investment portfolio and balance sheet strategies€¦ · balance sheet liquidity asset cashflow...

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Investment Portfolio and Balance Sheet Strategies

Dan Stimpson, CPASVP Strategic SolutionsVining Sparks

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Attributes of Sound Balance Sheet Management

• Investment Portfolio Decisions are Guided by:- Liquidity Requirements- Risk Management Requirements- Return Objectives

• Seeking investments that deliver the cash flows you need -then finding the best available return - reduces mistakes and delivers better returns over time.

Getting these priorities out of order can be costly!

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ALCO Management Process

Develop an understanding of the following:• Economic forecasts, market conditions and industry trends• Risk management position: risk, opportunities and

constraints• Set goals and targets• Strategies and tools available to achieve goals

Utilize our resources to assist in efficient management.

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Trends Impacting Bank Balance Sheets

• Flat-to-inverted yield curve; bond reinvestment yields down over 100bps from 10-year highs in Nov. 2018

• 9 rate hikes this cycle; 225 bps increase in Fed Funds• Community bank NIMs decline in Q1’19; pressure on cost of funds• Slowing loan growth in Q1’19 and build of cash from lower rates is

reducing liquidity-related pressures • Community bank ROE declined from 10.62% Q4’18 to 10.18%

Q1’19 (MT WY banks 10.85% to 10.41%)• Banks remain well positioned for rising rates with neutral-to-asset

sensitive IRR profiles; primary IRR exposure is to falling rates

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Net Interest Margin Pressure

Source: FDIC

MT WY Banks: 3.88%

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Projected NIM

3.50%

3.60%

3.70%

3.80%

3.90%

Banks running level II Risk Manager.

PROJECTED NIM BOTTOMED OUT IN MID-2015 AT 3.56%, INCREASED TO NEAR 3.90%, BUT HAS DECLINED THE PAST 2 QUARTERS

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Cost of Funds Continues to Increase

0.25%

0.35%

0.45%

0.55%

0.65%

0.75%

0.85%

0.95%

1.05%

1.15%

1.25%

Q3'15 Q4'15 Q1'16 Q2'16 Q3'16 Q4'16 Q1'17 Q2'17 Q3'17 Q4'17 Q1'18 Q2'18 Q3'18 Q4'18 Q1'19

All Insured >$100mm $100mm to $1bn $1bn to $10bn $10bn+ Risk Manager

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Cost of Funds Continues to Increase

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Fed Policy – Closer to Neutral

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Where Is The Inflation?

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Fed’s Massive March Shift

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Bond Markets Rally After Reaching 10-Year Highs

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Low Global Bond Yields Relative to Treasurys Despite 100bp plunge since November, US yields remain well above 2016 lows.

German 10yr Yield US Treasury 10yr Yield

Source: Bloomberg

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Low Global Bond Yields Relative to Treasurys

Source: Bloomberg

US vs German 10yr spread remains over 240bp

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Low Global Bond Yields Relative to Treasurys

Source: Bloomberg

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Treasury Bonds Rally Over 100bps from Peak

Source: Bloomberg

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Yield Curve: Leading Indicator of Economic Cycles

Sources: Bloomberg, NBER, Vining Sparks

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Curve Inversion

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Curve Inversion

Source: Bloomberg

3mo to 10yr Treasury Inversion is the biggest since 2007, 2’s to 10’s remains positive

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Markets Shift to High Probability of Rate CutsFed Funds Futures price in two rate cuts by December 2019, four rate cuts by December 2020.

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IRR Profiles: Risk to Falling RatesThe primary exposure is to declining rate scenarios from both an earnings and economic value standpoint.

Note: Assumes an immediate and parallel shift in the yield curve using a static balance sheet. Banks running level II Risk Manager.

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IRR Profiles: Risk to Falling RatesThe primary exposure is to declining rate scenarios for both earnings and economic value.

Note: Assumes an immediate and parallel shift in the yield curve using a static balance sheet. Banks running level II Risk Manager.

