Bank investment portfolios: What community banks should know about changing allocations in the current crisis
The pandemic financial “comma,” or shock, has changed the financial climate of the U.S.—and those around the world. Below are considerations for community bank presidents as they navigate through the pandemic and into recovery.
Avoid zero as much as possible
Portfolios are still around 2.5% in terms of tax equivalent yields, but if you have a cash reserve of half your portfolio at zero, those numbers fall sharply in that calculation. The goal is to mitigate this as much as possible.
The trio of bank investment portfolio options
For community banks’ investment portfolios, primary categories for consideration remain mortgage-backed securities (MBS), municipals bonds (munis) and agency bullets/callables. Following is recent guidance we have offered community banks about this trio of options:
- MBS: Mind the weighted average coupons (WAC). With current mortgage rates averaging right around 3% for both 15- and 30-year mortgages, look for collateral with WACs under 3.50%.
- Reducing the call risk with low WAC collateral tempers the risk inherent in higher premiums that are common in MBS today.
- Despite risks, MBS remains a viable option and continued overweight in this environment with spreads of 50-125bps to T-notes available.
- Municipals: Yields have dropped dramatically since early March as the Fed support of the market ushered in heavy buying. With exempt yields still well over 100% of comparable maturity treasuries, there is further room to the downside until munis find a bottom, which historically has been with ratios of 70-80 percent of T-notes.
- Agency bullets/callables: With bullet spreads under 15bps out to five years, it’s very tough to avoid callable paper with at least double the spread. Focus on one-time calls when possible and ladder calls and finals.
Our general perspective at present is keep it simple for your bank investment portfolio, work the trio and stay out of zero for long periods of time.
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