Independent Banker - December 2020 - 61

perform well in a declining rate
environment, " he says. " Your asset
liability profile and risk appetite will
dictate the appropriate bond for your
bank at any given time. "
Why prepayment protection
is important
In the current environment, Erhardt
likes agency MBS with some form of
prepayment protection. Community
banks that buy a mortgage-backed
security with a significant premium
and where a portion of the underlying
mortgages are prepaid could
experience low or even negative
yields. He advises community banks
looking for agency MBS to consider
collateral with prepayment friction,
such as low loan balance pools with a
maximum loan amount of $200,000.
These borrowers are less likely
to refinance, Erhardt says, because
the cost to do so is high relative
to the potential interest savings.
" Community banks should also
consider agency MBS with mortgage
loans originated in New York, where
there's a punitive tax on refinancing, "
he adds. " You don't want to pay a high
premium for a bond that might come
back to you at par tomorrow. "
Keep in mind that the Federal
Reserve has already bought $1 trillion
of agency MBS this year, Erhardt
says. " This is driving up the price
to well above par, so you have to be
careful, " he adds.
Loan trading is another option for
community banks sitting on excess
cash. According to Smith, banks in
regions with more loan demand may
be willing to sell loans for their own
balance sheet needs to banks where
loan demand remains low. " This is a
win-win for both banks, " he says.
Heading into the new year, the
only thing that appears certain is that
high volatility and more uncertainty
are likely to continue. It is likely that
2021 will be another challenging year
for community banks.
Don Sadler is a writer in Georgia.
independentbanker.org Q 57
4 portfolio planning
strategies for 2021
As we prepare to open our new calendars, Jim
Reber, president and CEO of ICBA Securities,
offers his insights to community bank portfolio
managers planning for the new year. They include:
1. When the Federal Reserve decided to
hold interest rates near zero back in
September, it also announced that it
did not anticipate raising rates at least
through the end of 2023 to give the
economy more time to recover from the
COVID-19 pandemic. " So, community
bankers can plan on operating in the
current low-rate environment for at least
another two years, " Reber says.
2. Reber stresses that community bank
margins and earnings will be tight until
interest rates begin to rise. " In general,
banks aren't exposed to rising rates, but
the opposite is true right now, " he says.
3. It's very expensive not to be invested
in something right now. " Given the
emphasis by regulators on high-quality,
government-guaranteed investments
with a very low risk of default, " Reber
says, " highly rated municipal bonds
remain a popular investment option for
community banks. "
4. Reber says municipal bonds-and General
Obligation bonds in particular-will
weather the COVID-19 storm. " Longer
duration mortgage securities can also be
appropriate for a lot of investors, " he adds.
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