Tag: funding

John V. Anderson bought F&M Bank in the early 1970s. It’s a third-generation family business today.

John V. Anderson celebrates 75 years in community banking this year. The chairman emeritus of F&M Bank offers us a glimpse of his life, his career and the lessons he’s learned along the way.

By Molly Bennett

---

How do you capture a life in 1,000 words? The answer: with difficulty. And when that life takes in the Great Depression, World War II and 75 years in community banking, the challenge becomes more acute. But here goes nothing.

John V. Anderson, who is 95, is chairman emeritus of F&M Bank in Crescent, Okla. Since buying it 50 years ago, he has watched it grow from a single-branch community bank to one with nine locations across the state and $650 million in assets. His three sons and one daughter are all involved in the 100% family-owned business, as are three of his grandchildren.

“And I’ve got great-grandchildren now that are beginning to drive cars, so that’s the next wave that wants a job,” he laughs.

“In these 75 years, I’ve made a lot of friends. I just did the best I could at whatever job I had.”
—John V. Anderson, F&M Bank

Anderson’s family ties have always been strong. He was born into a farming family in Choctaw, Okla., in 1927. His father’s family, members of the Citizens Potawatomi Nation, farmed corn and cotton, and his mother came from a produce farming family.

When Anderson was three, his father lost his job at the local utility company. “We had to skimp and save,” he says. “We picked cotton, and we chopped cotton and corn. We didn’t have a car, so we had to walk out to the fields. That made such an impression on me. So, every job I’ve had, I would do the best job I could.”

In 1945, right after high school, he enlisted in the Navy, finishing boot camp right as the U.S. dropped the bombs on Hiroshima and Nagasaki. He was stationed on an aircraft carrier and took part in Operation Magic Carpet, which saw U.S. troops collecting armed forces personnel from various Pacific islands and dropping them off at San Diego or Pearl Harbor. “We were a part of a really joyful time, because everybody was coming home,” Anderson says.

The banking adventure begins

After he was discharged, he worked at a utility company before taking a job at Liberty National Bank in Oklahoma City in 1947. There, he worked his way up from messenger to teller to the correspondence department. The latter is where he met his wife, Jo Laverne, who is 93.

“She worked about 10 feet from me … and I thought she was a pretty good-looking girl. I’d shoot a rubber band back there once in a while just to get her attention,” he laughs. The couple celebrated their 73rd wedding anniversary in September.

---

---

But back to 1972. That year, Anderson was senior vice president of operations at Liberty when one of his industry connections, J.R. Gibson, who owned F&M Bank in Crescent, Okla., told Anderson he was looking to sell due to health problems.

“He said, ‘If you are interested, you’d be my first choice,’” Anderson says. “I said, ‘J.R., let me tell you that I don’t have any money, I have no net worth and I have no secondary source of income. But I’ll see what I can do.’”

Anderson went to some colleagues at Liberty National Bank, and they agreed to consider loaning him the $548,000 he needed—about $4 million today. “And I thought, if you make me a loan, you’re probably the worst loan officers I’ve ever run into,” he laughs. “But anyhow, they made that loan.”

Anderson says that when one of the presidents at Liberty heard about the loan, he said, “Let me tell you something. You’re gonna be one of the last guys that can buy a bank with just sweat equity.”

And so began the Anderson family’s ownership of F&M Bank. It was a baptism of fire: The late 1970s and early 1980s brought a recession, high inflation and higher interest rates; Anderson was paying 18% interest on the loan he used to buy the bank. But F&M survived through hard work and the connections Anderson had made.

---

---

Since then, the community bank’s growth has been steady. It acquired a handful of distressed banks over the years and opened branches to expand its footprint. Anderson has been an active member of the Oklahoma Bankers Association and ICBA, and he also sat on the board of First National Bank & Trust Co., a Potawatomi tribal bank in Shawnee, Okla. His son, John Tom Anderson, is a current director.

“We have excellent relations with the tribe, and [F&M Bank] does some loans with the Bureau of Indian Affairs,” Anderson says.

Today, he and his family have their eyes on the future. “Right now, we’re in the process of drawing up rules for employing family members,” he says. “We want them to have a good education, and we want them to work someplace else for three or four years to see what it’s like to work for somebody that’s very objective. We want them to observe the same standards that everybody observes when they come to work for us.”