Risk Manager Medians Level II Banks 157 161 154 Variance 25th Percentile 75th Percentile

falling rising falling rising falling rising falling rising falling rising falling rising falling rising EAR Year 1 Down 100 -2.55% -2.44% -3.51% -0.11% 0.96% -4.79% -0.42%

EAR Year 1 Up 100 1.74% 1.58% 1.60% 0.16% 0.14% 0.16% 3.66% EAR Year 1 Down 200 -7.67% -7.76% -8.92% 0.09% 1.25% -11.73% -4.23%

EAR Year 1 Up 200 3.18% 2.45% 2.40% 0.73% 0.78% -0.68% 6.23% EAR Year 1 Down 300 -11.59% -12.40% -10.49% 0.81% -1.10% -16.53% -7.78%

EAR Year 1 Up 300 3.42% 2.53% 2.33% 0.89% 1.09% -2.46% 8.63% EAR Year 2 Down 300 -20.82% -23.57% -18.42% 2.75% -2.40% -26.89% -12.45%

EAR Year 2 Up 300 6.78% 5.85% 6.43% 0.92% 0.34% -0.60% 12.95%

Projected Margin Yr 1 (Base)

EVE @ Risk Down 100 -8.26% -6.47% -10.66% -1.80% 2.40% -11.99% -4.54% EVE @ Risk Up 100 3.90% 2.33% 4.34% 1.57% -0.44% 0.45% 6.66%

EVE @ Risk Down 200 -23.63% -19.19% -30.44% -4.44% 6.81% -30.24% -16.83% EVE @ Risk Up 200 4.59% 2.04% 5.16% 2.55% -0.57% -2.61% 9.89%

EVE @ Risk Down 300 -39.61% -40.52% -40.15% 0.91% 0.54% -48.33% -28.13% EVE @ Risk Up 300 1.90% -0.63% 3.56% 2.53% -1.66% -7.75% 10.60%

Lowest EV of Equity / EV of Assets

Beginning Economic Value

Mar-19

3.53%

6.83%

117.17%

Mar-19

4.24%

10.38%

143.21%140.56% 123.18% -13.12% 4.26%

QoQ YoY

Economic Value @ Risk (EVE)

Earnings @ Risk (EAR) Mar-19 Dec-18 Mar-18

3.87% 3.88% 3.79% 0.00% 0.09%

8.29% 8.89% 8.01% -0.60% 0.28%

127.43%

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Balance Sheet LiquidityAsset cashflow year 1 over 30% for many banks, and 50% or higher in 2 year cash flows as a percentage of total assets.

Source: Risk Manager IRR Model Medians Banks running level II Risk Manager.

Risk Manager Medians Level II Banks 157 161 154 Variance 25th Percentile 75th Percentile

Loans to Equity Wholesale Funding / Assets Earning Assets Ratio * Tier 1 Capital to Total Assets

Assets Cashflow Year 1 Liquid Assets Liability Coverage Ratio 3mo Borrowing Capacity / Total Assets Assets/Liability Cashflow 6mo Operating Liquidity Total Liquidity

EV Max Change +/- 200 bps Two Year Cashflow - Base vs Up 300 Optional Cash Flow (@200bps)

47.85%177.78%

9.89%-3.03%7.22%

18.97%95.68%12.34%

36.55%

8.8521.81%

30.84%

Mar-19

5.03

Mar-19

7.32

4.56%

5.08%92.68%9.41%

26.51%

4.1330.87%90.12%

-1.80%-4.97%

10.48%

18.16%

-3.97% -3.92% -4.03% -0.06% 0.05%5.92% 5.71% 7.12% 0.21% -1.20%

Stability / Optionality

4.78% 2.32% 5.22% 2.47% -0.44%

39.16% 38.27% 38.27% 0.90% 0.89%133.26% 126.08% 126.11% 7.18% 7.15%23.88% NA NA NA NA44.61% NA NA

6.28 5.83 5.66 0.45 0.63

31.68% 31.17% 30.84% 0.52% 0.84%15.28% 14.83% 15.50% 0.45% -0.22%

Balance Sheet Composition

6.20 6.23 6.11 -0.03 0.09

Liquidity / Optionality

10.97% 10.67% 10.84% 0.31%

10.75% 10.74% 10.50% 0.01% 0.25%

0.13%94.02% 94.04% 94.26% -0.03% -0.24%

NA NA 36.63% 54.60%

QoQ YoYMar-19 Dec-18 Mar-18

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Balance Sheet Liquidity

Source: Vining Sparks Performance Profile

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Bond Allocation ConsiderationsWhile community bank liquid assets have gradually contracted, holdings of municipal bonds have declined as a percentage of assets.

¹ Consists of 3319 Institutions ¹ Consists of 73 Institutions

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Bond Allocation ConsiderationsS Corp banks have a higher allocation in municipal bonds than C Corp banks.

