PORTFOLIO MANAGEMENT PLAYING UNDER PAR Community Banks Should Take a Page Out of the Golfer’s Playbook One thing that might have gone unnoticed over the past few months is the book price for the average community bank’s bond portfolio. It has dipped below par (100 cents on the dollar), according to the more than 700 financial institutions that process bond accounting reports with The Baker Group, though individual bank results may vary. More surprisingly, this hasn’t been the case since 2009. When the Fed began raising rates in 2022, prices on the universe of bonds swung from premiums to discounts. Portfolio managers admirably continued adding bonds to the portfolio in the face of steep unrealized losses. Today, they’re being rewarded for that faith as bond portfolio yields sit at 14-year highs and book prices are below par for the first time in roughly 17 years. Given that we find ourselves in not-recently-charted territory, it’s a good time to examine what this means for the bond portfolio and some lessons we can learn from the game of golf. Protecting the Scorecard It’s not often I find myself playing under par in golf, but one key to keeping that streak going for as many holes as possible is playing smart and managing risk. Just as taking too much risk in golf can turn a bad shot into a bad hole, buying the wrong bond or reaching for yield at the wrong time can wipe out years of progress. As fixed-income portfolio managers, we don’t have the benefit of uncapped gain potential like stocks do. Our yield can fluctuate based on prepayments, but we have a limit on what our investments can earn. That’s why taking too much credit risk is an asymmetrical risk: The maximum upside is capped to the yield we earn, but the maximum downside is total loss of principal. Our philosophy has always been to take credit risk on the loan side, where you draw from experience in evaluating credit risk, but you’re also better compensated for taking that risk. Reaching for yield in the bond portfolio can often mean taking on unknown risks. In today’s world of artificial intelligence, those potential risks are only growing. As a recent example, consider owning a corporate bond in IBM. IBM is a longstanding titan of Fortune 500 companies, but who could’ve predicted that a new AI coding tool would send the stock tumbling over fears that it could wipe out a strong revenue-generating business line for IBM? I’m certainly not calling for IBM to begin defaulting on its debt, but it’s an example of how quickly the picture can change By DILLON WIEDEMANN Senior Vice President of the Financial Strategies Group, The Baker Group 6 NEBRASKA INDEPENDENT BANKER
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