Page 38 - April 24, 2025 Bulletin

BUSINESS PARTNER FEATURE

The Importance of Maintaining a

Bond Portfolio in a

Community Bank Balance Sheet

John D. Bloss
Managing Partner
The Baker Group

Managing a community bank’s balance sheet is like return to robust performance—a chance to remodel
taking care of a home: it requires ongoing maintenance, the portfolio before rates potentially decline again.
thoughtful planning, and proactive decisions to Am I suggesting we prioritize bonds over loans?
preserve its value and ensure long term sustainability. Certainly not! At community banks, loans will be and
Just as a well-maintained house stands strong through should be the primary vehicles used to serve the local
storms and shifting seasons, a carefully tended bond economy, businesses, and households. However, when
portfolio anchors a community bank’s balance sheet loan demand is strong there is a tendency to ignore
against economic turbulence. For community banks, the bond portfolio. During these times, loans can be
certain bonds are more than just a safe haven; they’re like the exciting new addition to your house—lucrative
a critical tool for stabilizing income, managing risk, and when times are good, but prone to leaks (refinancing
preserving margins. Today, with the 5-year Treasury or defaults) when rates drop or the economy falters. In
yield hovering at its highest average level in seventeen low-rate environments, borrowers refinance at lower
years, banks have a unique opportunity to "renovate" costs, shrinking bank margins, or worse, default during
their portfolios, ensuring resilience for years to come.
downturns, leaving banks exposed. Bonds, especially
Think of a bond portfolio as the foundation of a house. those with predictable cash flows and structure, offer
Neglect it, and cracks appear—margins erode, and a stable yield vehicle to complement the loan portfolio.
vulnerabilities emerge. Maintain it, and it provides Selective bonds with specified collateral tend to not
steady support. Right now, the 5-year Treasury yield refinance unpredictably or default; they pay reliably,
offers a golden window for reinforcement. This part providing a buffer against loan volatility. This stability is
of the yield curve is often viewed as a good proxy for a lifeline for community banks aiming to protect their
bank portfolios, considering their average lives tend net interest margins.
to be around five years. As of February 24, 2025, this To seize this opportunity, banks should adopt or simply
yield has averaged around 4.20% over the past year, a maintain a dollar-cost averaging strategy—steadily
peak not seen consistently since 2007. Historical data investing in these elevated yields over time. Just as
over the last twenty years reveals this moment’s rarity. you wouldn’t renovate your entire house in one frantic
From 2005 to 2007, yields fluctuated between 4% and weekend, don’t chase the market in a single leap. By
5%, but the post-financial crisis era slashed them to spreading purchases across months, banks lock in
historic lows, averaging below 2% from 2011 to 2021. today’s high yields, building a portfolio that thrives even
This is not suggesting yields are going to drop in similar if rates fall. Make no mistake, market yield volatility is a
dramatic fashion. However, as risk managers, we must daily reality we’re currently experiencing with political
anticipate such an occurrence. Today’s rates signal a

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