Community Bank Bond Portfolios ARE FINALLY TURNING THE CORNER By RYAN W. HAYHURST, Managing Partner and President, The Baker Group For more than a decade, community bank bond portfolios languished under the weight of the Fed’s zero interest rate policy (ZIRP). Portfolios filled with higher-yielding bonds that matured or got called saw their yield slowly erode as the average bank portfolio yield fell from more than 5% in 2007 to less than 2% in 2021. In fact, bank holdings of low-yielding bonds (I’ll define that as less than 2%) have exceeded their holdings of high-yielding bonds (greater than 4%) for the last 13 years. But the Fed’s aggressive tightening cycle of 2022-2023 and the subsequent surge in bond yields have helped banks turn the page on the era of low-yielding bonds. For the first time since 2012, the percentage of bonds yielding 4% or more has surpassed the percentage yielding less than 2% (see chart). It’s a crossover that most bankers didn’t dare imagine just a few years ago. And it represents both a milestone worth celebrating and a call-to-action portfolio managers can’t afford to ignore. or prepaid ahead of schedule, banks reinvested the proceeds into a market offering historically low yields. By 2012, the percentage of sub-2% bonds owned by banks had surpassed the share of bonds yielding more than 4% — and it stayed that way for more than a decade. The pain was compounded further when rates finally did rise sharply in 2022-2023. Banks sitting on portfolios stuffed with 1-2% bonds watched their unrealized losses balloon, constraining capital, complicating balance sheets and limiting strategic flexibility. It was, for many institutions, the worst of both worlds. How We Got Here To understand where bond portfolios stand today, it helps to rewind to the era before the financial crisis. In 2007, nearly 90% of the bonds held by community banks carried yields above 4%. Rates were high, yield was plentiful and the idea that the Federal Reserve could actually cut rates to zero was considered crazy. Then came 2008. The Federal Reserve slashed rates to zero in response to the financial crisis and kept them there for years. As higher-yielding bonds matured, got called 12 In Touch
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