Independent Banker - May 2019 - 27

Next: Account-closing best practices
relatively distant future. Ladders don't have aggregates on
the edges; instead, they have most of their positions in the
medium-term, or middle, with some degree of structure.
Barbells were quite popular from the beginning of the
Great Recession until the past year or so. They produce reasonable
returns if rates are stable, and more so when the
yield curve flattens. Such was the case from 2016 to 2018,
as short rates rose about 200 basis points (2.0 percent), and
longer ones only about 50 basis points. The floating-rate
segment's yield kept pace with money market rates, and the
fixed-rate portion didn't experience an acute drop in value.
Next time around
Whether or not the Federal Open Market Committee
FOMC switches postures in 2019, the next secular shift in
the shape of the yield curve will almost have to be a steepening.
This is where the ladder comes in. A collection of
bonds with defined maturities in the intermediate portion
of the maturity spectrum will likely gain value if short-term
interest rates fall faster than longer-term rates, as we saw
happen in the 2007-2008 launch of the last recession.
A yield curve that shifts by having short rates fall faster
than longer rates is termed a " bull steepener " by bond analysts.
This is the norm, but there are recent exceptions. In
the 2013 calendar year, overnight rates stayed unchanged
(at near zero), while seven-to-10-year yields rose about
125 basis points. (It is worthy to note that the shift almost
exactly reversed itself the following year.) The 2013 experience
is known as a " bear steepener " and is not beneficial for
a ladder structure, although it is something of a black swan.
Ladder prospects
If you decide it's time to revisit the tried-and-true ladder
approach, where do you begin? The simplest approach (and
most banal) is to buy a series of bullet agency bonds with
differing maturities. There is total certainty to your outcome,
if you hold the bonds until they mature.
Your first alternative would be one-time callable agencies,
which would require some surveillance by the portfolio
manager but at marginally higher yields.
Otherwise, structured mortgage-backed securities (MBS)
that provide some likelihood of principal return in the middle
years of the ladder could be the answer. Examples of
these would be multifamily MBS like DUS bonds, Freddie
Mac K-Deals, or Fannie Mae ACES. An investor could select
a given pool that has a short-stated final of well under 10
years, and little or no principal cash flow until maturity.
(These products were featured in this column in April
2016.) More traditional MBS that are well-seasoned and
have little prepayment expectations (i.e., low-stated couA
site near you
Jim Reber and associates from Vining Sparks
will be speaking at numerous community bank
events throughout the summer. To view the
current calendar, visit icbasecurities.com/
seminarswebinars
Education on Tap
Webinar series continues
ICBA Securities and its exclusive broker, Vining
Sparks, have announced the next segment of their
2019 webinar series, Community Banking Matters,
for May 14 at 10 a.m. CDT. Greg Roll presents
" Balance Sheet Management and Your Loan
Portfolio. " Free CPE is available. To register, visit
viningsparks.com
pons) will work too. At the moment, 15-year MBS that are
three or more years old with a coupon rate of 2.50 percent
or less fit this description.
In the end (or the middle, as it were), recasting segments
of your bond portfolio to mature in the intermediate portion
of the maturity spectrum could have some merit in 2019
and beyond. If and when the yield curve steepens, a ladder
will create a solid basis for investment performance.
In the end (or the middle, as it
were), recasting segments of
your bond portfolio to mature
in the intermediate portion of
the maturity spectrum could
have some merit in 2019
and beyond.
independentbanker.org Q 27
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Independent Banker - May 2019

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