37 Hoosier Banker October 2014 shorten) the net duration of their assets. • Relative value swap. At any given point in time, some sectors of the bond market offer better value than others. Moreover the relative advantage of the different sectors (as measured by their yield spread relationships) is constantly changing. Mortgage-backed securities versus municipals, callables versus MBS … all of these relationships should be monitored as markets move. Savvy portfolio managers will take advantage of the changing relationships and do swaps that sell what is rich and buy what is cheap compared to historical averages. As always, each bank will have a different sector allocation that is optimal for it, given its liquidity and cash flow needs, tax position, etc. Here again, a bigpicture view of the balance sheet is necessary. • Muni tax-loss swap. Banks should always be looking at their tax position and working with their accountants to optimize their aftertax performance. Each bank has its own unique set of circumstances, but generally the Tax Code allows for a loss on the sale of securities to be deducted for tax purposes. Moreover, for a taxable bank, the interest income from reinvestment is allowed to be earned tax free if the proceeds are used to purchase municipals. The bottom line is that the bank can recoup a tax-deductible loss with tax-free income. This strategy in particular is best executed at the turn of the year in order to have an entire twelve months to recover any loss. • Cash flow/liquidity management swap. To a large extent, investment portfolio management is simply the management of cash flows. Just as we look at rate sensitivity for the overall balance sheet, we must also take a macro view of the portfolio and pay close attention to the positioning of cash flows for reinvestment. This involves creating and maintaining a schedule of maturities, prepayments and other sources of principal return that will optimize the risk and reward of reinvestment in future months and years, regardless of the direction of interest rates. Cash flows for many securities, callable bonds, and MBS in particular, are moving targets because of the options risk. This makes it critical that the profile be monitored and measured for changes in rates, and adjusted with bond swaps when necessary. Active portfolio management has distinct advantages if it is done properly. It is important to develop a sound decision-making process and well-defined goals, as well as reporting systems that allow for pre-trade analysis or scenario simulations. The tools and processes for making better decisions and achieving optimal performance are available, and now is the time to take advantage of them. t It’s an old business adage, but it’s true. The right team can make all the difference. So we make sure our accountants and risk management, tax, and technology consultants are knowledgeable and approachable. They genuinely care about the success of your bank to bring you a higher return on experience. Rob Bondy , Steve Schick, Mike Stearns, Elizabeth Snyder, Joe Oleksak Call for a complimentary consultation 877.622.2257, x34013. banks.plantemoran.com {Good People.}
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