In 2019, Anderson was inducted into the Oklahoma Bankers Hall of Fame. “I thought that was something,” he says. “I’ve done that through mentors and friendships, and in these 75 years I’ve made a lot of friends. I just did the best I could at whatever job I had.”

---

---

Molly Bennett is executive editor of Independent Banker.

After 40 years in its Cape Giradeau branch, Wood & Huston Bank moved to a new building and allowed firefighters to train in its former building.

Before Wood & Huston Bank’s former headquarters was demolished, the community bank lent the space to a local fire department for critical, hands-on training.

By William Atkinson

---

If you are in the process of pulling up roots from an existing building and moving to a new facility, and if you plan to demolish the older building, there may be a way to provide a valuable service to your community—one that is so valuable that it may actually save lives in the future.

Such a scenario happened in August 2022 in Cape Girardeau, Mo., where $1 billion-asset Wood & Huston Bank closed an existing branch and moved to a new one right next door.

“The decision to close our old facility and build new was made in the spring of 2021,” says Kate Yarbro, vice president and branch manager of the Cape Girardeau branch. “The Huston family generously chose to build us a new facility after 40 years of life in our previous building.”

The building had been renovated and extended many times since it was built in 1980. While it was a hard decision to tear down a piece of history, Yarbro says the community bank’s staff is excited about it and looks forward to the next 40 years in its new building.

Shortly after the move, Yarbro was approached by Matt Mittrucker, battalion chief of training and safety for the Cape Girardeau Fire Department. He asked if it would be possible to do some training in the building while they were waiting for demolition to begin.

“After discussing it with some colleagues,” says Yarbro, “we decided it would be a great opportunity for the department’s training and could also have a positive impact on our community.”

“We often look for buildings in town that may be demolished but that are still in safe conditions that we can train with,” says Mittrucker. “Those opportunities rarely present themselves.”

Wood & Huston, he notes, “graciously allowed us full access to the old building, before demolition, without burning it due to the close proximity to other structures.”

Bringing in the battalion

The fire department has three shifts of 21 firefighters each who staff four engines and one ladder. Each shift was able to send crews at least twice for training before the building was demolished.

“Each crew trained several hours each day while rotating in and out, so that we could still provide emergency services promptly,” says Mittrucker. The multiday training incorporated many different skills that crews would need in an emergency.

“We had a positive reaction from every customer we saw, and I feel the community as a whole was excited to see our city’s fire department get to train.”
—Kate Yarbro, Wood & Huston Bank

“We accomplished search training for victims in large structures used for commercial purposes that have drastically different layouts than a normal residential structure,” Mittrucker adds. “We advanced charged hoselines into the structure and were actually able to spray water in order to practice water stream control.”

However, one of the best trainings was practicing roof ventilation on a real roof.

“Due to the nature of the action, we often can’t do this in training, because it destroys the roof by cutting smoke and relief holes into a structure using chainsaws and rotary saws,” he says. “This action greatly improves victim survivability and improved working conditions for the interior firefighters.”

“It was fun for us to see them training for a few days,” Yarbro says. “We had some people concerned at first that the bank was on fire, but we quickly spread the word that the fire department was just doing some training. We had a positive reaction from every customer we saw, and I feel the community as a whole was excited to see our city’s fire department get to train.”

The facility was demolished the first week of September, after training had been completed. At that time, Wood & Huston Bank arranged to have the lot graded and concrete poured.

A better customer experience

The new, open-concept facility includes additional parking, two ITMs and other features designed to give customers a more customized banking experience. According to Yarbro, the new branch is “a breath of fresh air and a modern take on banking. We are looking forward to creating our home here, and excited for the future.”

“Any opportunity to partner with a local business such as Wood & Huston is a win for both,” says Mittrucker. “It shows the bank’s devotion to its community and shows our community businesses that we are ready to respond to any emergency that may arise.

“Wood & Huston’s allowance for us to train made an impact on all the citizens of Cape Girardeau for the foreseeable future, due to the fact that our firefighters will be familiar in a similar situation when emergencies occur,” he adds. “It was truly a priceless opportunity.”

---

William Atkinson is a writer in Illinois.

Illustration by Idey/Adobe

AI can help solve customer pain points—but does it mean community banks will lose the personal touch they pride themselves on? As community bankers themselves tell us, the answer is no.

