Liquidity Segmentation Tips for Your Investment Portfolio

Investment segmentation at a basic level means creating key components of the overall portfolio. For banks, those components revolve around liquidity and core segments. The segments will include different investments that can be aligned with the portfolio’s desired risk and return objectives.

The liquidity segment of the portfolio has objectives dictated by asset liability management constraints – regulatory or self-imposed. On-hand liquidity measures incorporate marketable securities into available projected funding sources. Banks utilize the portfolio liquidity to fund bank cash flow needs and complement short-term liabilities. Keep in mind – the ability to utilize the investment portfolio for funding operating and contingent liquidity needs is variable under different market environments.

Operating liquidity projections often include estimations of cash inflows (sources of funds) and outflows (uses of funds) in the balance sheet. Estimating those cash flows on the investment portfolio can be impacted by asset quality and unpredictable prepayments. Banks managing operating cash flows with a heavy lift from the investment portfolio generally favor high-quality investments and look to known cash flows from periodic principal and interest.

Contingent liquidity projections often favor asset-based liquidity sources. For example, pledging bonds to secure borrowings or line commitments. Secured borrowings are generally more reliable and less expensive, but may have varying requirements on acceptable collateral. For banks, these considerations often revolve around FHLB advances, Federal Reserve discount window, and secured federal funds lines. There also needs to be consideration of acceptable collateral for municipal deposit pledging if that is a component of the bank’s deposit mix.

Market conditions have put additional spotlight on pledged assets. Decreased securities market values have affected available levels of pledgeable assets.  Then you have to consider relative lack of desire in realizing losses from liquidating securities. There is not an easy answer on those existing holdings – some banks have elected to wait rather than sell, which in effect changes available liquidity.

Going forward, banks segmenting the liquidity portion of the investment portfolio will want to favor marketable securities with low interest-rate and price-risk profiles. This generally will mean high quality bonds with limited cash flow variability. The benefits are two-fold: likely source of eligible collateral for most parties and better bids if you need to sell.

Want to hear more? Bankers’ Bank brings expertise from a distinct banking perspective – we are bankers. We are pleased to introduce a new service, Bankers’ Investment Portfolio Services (BIPS), to assist banks in managing their investment portfolio objectives. BIPS as a comprehensive service that incorporates not only management and structuring of the investment portfolio, but it brings in ALM, custody, portfolio accounting, and analytics resources. Reach out to the Investment Department team for discussion on how we can assist your bank with your investment portfolio 800.955.4468.