C Corp S Corp

¹ Consists of 3319 Institutions 2110 C Corps 1209 S Corps

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Investment Considerations

• Invest being mindful of your balance sheet needs and market rate expectations

• Look for relative value across the curve• Use amortizing investments for cash flow and liquidity needs• Continue allocation to Municipals, be mindful of new TEYs and

spreads across curve• Consider investing excess cash, reducing negative convexity,

extending duration and locking out cashflow to protect against falling rates

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Bond Accounting Median Portfolio

Vining Sparks’ Bond Accounting Stats 416 banks Average portfolio size of $90mm;

median portfolio size of $41mm TEY of 2.82% (+36 bps YoY) Average price risk +300 bps of (10.1%) Effective duration of 2.91 Total credit exposure of ~27%

Source: Vining Sparks Bond Accounting data as of 3/31/19

Agencies11%

Agency CMOs19%

ARMs3%

Corporates5%

MBS26%

Municipals22%

SBA Fixed4%

SBA Floating5%

Other5%

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Agencies28%

Agency CMOs11%

ARMs3%Corporates

2%

MBS28%

Municipals16%

SBA Fixed2%

SBA Floating2%

Other8%

Agencies5%

Agency CMOs10%

ARMs4%

Corporates11%

MBS19%

Municipals41%

SBA Fixed3%

SBA Floating5%

Other2%

Peer ComparisonTop Performing Quartile

TEY: 3.47% | +300 Px Vol: (11.8%) | G/(L): +0.05%Bottom Performing Quartile

TEY: 2.28% | +300 Px Vol: (7.9%) | G/(L): (1.19%)


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Top Quartile Sector Allocation Over Time


4% 5% 5% 5% 5% 6% 5% 5% 5% 9% 10% 11% 11% 11%

26% 26% 24% 26% 25% 31% 25% 24% 30%33% 32% 28% 28% 28%

48% 49% 50% 49% 50% 44% 49% 49% 44% 38% 38% 41% 41% 41%

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

Q4'15 Q1'16 Q2'16 Q3'16 Q4'16 Q1'17 Q2'17 Q3'17 Q4'17 Q1'18 Q2'18 Q3'18 Q4'18 Q1'19

Municipals

SBA Floating &ARMsOther

SBA Fixed

MBS & CMO

Agencies

Corporates

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1.00%

1.50%

2.00%

2.50%

3.00%

3.50%

Q1'16 Q2'16 Q3'16 Q4'16 Q1'17 Q2'17 Q3'17 Q4'17 Q1'18 Q2'18 Q3'18 Q4'18 Q1'19

Fed Funds 1st 2nd 3rd 4th 5-Yr Treasury Yield

Portfolio Yields Improve with Rise in Rates

Bond Accounting Quartiles

3.12%

2.54%

1.57%

2.14%

3.47%

2.93%

2.28%

2.65%


Fed Funds Median

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2 Year Cumulative Bond Portfolio Cashflows64.1%

62.5%

55.2%

44.8%41.2% 39.6% 38.4% 37.5%

41.2% 40.0%

35.5%

29.0%24.1%

21.0%18.6% 16.9%

0%

10%

20%

30%

40%

50%

60%

70%

-300 -200 -100 Base +100 +200 +300 +400

Bottom Performing Quartile

Top Performing Quartile

Source: Bond Accounting Statistics Q1 2019

34.0% All Banks

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Cashflow Analysis – Bank AHigher yields often equate to elevated extension & call risk

Falling Rates Call/Reinvestment Risk Rising Rates Extension Risk

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Cashflow Analysis – Bank BHigh up-front cash flows provide increased liquidity at the expense of higher yields

Heavy Up-Front Cash Flows

Minimal Extension Risk

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Investment Yields and Duration

2.40%

2.60%

2.80%

3.00%

3.20%

Bank Securities Portfolio Yield Compared to Current Available Investment Yields

Bank Median Security Portfolio Yield: 2.82% / Effective Duration 2.91

MBS 15-Year 3.0% MBS Yield 2.59% / Effective Duration 2.7

FCLMC 30yr 4 3.03% / Effective Duration 1.6

Muni AA BQ 15Yr/10yr 3.29% (21% Tax Rate) TEY / Effective Duration 7.7

Corp A Financial 5Y Yield 2.81% Effective Duration 4.6

SBA Par Floater Yield 2.73% / Effective Duration 0.7

FNMA ACE Par Floater Yield 2.89% / Effective Duration 0.3

Source: Vining Sparks, Yield Book

7yr nc OTC 2.46% / Effective Duration 3.5

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Spread Changes YTD

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Municipal Securities• “Foundation of Yield” in top quartile portfolios• Consistent investing on longer part of curve, driven by wider spreads.• Muni curve typically maintains a positive slope…structure of supply,

IRR, credit curve, change in tax laws.• Higher coupon bonds perform better in rising rate environments;

however, lower coupon may offer more spread.• General market municipals may offer incremental yield pick-up, need

to understand the impact of an increase in COF due to TEFRA.• Tax reform could impact municipal holdings. Realized tax-equivalent

yields reduced from lower tax rates.• Essential Service Revenue Bonds can add incremental yield to a

portfolio, without taking on additional interest rate or credit risk.

