Independent Banker - December 2023 - 28

PORTFOLIO PORTFOLIO MANAGEMENT
Pushing the boundaries
Cost of funds is putting pressure on bond portfolio's net margins
By Jim Reber, ICBA Securities
et's get right to the point: Your
community bank's net interest
margin, which may have shrunk in
the last couple of quarters, has been
especially compromised by your bond
portfolio's performance. And I'm
not talking about the credit quality;
this is purely interest rate driven.
Historically, when we look at the
portfolio's tax-equivalent yield (TEY)
compared with cost of funds (COF),
the difference is around 200 basis
points, or 2% (see table).
This has held true in virtually all
rate environments. This includes
the 2013-15 period, when we were
clawing our way out of the Great
Recession and the fed funds rate was
anchored at 25 basis points (0.25%).
It also includes 2019, when fed funds
L
got up to 2.5% and the yield curve
inverted for a few minutes.
The current math isn't so appealing,
and the trend actually began with
the monetary policy response to
the pandemic. So let's see what
can be done to maintain your own
" boundary, " or spread, between the
bonds' yields and your cost of carry.
Back in the day
For those with limited recall (like
your correspondent), the mid-2010s
was a period with weak loan demand,
seemingly no pricing power, and
therefore little inflation. Core personal
consumption expenditures (PCE)
never breached the 2% target between
2012 and 2018. In many months, it
was closer to 1%. This normally would
have caused the net earnings of the
bond portfolio to shrink, as margin
compression would have taken over.
However, that didn't happen, as
community banks were able to fund
themselves with overall cost of funds
well below 1%.
Even when inflation did perk
up modestly, as in 2018-19, the
200-basis point net spread was
maintained. COF, with its modest
beta, stayed put for the most part,
while bond portfolio yields rose
enough to keep the boundary in place.
It's also worth mentioning portfolio
durations stayed within their
historical bands during the teens,
generally around three years, so it
doesn't look like there was " yield
reach " in this era. This is especially
28 // ICBA Independent Banker // December 2023
Photo by Kolidzei/Adobe

Independent Banker - December 2023

Table of Contents for the Digital Edition of Independent Banker - December 2023

Contents
Independent Banker - December 2023 - Intro
Independent Banker - December 2023 - Cover1
Independent Banker - December 2023 - Cover2
Independent Banker - December 2023 - Contents
Independent Banker - December 2023 - 2
Independent Banker - December 2023 - 3
Independent Banker - December 2023 - 4
Independent Banker - December 2023 - 5
Independent Banker - December 2023 - 6
Independent Banker - December 2023 - 7
Independent Banker - December 2023 - 8
Independent Banker - December 2023 - 9
Independent Banker - December 2023 - 10
Independent Banker - December 2023 - 11
Independent Banker - December 2023 - 12
Independent Banker - December 2023 - 13
Independent Banker - December 2023 - 14
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Independent Banker - December 2023 - 16
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Independent Banker - December 2023 - 18
Independent Banker - December 2023 - 19
Independent Banker - December 2023 - 20
Independent Banker - December 2023 - 21
Independent Banker - December 2023 - 22
Independent Banker - December 2023 - 23
Independent Banker - December 2023 - 24
Independent Banker - December 2023 - FIS1
Independent Banker - December 2023 - FIS2
Independent Banker - December 2023 - FIS3
Independent Banker - December 2023 - FIS4
Independent Banker - December 2023 - 25
Independent Banker - December 2023 - 26
Independent Banker - December 2023 - 27
Independent Banker - December 2023 - 28
Independent Banker - December 2023 - 29
Independent Banker - December 2023 - 30
Independent Banker - December 2023 - 31
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Independent Banker - December 2023 - Cover3
Independent Banker - December 2023 - Cover4
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