Independent Banker - April 2019 - 35

Next: Could a messaging app boost productivity at your bank?
way, the typical community bank is now exposed to falling
rates.
Two pieces of evidence support this. First, for the 300plus
institutions that utilize Vining Sparks for their rate risk
monitoring, the average user has positive Earnings at Risk
(EAR) and Economic Value of Equity (EVE) postures, and
very little Capital at Risk (CAR).
Secondly, the average investment portfolio's effective
duration, another common risk yardstick, was 2.97 years
as of December 2018. This is a historically low number, the
least it's been in six years.
So as community banks have insulated themselves
from further rate hikes, the Federal Reserve has adopted
a " patience " refrain. The bond market is now anticipating
maybe one additional rate increase before the end of 2019.
Longer-termed maturities' yields have fallen noticeably
since last December.
Portfolios have been recast
If a community bank investment manager decides that he
or she needs to maintain or even increase the portfolio's
duration, here's another curveball: Since tax reform became
effective in 2017, community banks have shrunk their
tax-free municipal holdings. Munis have long been the preferred
vehicle for locking in some yield on the long end of
the duration spectrum. But as tax-frees' yields are not what
they used to be, banks are trying to figure out the optimum
mix of their investments.
Some institutions have recently decided to take positions
in a historically verboten sector: 30-year fixed-rate mortgage-backed
securities (MBS). Before you conclude this
would be the commission of a cardinal sin, please read on.
Their risk-return profiles are potentially not much different
than munis, especially for C corps, and they provide
much-desired diversification to boot.
The current mix of price,
yield, supply, risk and need
behooves the informed
investment manager to
consider cutting against
the grain when creating a
productive securities portfolio.
Education on Tap
New investment commentary
available
Vining Sparks, ICBA Securities' exclusive broker,
recently published a Strategic Insight, 30-Year
MBS: Tax Reform and Relative Value. For your copy
of this report, contact your Vining Sparks rep or
visit viningsparks.com
Webinar series continues
ICBA Securities and Vining Sparks present the
next segment of their 2019 webinar series,
Community Banking Matters, on April 16 at 10 a.m.
CDT. Katharine Bray and Dan Stimpson of Vining
Sparks will discuss " Balance Sheet Strategies
for 2019. " Free CPE is available. To register, visit
icbasecurities.com
This may not be for your community bank. If an institution
is exposed to rising rates, and many still are, longer-durated
assets are not your friend. Still, it's worthwhile to take a dive
into comparing a muni to a 30-year MBS.
Munis vs. MBS
As of this writing, a standard muni with an AA rating and a
15-year maturity or 10-year call structure will produce about
a 3.5 percent tax-equivalent yield for a C corp bank. A new
30-year MBS with the right mix of coupon and premium can
match that yield. Here's the kicker: The MBS probably has
lower price risk. Of course, either option will lose value as
rates rise, but a mortgage security with a 4 percent coupon
or more will probably have an effective duration of about
four years, versus seven years for the tax-free. As we've
learned, less is more when discussing price risk.
Finally, you'll recognize that these are two very different
investment choices. If your community bank is in fact
exposed to falling rates, the monthly cash flow from the
MBS won't help matters. Supply and liquidity for MBS are
superior to tax-frees, as 88 percent of the entire mortgage
market consists of 30-year loans. There are differing factors
for pledgability and risk weighting to consider.
In sum, the current mix of price, yield, supply, risk
and need behooves the informed investment manager
to consider cutting against the grain when creating a
productive securities portfolio. Counterintuitive need not
be counterproductive.
independentbanker.org Q 35
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Independent Banker - April 2019

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