5 Ways to Maximize the Value of Your Investment Portfolio

The security portfolio is typically 20% to 30% of earning assets for many financial institutions (FIs). Loan interest makes up the majority of the interest income generated by an FI, but improving security portfolio yields can also help to bolster total interest income earned, return on assets (ROA) and return on equity (ROE). Five ways to maximize the value of the investment portfolio are:

  1. Improving transaction execution
  2. Organizing the portfolio into a Liquidity Portfolio and an Earnings Portfolio
  3. Establishing a strong process to analyze and measure credit risk
  4. Steering clear of “story” bonds
  5. Avoiding tax-exempt municipal bonds


Transaction Execution Improvement

The security purchase process for many FIs starts with the Investment Manager making calls to approved broker/dealers, and receiving security suggestions and offer prices throughout the day. The Investment Manager reviews the available alternatives, and then calls the broker/dealer to execute the trade. The time between the Investment Manager receiving the investment options and the ultimate execution of the trade can usually be measured in hours. By implementing the following suggestions, the FI could be able to improve trade execution by between 2 ticks and 16 ticks, which could improve security yields by 3 to 10 bps on average.

  • Gather as much information prior to transaction execution about current market conditions for the security type planned to purchase.
  • Check recent trade activity on TRACE (Trade Reporting and Compliance Engine) or EMMA (Electronic Municipal Market Access) prior to purchase.
  • Ask the broker/dealer if they hold the bond in inventory. If not, the bond could be purchased for cheaper from another trusted broker/dealer.
  • Ask for quotes from the broker/dealer in spread or pay-up terms, not just dollar price. The market will move between the time when the offer price is received and the time when the trade is actually executed. If pricing is presented in spread or pay-up terms, the broker/dealer can eliminate any cushion they had in the price to protect themselves against market movements, thus providing better trade execution.
  • Work with trustworthy brokers/dealers by checking on BrokerCheck by FINRA (Financial Industry Regulatory Authority).

A critical tool needed to ensure success with the suggestions above is direct access to real time market data such as a Bloomberg terminal. Adding an independent investment advisor to the security purchase process would help the Investment Manager by virtue of having access to real time market information.


Liquidity Portfolio Versus Earnings Portfolio

For most FIs, the security portfolio is primarily structured to support its liquidity needs. Using traditional measurements such as the loan-to-deposit ratio (LTD), as well as dynamic liquidity measurements which measure cash inflows versus cash outflows over various time horizons, the FI’s Liquidity Manager can determine the dollar amount of liquid assets the FI needs at any time. Several steps to consider include:

  • Establish how much of the investment portfolio needs to be available for liquidity risk management purposes. The amount identified will make up the Liquidity Portfolio.
    • Typically, the Liquidity Portfolio has a shorter duration/lower price sensitivity and minimal credit risk.
  • Any excess over the amount needed for liquidity can be invested in the Earnings Portfolio.
    • The Earnings Portfolio can be invested in bonds with longer duration and/or additional credit risk providing increased yield versus the bonds in the Liquidity Portfolio.

Not having enough liquidity clearly poses risk to the FI. But having too much liquidity can hinder the FI’s financial results. Finding the right mix between securities needed for liquidity and securities that can be invested for earnings will serve to improve the FI’s overall security portfolio yield, ROA and ROE.


Develop a Process to Analyze and Measure Credit Risk in the Bond Portfolio

The Earnings Portfolio described above will often hold the following:

  • Corporate bonds
  • Tax-exempt bonds
  • Bonds with structured cash flows
    • Agency-backed Collateralized Mortgage Obligations (CMOs) and Commercial Mortgage Backed Securities (CMBS)
    • Non-agency Collateralized Loan Obligations (CLOs)

Adding credit related bonds and non-agency structured bonds to the investment portfolio increases risk to the FI. In order to mitigate the additional risk, the FI will need to develop and implement a process to continually analyze the bonds for cash flow or credit risk changes. The monitoring process should include:

  • For credit related bonds:
    • Gathering up-to-date financial information on the issuer
    • Monitoring news reports concerning the issuer
    • Establishing a process to measure and assess the financial performance of the issuer
      • Including identification of early warning indicators on the financial health of the issuer
  • For non-agency structured bonds:
    • Obtain monthly trustee reports
    • Analyze credit quality of the underlying assets
    • Assess the changes in subordinated classes
    • Monitor financial triggers and metrics delineated in the prospectus concerning the cash flow waterfall
    • Measure any changes in risk weighting for risk based capital purposes
      • Utilize the Simplified Supervisory Formula Approach (SSFA) or the Gross-Up Approach

Establishing the process for continual monitoring of the aforementioned bonds will serve to mitigate the additional risk of owning these bonds, and help to limit loss exposure. An independent investment advisor can assist with the analyses listed above and can enhance the risk management of the overall bond portfolio.


