Independent Banker - August 2021 - 29

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modeling is called eff ective duration,
which accounts for principal and
interest cash fl ow, the value of
embedded options and for bonds with
variable rates of interest. In other
words, eff ective duration is the risk
measuring stick for a 21st century
bond portfolio.
Got big, quickly
To keep things succinct, let's remind
ourselves duration tells us about how
much your portfolio's market price will
grow or shrink, given a 100 basis point
(1%) shock in interest rates. A group
of bonds with a duration of three
years will therefore improve in market
value by 3%, given a drop in market
rates of 1%. In just the fi rst 90 days
of 2021, community banks' durations
increased from 3.2 years to a record
4.5 years. Given what I've learned
from talking with Vining Sparks
traders and community bankers, this
is no mistake. As rates, especially
those for longer-term bonds, have
risen this year, portfolio managers
have seen fi t to do some backfi lling on
their net interest margins.
If you've indulged in some duration
expansion, it's now doubly important to
keep your price volatility on the rails.
Nonetheless, in simple terms,
community banks have increased their
price risk by more than 40% in just
three months. That has required a lot
of buying of a lot of long investments
by a lot of banks in less than 100 days.
The extension has been in a variety of
investment sectors, too. Munis' price
volatility grew 15%. Collateralized
mortgage obligations' risk increased
66%. Mortgage-backed securities'
eff ective duration more than doubled.
And let me restate that this only took
three months.
Subject to change
It's possible that 2021 will give
portfolio watchers a case study in
risk management. While it's clear
that investment managers intended
to build out longer durations, it's also
clear that our old friend optionality is
part of this mix. What this means is
that any estimate of price volatility will
include assumptions about current
and future interest rates, and virtually
all portfolios will see their durations
positively correlated with market levels.
Again, to oversimplify, at least some of
the duration growth in the fi rst quarter
of this year can be attributed to rates
rising, with some call options moving
out of the money.
Education on Tap
Balance Sheet Academy
ICBA Securities and its exclusively endorsed broker Vining Sparks
announce the 2021 Balance Sheet Academy. It will be presented in
a live session Oct. 18-19 in Memphis, Tenn. This intermediate-level
course will discuss a variety of topics including interest rate products
and portfolio modeling. Space is limited. Visit viningsparks.com to
register. Up to 12 hours of CPE credit are off ered.
ICBA Securities is on the road again
We will be on the convention trail in earnest this summer and fall.
ICBA Securities will exhibit, sponsor, and make presentations at a
number of its state association aff iliates' events between now and
October. For a full list of our upcoming appearances, check out
icba.org/icba-securities/educational-events
So, just as we've seen a record amount
of price risk installed in community
bank bond portfolios, if rates stabilize
or fall later this year, we'll see durations
decline, all things remaining equal. We
know they are not, as long as portfolio
managers believe they're sitting on
ample supplies of uninvested cash
earning next-to-nothing. Nonetheless,
here's our requisite recommendation
to keep your eyes on your price risk.
If you've indulged in some duration
expansion, it's now doubly important
to keep your price volatility on the rails.
Eff ective duration is the preferred tool
for your risk management monitoring. 
Jim Reber, CPA, CFA (jreber@
icbasecurities.com), is president
and CEO of ICBA Securities, ICBA's
institutional, fixed-income brokerdealer
for community banks
independentbanker.org Q 29
http://www.viningsparks.com http://www.icba.org/icba-securities/educational-events http://www.independentbanker.org
Independent Banker - August 2021

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