye to make sure that in the end of the day, the models and our decision making framework are helping us to build high performing portfolios. And when we find things or individual assets where our models are not doing a good job of helping us select assets, then we do more and more research and tweak them. You know, models and things like that are like cars. You have to keep them tuned up or they'll, they can break down on you. And you learn in these markets as time goes by prepayment behavior on different types of collateral for example, those things may be here today and they require research today, but they may not have even been here 10 years ago. So you have to keep things tuned up. And that means if you're going to be, if you're going to create and produce repeatable results over a long period of time, you have to have that dedication to research and model tuning, or you can get off the rails pretty fast.
Mike Ensweiler:Yeah. That makes perfect sense to me, you know, and you've brought up a couple of ideas I'd like to just maybe touch on a little bit more. You've talked about pricing models or, you know, pricing assets appropriately comparing them against one another in an OAS framework and that makes perfect sense to me. You know, what other tools do depository needs in their toolboxes, especially in turbulent times.
Robert Perry:So, you know, Mike, there's a couple of things that if you really had the toolbox full of everything that you could use, a good example would be an institution that can't freely hedge. Most depositories have a difficult time funding out the yield curve. So even in an OAS framework, one asset may come with more duration than your institution can really handle. So if you can hedge that interest rate risk independent of the funding source, a lot of clients and a lot of institutions will, you know, they'll just use FHLB advances or alternative funding sources, non-deposit funding sources, to extend duration of liabilities because they're not natural funders out the yield curve. And a lot of mortgage risk sits out in the tenure part of the yield curve. So institutions that can hedge have a leg up on the rest of the institutions because they can build... they have access to more assets that they may not put into a portfolio or on a balance sheet if they couldn't hedge. And when I talk about that, I usually refer to that as the profitable side of risk management. It's that using derivatives, using hedging strategies to manage interest rate risk, actively produces a higher performing portfolio, not a lower performing portfolio, because it allows you to think about, instead of these 200 assets to pick from, I have a thousand assets to pick from. And if, when I mix them all together, if the highest performing combination of them has too much duration with it, then I can just manage that duration without doing it through the security selection process.
Mike Ensweiler:Yup. Makes perfect sense. You know, the other thing that seems a hot topic right now is liquidity. How much liquidity should I have, you know, in these times, and in normal times? What are some, you know, maybe non-typical sources of liquidity? What are you talking to your clients about as it relates to, you know, how much liquidity should we be holding and what are some of the other sources of liquidity that they may not be thinking of?
Robert Perry:Yeah, it's definitely a topic on everyone's mind today. And, you know, as we see with our client base currently really no liquidity issues. I had a conversation with the NCUA recently along the same lines and deposit growth is up, loan growth has slowed a little bit, but there's just a lot of liquidity sloshing around in the market. So no real liquidity issues going on that we can see so far, but a progressive liquidity risk management program inside of an institution is a best practice. So managing cash and managing liquidity in a way that keeps the institution safe and also generates a reasonable return for that liquidity. Whenever you think about liquidity, liquidity costs something, right? If when you ultimately look at performance of a portfolio or performance of an institution, being a liquidity provider is part of the way that a bank or a credit union actually generates profits. So finding a healthy balance between having too much liquidity or giving up too much liquidity is really something all institutions should embrace when they're putting different assets on their balance sheet. And another thing to consider there is that with interest rates, as low as they are a little extra return goes a long way when interest rates are so low. So with the Fed paying 10 basis points on IOER making 15 or 18 or 20 basis points in a repo is a big difference from only earning 10 basis points. We've had a lot of conversations with clients about that idea recently in that if you manage a spread portfolio that outperforms treasuries by 50 basis points when rates are at 5%, that's one thing. But when you beat treasuries by 50 basis points, when treasury rates are at 50 basis points, that's another thing. It's a much bigger difference when interest rates are so low when every basis point counts, every dime really counts. So understanding that that balance between profits and liquidity is something that everyone should really, really pay attention to that, especially given the low level of interest rates today.
Mike Ensweiler:Yup. I like it. So, you know, we are budding out of time. And so, you know, as part of your closing thoughts, I'd love to hear, you know, what are the top three things you would be doing or looking at if you were sitting in the treasury management seat at a bank or a credit union right now?
Robert Perry:Mike, whenever I think about things like that, I mean, if being a good funds management person and working, sitting in that seat, the things that you're working on and focusing on now are really not that dissimilar from the things that you should be focusing on all the time. Asset pricing and liability pricing are our key functions in that area. When markets get volatile and rates move around, asset pricing becomes really critical. So pricing your assets so that if they are capitalized and end up on your balance sheet, that they generate a reasonable enough return on that allocated capital, same thing on the funding side. With rates as low as they are and funding in the wholesale markets fairly inexpensive right now, understanding your deposit pricing and your funding costs is pretty critical. Those are pretty standard responsibilities for that type of job. In the bond portfolio, you know, there's a lot of reinvestment risk going on and there's a lot of reinvestment activity going on. So just having your hands around what your next three or four trades are going to look like, how to keep the portfolio working and chugging away so that it's doing its part. And then risk management, pricing liquidity, pricing credit, pricing interest rate risk, all of the things that would be normal risk management functions in there are ones that I think are important today, but they're also important over the long run.
Mike Ensweiler:Thank you so much Robert we greatly appreciate your time and all the work that you do at ALM First.
Robert Perry:Thanks Mike.
Mike Ensweiler:Thank you Robert, for taking time to talk about balance sheet management and turbulent times with us. At the end of each episode, I like to take a moment and let you know about some of the events or articles we have coming up. What I'd like to focus on this time is Capital Stress Testing. As you heard from Robert these are volatile times. We've seen a lot of change just in 2020 alone and Capital Stress Testing is really a comprehensive examination of the balance sheet, which can allow you as a leader to critically evaluate your current position and potential for success within various scenarios. If you have any questions, the easiest way to contact us is that podcast@ almfirst.com as always, stay safe, stay healthy, and thank you for listening to In Your Best Interest an ALM First podcast.
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