By Susan Springer

---

From gaming and online advertisements to autonomous vehicles and smart homes, artificial intelligence (AI) is used in a wide variety of ways. When it comes to banking, adoption is still in the early stages. However, when it’s thoughtfully applied to customer service, community banks can solve customer pain points and reap significant benefits—without losing the personal touch they’re known for.

How can AI accomplish this? First, with AI’s ability to mimic human intelligence, community banks can quickly process huge amounts of data to ease customer friction. Then, by monitoring AI as it works, banks can see where their customers’ experience can improve. That’s because AI iteratively improves itself based on the information it collects, with computer systems processing data and learning patterns through advanced algorithms.

“There’s incredible value in banks’ data, and they aren’t optimizing it either because of a lack of technology or it’s locked in the core. With AI, we can turn it into actionable insights.”
—Carson Lappetito, Sunwest Bank

Here are common issues customers experience that AI could improve.

“My accounts are scattered at different banks.”

“Many orphaned accounts sit inside community banks,” says Carson Lappetito, president of $2.5 billion-asset Sunwest Bank in Sandy, Utah.

Customers don’t want a fragmented banking relationship. “They often say, ‘You’re my core bank and I want my accounts together, I just didn’t know you had an SBA loan department,’” says Lappetito.

He believes community banks can easily improve their ability to cross-sell by using robust data analytics and AI to place the right products in front of the right customers. Partnering with vendor Neocova to identify cross-selling opportunities within Sunwest’s customer data was a game changer, he says. “We can see customers who are paying loans at other institutions, estimate loan balances and generate a shortlist by relationship manager,” says Lappetito.

Only a few months of targeted cross-selling has made a meaningful impact, increasing loan production and uncovering more deposit opportunities for customers. “It provided incredible fruits for us both in additional revenue opportunities and customer satisfaction.” While traditional cross-sell campaigns produced overload in the sales team, AI eased the process for all involved.

In addition, AI enabled Sunwest to pursue its specialty of solar lending. “Because the value in AI learning is a function of repetition, the more models and use cases, the more knowledge,” Lappetito says. Thanks to data sets beyond his own bank, the AI platform identified customers with large electric bills who would benefit from Sunwest’s solar expertise.

“There’s incredible value in banks’ data, and they aren’t optimizing it either because of a lack of technology or it’s locked in the core,” he says. “With AI, we can turn it into actionable insights.”

“It takes too long to get answers to simple questions.”

The pandemic meant fewer face-to-face opportunities for community banks. “They got creative quickly; the adoption of virtual assistants and chatbots spiked during COVID,” says Nicole Harper, director, corporate strategy at Jack Henry.

Chatbots, a software application that can conduct an online chat conversation via text, and digital virtual assistants (VAs) can give customers fast answers on their bank’s mobile app to routine questions such as, “What’s my balance?”

“Look at the top 20 reasons why they call, and you will identify the sweet spot of the high-volume, low-complexity things that create an opportunity to serve through AI,” says Harper.

She says community banks can tailor automation to their own customer service strategies. For example, a bank may feel comfortable allowing a VA to solve a login problem, while situations like a lost card are solved by an empathetic human. “Issues that create emotion are where you want to stand up and be the hero, since customers may have less appetite for automation,” Harper says.

“We want to balance providing the fast answers and solutions that customers are looking for without losing that personal touch.”
—Rory Bidinger, Stearns Bank

Some AI platforms can even detect emotion such as a raised voice, so that if an interaction moves beyond a simply query to frustration, the customer can be sent to an agent.

While chatbots or VAs are usually thought of as customer facing, there is also an agent assist model. “That can ensure your agent gets to the single right answer quickly,” Harper says.

“Did I get the loan or not?”

“We want to balance providing the fast answers and solutions that customers are looking for without losing that personal touch,” says Rory Bidinger, chief marketing officer of Stearns Bank N.A. in St. Cloud, Minn., adding that business customers may have high expectations of speed set by online lenders who can put them in touch with loans in a matter of minutes.

Stearns is still researching the expansion of AI operational functions, Bidinger says. Because the $2.3 billion-asset community bank prioritizes a personal connection with its customers and “commits that we will answer on the first ring,” it is considering how to provide convenience through AI while maintaining the human touch.

