By Jim Reber ICBA Securities TREASURIES FOR THE WIN! Low yield spreads send community banks back to the basics Education on tap 2022 webinar series will commence soon ICBA Securities and its exclusive broker Vining Sparks will again present a seven-part webinar series, Community Banking Matters. The first event is Feb. 22 at 10 a.m. Central. CPE credit of one hour is offered for each webinar. For more information, visit viningsparks.com. I’ll let you in on a secret: sometimes your columnist runs out of new ideas to cover. A dearth of new products, no new regs, a stable rate environment — all of these can cause a writer to run aground while sailing the financial seas in search of material. Then it dawns on me: I’ve never covered Treasury securities! For the most part, you should be glad. Over the last quarter century, this sector has gradually receded into the background of bank portfolio management as community bankers everywhere have been on the hunt for higher returns. For all of Treasuries’ built-in benefits, there’s the fact that they yield less than anything else on your brokers’ offering menus. While the Treasury yield curve is the basis from which your entire balance sheet is priced, as investments, they’ve been, at best, an afterthought. United States Treasury’s historical role So why am I bothering to cover a sector that community banks don’t own? There’s more to this story than meets the eye, and besides, it’s possible the readers have forgotten some of the more salient points. Being the master of the obvious, I’ll point out that Treasuries have unmatched credit quality and liquidity. There are other features that portfolio managers like, such as the fact that an investor can pick virtually any maturity out to 30 years and that small block sizes trade at virtually the same prices as large blocks. There was also a time and place when bank investment portfolios regularly contained Treasuries. If we were to look back a generation, we’d see that mortgage-backed securities (MBS) in particular weren’t highly represented. Several factors working in concert have changed the attitudes and objectives of portfolio managers. First, the long-term trend toward lower interest rates since the 1980s has contributed to smaller net interest margins, hence the urgency for incremental yield. Secondly, investors of all stripes, and community banks, in particular, have made it their business to be more sophisticated in their understanding of available options. Thirdly, MBS underwriters have continued to bring new products to market, many of which are coveted by bank portfolio managers. Two examples are Collateralized Mortgage Obligations (CMOs) and “prepayment friction” MBS. The typical community bank’s bond portfolio now has the majority of its investments in the mortgage security category. What changed in 2021? So why now are community banks reverting to old practices at a time when nominal rates are still low and loan demand is tepid at best? As you may have heard, yield spreads on traditional investments are at an all-time low. For example, if a banker purchases a simple five-year agency bond, they can expect to get three basis points (0.03%) more yield than the five-year Treasury note. In the not-too-distant past, that spread would have been 15 to 20 basis points. As to why the incremental yield is so hard to come by, the simple explanation is that supply/demand is at work. The still-massive amounts of uninvested cash in the banking system, chasing supplies of bank-suitable bonds that aren’t growing much, if at all, have resulted in narrowing spreads. I, for 20 | The Show-Me Banker Magazine
RkJQdWJsaXNoZXIy ODQxMjUw