Steering Clear of “Story” Bonds

Exercising caution with “story” bonds is usually one of the first things a new investment professional learns. What is a “story” bond? If the cash flow variability and expected yield in different rate scenarios cannot be explained in plain English in one minute, you have a “story” bond. Steering clear of “story” bonds seems quite clear, but many FIs have had to record losses over the years that would fall into this category. Here are some examples:

  • Pooled trust preferred securities
  • Non-agency mortgage backed securities backed with residential mortgages underwritten with no support of the borrowers’ income or asset position
  • Auction rate preferred securities

Experience has shown that many “story” bonds end up in Other-Than-Temporary Impairment land, and not happily ever after.


Avoiding Tax-Exempt Municipal Bonds

Although one may think that the suggestion to avoid tax-exempt municipal bonds is due to potential credit concerns for municipal issuers, the suggestion is actually focused on the relative value of tax-exempt municipal bonds for FIs due to federal tax rates being reduced to 21%.

Prior to the corporate tax rate reduction starting in 2018, tax-exempt municipal bonds tax equivalent yields (TEY) were superior to corporate bonds with similar credit ratings. Since the corporate tax rate cut, TEY for tax-exempt municipal bonds for FIs at the 21% tax rate are not as appealing when compared to corporate bonds in the market. What happened to the relative value between tax-exempt municipal bonds and corporate bonds? The answer can be found with individual (non-corporate) investors who have shown a large appetite for tax-exempt paper due to being subject to a higher marginal tax rate than 21%. Tax-exempt debt is more valuable and appealing to an investor at a higher marginal tax rate versus a corporate entity at the 21% marginal tax rate, thus providing a floor for the value of tax-exempt bonds in the current market environment.

If an FI still wants to invest in tax-exempt municipal bonds, it should consider:

  • Staying on the sidelines until TEYs for tax-exempt municipal debt relative value improves.
  • Calculating TEY adjusted for TEFRA using potential changes in cost of funds (COF) over the life of the bond. Best practice is to use a conservative estimate of COF over the entire period rather than current COF when analyzing tax-exempt municipal bonds.

Although the items above do not focus on the credit aspect of investing in tax-exempt municipal debt, understanding the credit quality and financial position of the issuer is a key consideration prior to purchase of any credit related bond. For more information, refer to this white paper “FIs Investing in Municipal Bonds: What to Look For”.


One More Thought Concerning Equity Securities

Some financial institutions’ charters allow for investing in equity securities; remember that equity security changes in value will be reported in the income statement starting in 2019. Accordingly, financial statement and regulatory capital will fluctuate with equity market value changes.



Applying any or all of the five suggestions outlined here will serve to improve portfolio construction and yield, as well as improve the overall performance of the FI. Introducing an independent investment advisor to the investment management process will allow the financial institution to quickly benefit from the five ways to maximize the value of your investment portfolio. Stay tuned for the next post on understanding the cost to shifting portfolio management process.


Choosing a partner for your financial institution’s investment advisory starts with one key factor: a foundation of trust. As an independent advisor to over 160 community and regional banks, and with $3.5 billion in assets under management, Chatham Financial and Chatham Investment Advisors have established long-term, trusted relationships with its partners throughout the industry. Members of the Chatham team have sat in CFO and treasury roles at community FIs, and know what it takes to manage a successful investment portfolio.



Chatham Hedging Advisors, LLC (CHA) is a subsidiary of Chatham Financial Corp. and provides hedge advisory, accounting and execution services related to swap transactions in the United States. CHA is registered with the Commodity Futures Trading Commission (CFTC) as a commodity trading advisor and is a member of the National Futures Association (NFA); however, neither the CFTC nor the NFA have passed upon the merits of participating in any advisory services offered by CHA. For further information, please visit https://www.chathamfinancial.com/legal-notices/.

Transactions in over-the-counter derivatives (or “swaps”) have significant risks, including, but not limited to, substantial risk of loss. You should consult your own business, legal, tax and accounting advisers with respect to proposed swap transaction and you should refrain from entering into any swap transaction unless you have fully understood the terms and risks of the transaction, including the extent of your potential risk of loss. This material has been prepared by a sales or trading employee or agent of Chatham Hedging Advisors and could be deemed a solicitation for entering into a derivatives transaction. This material is not a research report prepared by Chatham Hedging Advisors. If you are not an experienced user of the derivatives markets, capable of making independent trading decisions, then you should not rely solely on this communication in making trading decisions. All rights reserved. 18-0133

About the Author

Dave Sweeney

David J. Sweeney is Managing Director for Chatham Investment Advisors, an independent investment advisor. David spent fourteen years as a Principal at a big four accounting firm, and eight years in CFO and treasury positions at community banks, managing over $1 billion in investment securities, and over $1 billion in wholesale funding and asset/liability management process. He leads a team of advisory professionals with deep community bank experience.

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