Independent Banker - January 2021 - 33

Next: What regulatory updates will we see this year? 
yields will automatically, magically,
increase, too.
This presumes that the bonds in
a portfolio have some optionality.
That means they can prepay at the
borrower's discretion. They include
bonds both with explicit call options,
as in the case of a callable agency, and
those with implicit options, as in the
case of a mortgage-backed security
(MBS). It's a pretty good bet that your
portfolio is short these options, since
well more than 80% of the bonds at
a community bank has some kind of
callability. It's common for a broker
or a consultant to produce a report
that calculates the prospective yields
in their clients' portfolios given a
change in rates.
Bear steepener ahead
The latter months of 2020 saw the
long end of the curve test some
technical support levels. After
averaging around 70 basis points
(0.7%) from April through November,
the 10-year note reached more than
1% in November, while shorter yields
remained anchored by the Fed's
words and deeds. The result was a
Treasury yield curve that was the
steepest since early 2018. This may be
The next phase of portfolio
management for community banks
has some potential: lots of liquidity,
higher rates, a steeper curve and most
of a calendar year to benefit from a
bond swap.
viewed as an opportunity to buy " out
on the curve, " as certain maturities
are now noticeably cheaper than at
anytime since the pandemic took over
our bond portfolios.
Recall, too, that many community
banks are now exposed to falling
rates. Therefore, those institutions
can cut their rate risk by locking up
some yield on the longer end. And this
steepening has taken place during a
period in which the Fed has signaled
no change in its commitment to
keeping rates low for an extended
period of time. All of these factors
build a plausible case for selling
shorter duration investments and
tactically extending average lives.
No free lunch
Education on Tap
Vining Sparks, ICBA Securities'
exclusive broker, will once
again host quarterly webinars
that discuss the state of the
economy and interest rate
trends. Economists Craig
Dismuke and Dudley Carter
will kick off the series on
Jan. 12 at 10 a.m. Central. Visit
viningsparks.com to register.
This rise in available yields should
be taken in context. We are still in an
environment that is historically low
and a yield curve that is historically
fl at. And, with all the defi cit spending
we did in the past year, at some point
one would think that the supply of
Federal debt could start to weigh on
bond prices. Investors in Treasury
securities continue to earn negative
real rates.
Nonetheless, the start of the year is
a great time to consider a bond swap.
This year, most bonds have unrealized
gains, so the test isn't going to be how
quickly a loss will be made up; it will
be how much incremental income will
be earned through the average life of
the bonds that are sold. This will also
require some careful analysis, because
it's possible-if not likely-that the
" new " bonds will have lower yields
than the " old " ones.
This brings up another factor to
consider: the timing of the recognition
of income. Most tax accountants
would recommend that tax liability be
delayed, not accelerated. One way to
deal with this is to sell a combination
of bonds at a net breakeven or a
net loss. Also, recall that the least
advantageous sector to take gains is
tax-free municipals. Concentrate fi rst
on taxables.
So, the next phase of portfolio
management for community
banks has some potential: lots of
liquidity, higher rates, a steeper
curve and most of a calendar year
to benefi t from a bond swap. Also,
no suggestion from your columnist
about rate stability in 2021. 
Jim Reber, CPA, CFA (jreber@
icbasecurities.com), is president
and CEO of ICBA Securities, ICBA's
institutional, fixed-income brokerdealer
for community banks
independentbanker.org Q 33
http://www.viningsparks.com http://www.independentbanker.org
Independent Banker - January 2021

Table of Contents for the Digital Edition of Independent Banker - January 2021