Stearns is exploring the use of AI for smaller business loans in its equipment finance division. As a national bank that serves customers in multiple states, Stearns makes loans and finance equipment for various industries, including medical, agriculture, construction and transportation. While AI can speed up answers to customers’ questions by automating credit reports, the community bank wants to understand and make loan decisions based on the whole customer—not just their credit score. A hybrid approach would enable customers to obtain funding faster while bankers maintained the customer relationship.

“We are trying to identify these types of opportunities where we can partner with other technology companies to provide services that our customers are looking for, instead of reinventing the wheel,” Bidinger says.

“It’s hard to reach a real human to help me.”

It’s no secret that the banking industry is one of many affected by the current staffing crisis, which has encouraged many banks to look for technology solutions. Some saw AI as the silver bullet.

“Customer experience has become a critical competitive advantage, requiring banks to completely change their approach to servicing customers,” says N. Venu Gopal, chairman of the board of Quinte Financial Technologies, Inc. “Today … people expect specialized services everywhere, all the time.”

AI can streamline processes significantly, freeing bankers’ time to interact with customers. For example, Gopal says there is a growing focus on automated lending. AI can be applied to capture credit information, perform some underwriting functions and present all relevant information, including analyst recommendations, on a single dashboard to lending staff to facilitate the decision-making process. With AI substantially improving operational efficiency in the back office, banks can reduce operational cost, errors and time required to process customer requests.

“We are seeing greater success in implementing AI to help with the automation of processes, which results in superior service and reduced turnaround time,” Gopal says. “We also see community banks striving to maintain that personal touch by empowering their staff through the use of AI.”

However, AI is not a set-it-and-forget-it solution, he says. “The systems do require constant supervision and review of outcomes to ensure that needs of the customer are consistently being met.”

“Paperwork takes way too long.”

“While AI could be applied to any layer in the tech stack, from back office, to customer facing, start with the back office including document processing, compliance verification and fraud detection,” says Sarah Hovde, head of investor relations at BankTech Ventures.

Hovde says banks need to clean up the back office first, so that customers don’t experience slowdowns due to bottlenecks in processing. If banks are driving more sales volume, they need the infrastructure to support that increased activity, or they’ll drown staff. AI can quickly manage repetitive, monotonous tasks. For example, tech can expedite showing a full view of a customer from a variety of platforms instead of a person working half a day to aggregate that same data.

“Leverage the technology to free up human capital by spending less time sorting through data,” says Hovde. “Then, move into the front office to improve customer service by offering more personalized products.”

---

Susan Springer is a writer in Oregon.

“FedNow can be another positive differentiator for our nation’s community banks, but we must be ready for this real-time service and its 24/7/365 requirements.”

We’ve been working toward a faster payments future for a decade now, and we’re finally seeing the fruits of our labor: the launch of FedNow. Our efforts to encourage the Fed to offer an instant payments solution have led to this result; it was our voices that expedited FedNow’s time to market, with the Fed updating the original timeline due to our focused advocacy efforts. By mid-2023, we will be able to begin offering this solution to our customers.

With FedNow entering the market, community banks can add in a missing payments link—instant payments—and help level the playing field with the nation’s largest financial institutions. FedNow will be a great equalizer for the industry, bringing real-time payment clearing and settlement to community banks across the country.

So, with FedNow’s launch on the horizon, what can community banks do to prepare? I, for one, have been speaking with our core provider, expressing our interest in FedNow and getting into the details of when it will be available to us and at what price.

While many providers are still ironing out their plans, we must actively seek information. It’s important to reach out and emphasize that FedNow is a priority. Think of it like you would an advocacy visit on Capitol Hill: Go in with your ask, and make it clear what you want from them and by when. Every executive reading this column should take five minutes to send an email to their core provider to inquire about FedNow availability, timing and pricing.

While you’re waiting to firm up those details, take steps to ensure your teams are up to speed on what FedNow will mean for your customers. From signing up for the FedNow webinar series offered by ICBA Bancard to subscribing to FedNow notification emails, resources exist that will help you deepen your knowledge of the solution and its potential.

In addition, having conversations with your Fed rep to understand how you should prepare will provide a firsthand perspective on the more nuanced elements of FedNow implementation.

