ABA Banking Journal - November 2010 - (Page 42)

investment management | by joe wheeler The puzzle of BABs Should you buy “Build America Bonds”? That and other portfolio questions answered Loans represent 81% of the typical bank’s earning assets, according to FDIC 2010 averages. Securities represent just 19%. So what makes one fifth of anything so important? Simply this: margin needs and liquidity requirements. Loan demand remains soft and rates low, equaling few options for increasing assets or margin. Examiners affirm that investment reviews have moved down in priority (except private-labeled mortgage-backed securities or trust preferreds) while liquidity analysis has moved up. Contingency Funding Planning and Sources and Uses of Funds analyses require multiple “what-if ” scenarios as the new normal. “Bankers ask, ‘What should I do?’, says Ken Bretthorst, president/CEO, First Bankers Banc Securities, St. Louis. “I tell them, ‘Make your portfolio reflect your culture and guidelines. If you’ve got something you don’t want—sell it! If you’re outside guidelines—sell it! If you’re 80% sure rates are going up, invest 80% of available funds to accommodate that scenario and the other 20% to hedge that position in case you’re wrong. Consider taxable municipals which offer an attractive yield in the intermediate range’.” Let’s specifically look at Build America Bonds. BABs allow state and local governments to issue taxable bonds (2009 and 2010) for capital projects and receive a direct federal subsidy for a portion of borrowing costs. Issuers can choose to offer a tax credit for the buyer or receive a direct payment from the federal government equal to 35% of interest costs. BABs have become popular as municipalities deal with strained revenue generation. Bill Emmons, assistant vice-president and economist, Division of Banking Supervision and Regulation of the Federal Reserve Bank of St. Louis, says, “The economic outlook is challenging in 2010 and beyond, particularly in regions that have suffered great housing-market volatility. The overhang of large debt burdens among many state and local governments combined with household efforts to de-leverage their balance sheets, suggest some risk of localized state and local budget crises and loss of investor confidence in particular issuers.” BABs are attractive because issuers can offer higher interest rates than comparable tax-exempt municipals. Yields can be higher than similarly rated corporate bonds. Potential drawback? Liquidity. Because these bonds are new, there is a risk that not enough buyers will be available. So far, this has not been the case. 42  |  ABA BANKING JOURNAL  |  november 2010 Nationally, municipals average 1.25% of bank assets. BABs were designed to help state and local governments finance capital projects at lower costs with federal government subsidy of interest paid. Their use for building schools, roads, and other projects can help depressed real estate values. Banks tell customers to diversify their portfolios for maximum return. There is something to be said for “as goes the market (deteriorating or thriving) so goes the bank.” This risk/reward discussion calls for a little “bonding” with your broker. n Joe Wheeler is vice-president, Consulting Services at Plansmith, which assists banks with strategic, IRR/ALM, forecasting, and regulatory performance, jwheeler@ plansmith.com. Find a more-detailed version of this article online at this speedlink: http://tinyurl.com/BABSonline http://www.ababj.com/index.php?option=com_content&task=view&id=1568&Itemid=1 http://www.ababj.com/index.php?option=com_content&task=view&id=1568&Itemid=1

Table of Contents for the Digital Edition of ABA Banking Journal - November 2010

ABA Banking Journal - November 2010
Contents
Chairman’s View
Editor’s Column
The Economy
Bank Notes
ABA Community Banking: Chapter 12’s Bad Fit
Pass the Aspirin
Tech Topics
Capital Squeeze
Basel III Redefines Capital
Compliance Clinic
Compliance Inbox
ABA Resources
Investment Management
Surveys & Trends
First Person

ABA Banking Journal - November 2010

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