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Municipal Bond Allocation ConsiderationsFactors that influence the sector allocation to municipal bonds for banks include:

• Liquidity, IRR / ALCO Mgmt. / Income• Balance Sheet Trends: Loan growth? Deposit runoff? Wholesale Funding? NIM Pressures?

• Balance Sheet mix and concentration ratios:o Loans to assets – current and projectedo Securities to assetso Loans to depositso Municipal bonds as a % of assets, securities, and capital

• Tax Equivalent Adjustment (21% C Corp / 29.6% or 33.4% S Corp)• TEFRA Disallowance COF: 0% or 100% for S Corp or 20% or 100% for C Corp (BQ or GM)• Tax Position: TE Rate, NOL, AMT (C Corp), Distribution Plans (S Corp)• Pledge / Collateral needs for borrowings and public deposits• Capital Risk Weights: 20% GO; 50% Revenue• Credit Analysis / Due Diligence Dodd Frank: Pre-purchase and ongoing• IRR and CAR Position

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Municipal Yield Curves

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Bank Portfolio Ideas for Municipals

• Extension Swaps – Selling the short to middle portion of the curve (7 years and in) into the strong retail bid

• Selling high-tax state holdings (NY, MN, NJ, CA, etc) into a extremely strong retail bid on the same short to middle portion of the curve

- SALT deductions have decreased• Outright purchase of longer dated municipals to take advantage of

the spreads available and higher TEYs• Portfolio Clean-up of smaller block size holdings (<150K) with tighter

spreads on shorter paper due to the retail demand

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Monitoring Performance and RiskThe Performance Profile report includes detailed credit ratings on municipal and corporate bonds at the CUSIP level and the date the credit report was last updated.

*Rating dates more than two years old are shown in red, rating dates less than one year old are shown in blue.


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Bank Portfolio Mortgage Allocations

MBS, ARM, and CMOs combined represent 48.5% of bond accounting customer portfolio balances.Q1: 32.5%Q2: 48.6%Q3: 60.7%Q4: 42.5%

Yield by Sector: Range; All BanksMBS: 2.23% - 3.04%; 2.59%ARM: 2.19% - 2.74%; 2.57%CMO: 2.35% - 2.89%; 2.62%

PVOL by Sector: Range; All BanksMBS: -10.54% to -14.78%; -12.05%ARM: -5.17% to -7.18%; -6.18%CMO: -9.98% to -11.35%; -10.97%

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Mortgage Investments Offer Cash Flow

• MBS allocations have increased as institutions are looking to add cash flow to their balance sheets.

• Not all MBS exhibit same cash flow structure- Limit extension by investing in 10YR and 15YR MBS and

seasoned 20YR and 30YR MBS- Diversify coupons, higher coupons perform better in

rising rate environment…..Lower coupons in falling rate environment

- Understand collateral composition… Low loan balances, HLTV, Jumbos, Relos, Investment Properties…

• CMOs offer structure and can limit extension

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Mortgage Coupon Stack and Refis• Mortgage rates down approx. 75 to 80bps from Nov ‘18• Discount 15YR 2% and 2.5% coupon• Discount 30YR 2.5% coupon• Prepayment speeds have been historically low in 2017

and 2018; slight pickup in 2019

Source: Bloomberg2.00

2.50

3.00

3.50

4.00

4.50

5.00

0

1000

2000

3000

4000

5000

6000

7000

Mor

tgag

e Ra

tes

Refi

Inde

x

MBA Refi Index and Mortgage Rates

Refi Index 30yr Mtg Rate 15yr MTG Rate

1255

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MBS Spreads Have Widened Recently

Source: Bloomberg

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Agency MBS

Source: Vining Sparks (Investment Alternatives Matrix)

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Agency MBS

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Total Return Assumptions

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Monitoring Performance and Risk


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Ample Cash Flow? Diversify Structure and Yield

CMBS: yield pickup of approx. 20 to 25bps over 5-10yr agency bullets.Source: Yield Book - 05/29/2019

* TEY assumes a 21% tax rate

Agency backed multi-family investments offer CF like bullets, IRR & yield similar to MBS, yet less extension

Collateralized with single loan backed by multi-family property, typically 30 year amortization, 7-10 year balloon

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Ample Cash Flow? Diversify Structure and Yield SBA SBIC and DCPC fixed rate bonds offer similar yield vs. DUS bonds with lower effective duration and

lower risk weighting. SBIC 10yr maturity; issued twice a year; non amortizing

SBA 0% Risk Weight and 20% Risk Weight for FNMA DUS and Freddie K’s.

