Reduce liability for losses on commercial accounts by adhering to four requirements.
I am always looking for clues about the direction of interest rates. Although consistently outguessing the bond market is impossible, there are three very reliable indicators that can help you improve your rate guess, and consequently, your bond portfolio’s performance. Your goal as portfolio manager is to be vaguely right rather than precisely wrong on interest rates.
One of the most accurate signs is the level of liquidity in banks. Because we tend to make more loans when economic times are good and interest rates are higher, you can actually use your liquidity position as a contra-indicator. Invest shorter when your loan demand is soft and you are flush with cash, and lengthen your purchases when loan demand is strong. In both cases, you will be very, very tempted to do just the opposite, which by the way, is the second key indicator.
A third clue about the direction of rates is the gain or loss position of your bond portfolio. The chart below displays the tremendous rollercoaster ride we have experienced over the past seven years from large losses to large gains, and then all the way back to essentially break even today. Check out the $825 million swing from 2000 to 2003.
UMB Bank holds approximately $18 billion of securities in safekeeping from roughly 1,000 banks located in 45 states. It seems to me that studying the direction and magnitude of the gains and losses on this huge sum of money can perhaps help us better identify the macroeconomic trends, improve our rate guess and also provide a guide to where to invest next.
Everyone knows that losses occur when current bond market yields rise above your portfolio’s overall yield. When you mark your bonds to the current market, you create a book loss. Gains are just the opposite as they are the result of falling interest rates relative to your portfolio’s yield. Following the trend in your gains and losses — try this at home — can provide a very valuable and emotionless clue for where to invest new funds.
The best bond markets for bank investors are always the ones you cannot get in, and the worst ones force you to get in.
In summary, today’s break even position in the market value of your portfolio indicates a transition point for the direction of interest rates. Because of a slower economy and tighter credit conditions, I think we will be very tempted over the next three to six months to reach out for yield.
My advice . . . think about doing exactly the opposite.
Best wishes for a safe and happy holiday season, and a special thanks to BankNews for the privilege of writing in this space the past 18 years.
Jeff Goble is executive vice president and managing director, investment banking at UMB Bank, n.a., Kansas City. His email address is Jeffrey.Goble(at)umb.com.
Copyright © December 2007 BankNews Publications