Page 18 - Summer 2024 - 2.pub

BASIS POINTS

The Meek….

Inherit a prominent place in bond portfolios.

BY JIM REBER

grade tax-frees trade at levels that are
There are a whole lot of anomalies in community banking in the “through the curve” (i.e., lower than
waning stages of this restric ve Fed cycle. One of the overriding treasuries) for most maturi es out to 10
themes is the sheer dura on of the process. We’re now fully one year years.
past the last ghtening, which has le the effec ve overnight rate at
5.375% since July 2023, and giving rise to the “higher for longer” sound Born to run
bite. The past six ghtening cycles have averaged well under a year Mortgage-backed securi es (MBS)
between last hike and first ease. We will be soon approaching another con nue to play a significant role for
record: the longest-ever pause between last hike and first cut is 15 community bank balance sheets. In
months, from June 2006 to September 2007. aggregate, MBS s ll comprise the
majority of all posi ons in bond
There are myriad implica ons on community bank opera ons from this por olios. The runup in their sector
year-plus hiberna on. Being a representa ve of the broker-dealer weigh ngs took place between 2019 and
industry, I’d like to point out the a rac ve yields available in most any 2021, and as a group their unrealized Jim Reber is president and
investment sector that banks care about. Baked into this decadent losses are well over 10%. Those posi ons CEO of ICBA Securities, an
ba er, however, are three obstacles for por olio managers. are paying down at a torturously slow ICBA subsidiary and ACB
pace as new mortgage rates remain Preferred Services Provider.
Hills to climb elevated. You may connect with Jim at
The first is this persistently inverted yield curve, which is now more (800) 422-6442 or
than two years old. This makes decision-making dicier: Extend, and S ll, their appeal in the current market jreber@icbasecurities.com.
forego current income for future total return benefits, or stay short and stems from the ready supply of product
invest at today’s higher yields, and accept some reinvestment risk? at prices deeply discounted to par. One
day there could be an accelera on of refinance ac vity, and MBS with
The second is the s ll-to-be-determined outcome of the great deposit purchase prices in the mid- to low-90’s will show a big bump in book
shuffle, which really began with Silicon Valley Bank’s demise in March yields if mortgage rates drop 200 basis points (2%). A popular example
2023. The disintermedia on of core deposits con nues. Many is the “Hybrid ARM.” Hybrids are issued by your favorite government
community banks have, for the first me ever, entered the brokered sponsored enterprises (GSE), namely Fannie Mae, Freddie Mac, and
deposit market. FHLBank system advances nearly tripled between Ginnie Mae. They have 30-year amor za on periods, and a fixed rate
March 2022 and March 2023, from $375 million to $1.04 trillion. period between three and 10 years that you can pick. A er the “roll
date,” the remaining face value will float annually. And this: they’re
The third are the he y unrealized losses as quan fied in the AOCI available at well over 5% yields, and no premium risk.
account at virtually all depositories. As of the end of June, those losses
are s ll in the neighborhood of 12% of face value. This number has Best news yet
actually go en a bit worse since the Fed hit the pause bu on, as yield We have established that the highest-yielding bond por olios have a
spreads have remained historically wide, and the effect of the inverted healthy dose of the most simplis c bonds. What else is a departure
curve has taken root. from conven on is that the shorter the collec on of investments, the
be er the performance. According to S fel, as of June 30 the top
Simply elegant quar le por olios have an effec ve dura on of only 3.5 years. The
Here’s what es mable investment managers have no ced: It can pay to bo om quar le’s dura on is a full year longer, and has tax-equivalent
rid oneself of op on risk. That’s a complicated way to say that the yields that are exactly one-half of the top 25%’s: 3.87% versus 1.94%.
simplest bonds may have the best rela ve value in mid-2024. So far this
year, a large percentage of bonds purchased by community banks have There will be a day when investment fundamentals will normalize.
been treasury and noncallable (“bullet”) agencies. This may be the first Posi vely-sloped curves, for example, will force managers onto a
year in a genera on for high performing por olios to hold more different branch of the decision tree. However, for the me being, less
treasuries than municipal bonds. The current appeal of treasuries and is more, and simple delivers rela ve value.
agencies is due to the nominal yields, which investors sense may be
short-lived. Add to this the “lock in” benefits of a bond that cannot be
redeemed early, and you’ve got a winner.

Many por olio managers are building in some future ability to swap
out of these highly liquid instruments for others with be er market
yields once the yield curve assumes its normal shape. Also, munis
con nue to be prohibi vely expensive for C Corpora ons. Investment

A COMMUNITY BANKER | 18 | Summer 2024
RKANSAS