SBA yield pickup of approx. 17bps to 28bps over 7yr bullets 0% risk weight with full faith and credit guarantee Diversification of optionality compared to interest rate sensitive mortgage bonds

Source: Yield Book - 05/29/2019

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Bond Alternatives• Flat yield curve has resulted in similar yields across the curve. Opportunity to manage IRR position with minimal

impact on current income and NIM.

• A barbell strategy generally has a % weighting on the short end of the curve and a % weighting on the long end, with nothing in the middle.

• Allows investors to benefit from rising short term rates, while longer-term alternatives offer protection against falling rates.

53

Floating Rate Securities

54

CD Spreads Widen During Rally

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Vining Sparks Tools

• ALM Reporting Package• Quarterly Liquidity Stress Testing• Quarterly Assumption Stress Testing • Annual Back Testing

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Performance Profile

The Performance Profile starts at a summary and financial overview level, with increasing levels of details and analytics.

- Executive Summary - overview of portfolio, economic information

- Financial Performance - balance sheet trends, interest rate risk and liquidity analysis

- Portfolio Analysis - composition, price and yield volatility, etc.

- Peer Comparison- ratio reports, relative performance, bond accounting comparative

- Cash flow Analysis - scenario cash flow, projected calls, yield forecaster

- Sector Analysis - sector level price and yield volatility, gain (loss), etc.

- Sector Supplemental Charts- deeper analytical info, sector contribution analysis, prepayments speeds, SBA prepayment

vectors, credit ratings, concentrations, etc.

- CUSIP Details - CUSIP level descriptive and summary information

- Scenario Yield and Price Analysis - CUSIP level book yield projections and price volatilities

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Performance Architect

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Performance Architect - $10M Cash

15YR 3% and 20YR 2.5% and 3% MBS

SBA DCPC, SBIC, FNMA DUS, GNMA Project

Barbell 50/50 SBA Floater, Tax Exempt Muni21% TEY

29.6% TEY

21% TEY 29.6% TEY

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21% TEY

Proforma Strategies#1 MBS #2 SBA DCPC, SBIC, FNMA DUS, GNMA Proj #3 Barbell 50/50 SBA and FNMA ACE Floater, Tax Exempt Muni (15/10YR)

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Results weighted: 2x best, 1x 2nd best, zero worst

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Key TakeawaysConsistent investment activity within liquidity and A/L parameters usually leads to optimal performance• Understand Your Balance Sheet Needs

- Loan Portfolio: Repricing, Growing, Extending?- Deposits: Inflow, Surge, Shift in Composition- Capital and IRR Constraints- Consider wholesale options (loan trading, funding and swaps) for yield

enhancement and managing interest rate risk• Understand Investment Portfolio Characteristics

- Current and Future Cash Flows- Yield: What Investments Create the Optimal Value?

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Key Takeaways • Current market rates and the flat curve are a challenge; however, the flat curve

offers IRR flexibility without significant impact on current income• The investment portfolio should provide needed cash flow for liquidity to

deploy into loan demand, if available• Diversified portfolios typically outperform portfolios with high concentrations • Use amortizing investments for cash flow and liquidity needs• Investing short and long simultaneously may create optimal yield and structure• Consider strategies to mitigate falling rate exposures• Utilize wholesale funding, loan trading and interest rate swaps and analyze the

results using Performance Architect

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INTENDED FOR INSTITUTIONAL INVESTORS ONLY. The information included herein has been obtained from sources deemed reliable, but it is not in any way guaranteed, andit, together with any opinions expressed, is subject to change at any time. Any and all details offered in this publication are preliminary and are therefore subject to change atany time. This has been prepared for general information purposes only and does not consider the specific investment objectives, financial situation and particular needs ofany individual or institution. This information is, by its very nature, incomplete and specifically lacks information critical to making final investment decisions. Investors shouldseek financial advice as to the appropriateness of investing in any securities or investment strategies mentioned or recommended. The accuracy of the financial projections isdependent on the occurrence of future events which cannot be assured; therefore, the actual results achieved during the projection period may vary from the projections. Thefirm may have positions, long or short, in any or all securities mentioned. Member FINRA/SIPC.

Thank You

Dan Stimpson, CPASenior Vice President

Vining Sparks

investment portfolio and balance sheet strategies€¦ · balance sheet liquidity asset cashflow...

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