Pub. 7 2018 Issue 2

The CommunityBanker 14 A s yields continue to set cyclical highs during 2018, many community bankers have asked us questions about where to invest their next purchases. Some of them have been surprised to hear an answer that I’ve been giving for the better part of this decade, even though absolute yields and the shape of the curve look nothing like the 2010s. This answer is rooted in history and in forecasts. While the difference in yields between short maturities and longer ones is the smallest it has been in 11 years (i.e. the curve has flattened), most bond analysts, economists and the Federal Reserve itself are predicting that we’ll see more of the same. When it’s expected that yields will continue to converge into what looks like a straight line, the type of portfolio structure that performs the best is a “bar- bell.” This month, we review the structure and the advantag- es of such an exercise for your investment portfolio. Repetition and Resistance By being disciplined and deliberate about your invest- ment structures, you can take advantage of today’s yields and simultaneously hedge your risk against what looks to be on the cards for the next couple of years. The barbell is simple to build and easy to evaluate later. It just requires an inves- tor to define what it considers to be suitable short-term and long-term investments. To be sure, community bankers have differing opinions on what counts as a long-term investment, but generally speaking, those with durations of five years and greater are considered as being on the high end of the price- risk scale. Once we’ve identified the target investments, the portfolio manager will purchase roughly similar amounts of both and keep the weight balanced through ongoing monitoring. By having a collection of bonds that are heavy on both ends of the maturity spectrum, you’ve successfully built a barbell. Classic Structure Among the bonds that meet community banks criteria of liquidity and credit quality are those issued by the Small Business Administration (SBA). They are direct obligations of Uncle Sam, and new issue volumes continue to set records, so the SBA market continues to broaden and deepen. Two of the more visible products are 7(a) pools, which are true floating rate instruments, and Development Company Participation Certificates (DCPCs), which are fixed rate pools with long average lives. It makes logical sense to consider them together for a barbell. For one thing, credit quality is unsurpassed. For an- other, it would be hard-pressed to find two bonds with more disparate price-risk profiles. For still another, we can address premium risk that attaches to the 7(a)s by pairing them with a DCPC that is available at a price below par. Finally, at this point in the rate cycle, both ends of the barbell yield much Portfolio Power By Jim Reber F E A T U R E Barbell Structure May Be the Right Regimen