Things to Consider when Repositioning Your Investment Portfolio

Late last year, a number of publicly traded banks sold underwater bonds in their portfolios to reposition low-yielding securities holdings and provide additional liquidity to the balance sheet. The November bond rally reduced the unrealized losses on many US bank’s securities portfolios to the lowest levels in a year and a half. Ideally banks could offset losses with securities gains when selling, but still many banks have a larger proportion of bonds showing losses compared to gains. With more banks looking at executing loss trade strategies, the following are considerations for your bank.

Uses of cash proceeds from loss trade strategy:

• Reinvest the cash in higher yielding securities — keep the investment portfolio as a percentage of balance sheet fairly constant. The strategy here is repositioning the investment portfolio to better support the bank for future interest rate changes, liquidity needs, and earnings.
• Pay off higher costing borrowings. This strategy supports managing current year net interest margins, particularly cost of funds for the entire balance sheet.

Considerations:

• Timely investment sales
  • November’s bond rally reduced the hypothetical hit a bank would take as compared to sales even a month earlier in October. Timing the market is difficult and imperfect, but the incremental spreading out of the sales can help limit sellers’ remorse. Conversely, a methodical approach to reinvesting cash into securities limits buyers’ remorse.
  • Fact – rarely does the yield curve move in parallel shifts: the opportunities to liquidate at different points of the curve varies over time. Bond duration measures price changes for interest rate moves, meaning that price changes may be more impactful on different parts of the curve if non-parallel shifts. For portfolios considering repositioning, this strategy looks at potentially limiting sale losses while readjusting for future balance sheet needs.
• Liquidity profile
  • Cash flow from the portfolio – predictable vs. future cash flow timing when repositioning investments. Determine how much value the bank puts on regular known cash flows as compared to variable or extended timing of cash flows.
  • HTM vs AFS – which bonds can we sell in the future. Consider the bond sales impact on future capability to raise liquidity without running afoul of previously accounted for holding bonds.
  • Ability to pledge securities for liquidity – unrealized losses on collateral impacting amount of collateral available. Establish the true amount of available collateral post-sale prior to selling bonds out of the portfolio.
  • Contingency funding plan – ratios of liquid assets and testing lines. Update potential available collateral changes when selling bonds – detail alternative sources of liquidity or collateral.
• Earnings Profile
  • Investment yields vs. alternatives such as loans – typically loan rates will be higher to compensate for additional credit risk. Define the bank’s loan to deposit objectives and future growth expectations after the loss sale.
  • Reliance on investment portfolio earnings as compared to loans – repositioning the portfolio can align the bank for future needs. Model earnings at risk for multiple interest rate scenarios.
  • Taxes: updated tax exempt benefits going forward may limit need for municipal bonds. Plan for future tax implications and needs for your bank and its investors when choosing what bonds to sell.
  • “Other” items: one-time events that can offset losses from investment sales. Project future impact to restructure portfolio in context of bank growth.
• Capital profile
  • Tangible Tier 1 Leverage ratios mostly improved in Q4 2023 with accumulated other comprehensive income (AOCI) deficits shrinking in the year-end bond rally. Model capital ratios in context of future equity leverage objectives -examine the impacts of a decreased or increased pace of AOCI losses recovery.
  • The bond portfolio can provide different interest rate risk management characteristics than other assets. Examine Economic Value of Equity (EVE) changes due to interest rate risk modifications from a repositioned investment portfolio.

Your Bankers’ Bank team is available to discuss potential strategies for your bank and investment portfolio. In addition to our Investment Department resources for the portfolio, Bankers’ Bank provides ALM consulting and expertise to assist your bank. We are available to discuss your potential strategies and provide insight on successful strategies incorporated by other banks.