Regardless of the steps you take, the time to act has arrived. FedNow can be another positive differentiator for our nation’s community banks, but we must be ready for this real-time service and its 24/7/365 requirements. We need to be able to upgrade our infrastructure and processes in a positive, strategic way to make the most of the opportunity. For community banks, it’s time to unlock FedNow’s potential and take advantage of all that this solution will offer.

---

Brad Bolton, Chairman, ICBA
Brad Bolton is president and CEO of Community Spirit Bank in Red Bay, Ala.
Connect with Brad @BradMBolton

Illustration by Alex/Adobe

A convergence of economic and marketplace factors presents community banks with new opportunities for innovation and growth as they look to the new year.

By Charles Potts, ICBA

---

The fintech landscape is shifting. Investments in new companies have slowed, valuations that some early-stage companies commanded last year are ratcheting back, and financial technology providers are tightening their proverbial belts. While challenging for some, this convergence of economic and marketplace factors presents community banks with new opportunities for innovation and growth as they look to the new year.

With community banks finalizing 2023 budgets, now is an excellent time to reevaluate current business partnerships and consider whether partnering with additional or different fintech providers would better meet the bank’s and customers’ needs.

For community banks that have yet to start evaluating digital solutions and providers, now is the time to act. Current market shifts have created a buyer’s market, putting community banks in a favorable position to renegotiate contractual terms and become more selective in their provider choices.

As community banks leverage these marketplace advantages, they should consider partnering with providers that bundle their services and solutions to meet customers’ demands. For the past few years, fintechs have worked to address specific challenges or niches, creating a siloed approach that resulted in multiple solution providers and platforms, creating unnecessary friction for community banks and their customers.

In response, community banks, like $779 million-asset Lead Bank in Kansas City, Mo., have begun investing in fintech providers that can arm them with the capabilities to bundle their services and streamline processes. We see this same trend playing out in larger financial institutions as well. Earlier this year, Bank of America announced its new super app, which facilitates bundling multiple solutions under one umbrella.

In this time of economic uncertainty, community banks also have an opportunity to remind their customers of their presence, value and stability. Through partnerships with robust solution providers and a keen focus on attending to customers’ desires, community banks can not only enhance customer loyalty but bring new customers into the fold.

Digital banking solutions remain a primary focus for ICBA, reflected in initiatives such as our renowned ThinkTECH Accelerator program, which we are bringing in-house in 2023. We’re excited to take the next step on this journey to build more comprehensive programming aimed at further addressing the emerging needs of community banks and the customers they serve.

Imagine the possibilities and embrace the opportunities before you. Seize the moment to explore innovation.

---

Charles Potts (charles.potts@icba.org) is ICBA executive vice president and chief innovation officer

The two-day summit included presentations on the metaverse, instant payments and more.

At this year’s ICBA LEAD FWD Summit, up-and-coming community bankers gathered from around the country to strengthen their leadership, technical banking and advocacy skills. The leadership conference hosted 26 speakers that helped attendees prepare for the future of banking.

---

---

---

---

---

---

---

---

Photo by Dragana Gordic/Adobe

Improving the small business loan experience is a great way to build new relationships and deepen existing ones. We spoke with industry specialists about the priorities for community banks as they build a digital loan process for small businesses.

By William Atkinson

---

Digital lending capabilities are quickly becoming table stakes, particularly when it comes to small business lending. It’s critical for community banks to have online loan applications, process automation staff skilled in digitization and more.

However, banks should first consider their customers’ needs and the infrastructure and features needed in a lending platform before adopting a new digital strategy.

Benefits of digital lending

“Today’s customer, whether consumer or small business, has become very comfortable and accustomed to anytime, anywhere self-service,” says Charles Potts, ICBA’s executive vice president and chief innovation officer. “The necessities of a digital-first approach were greatly magnified during the pandemic, with many banks having to close branches and rapidly adopt new digital technology to address the needs of the PPP [Paycheck Protection Plan] loan. Providing a digital lending experience and, at the same time, maintaining a unique relationship banking model is now a critical ‘must have’ for most community banks.”

According to Kevin Wilzbach, director of technology product management for Wolters Kluwer Compliance Solutions, providing digital lending opportunities helps community banks stay true to their mission by providing the best customer experience.

“Consumers have a growing expectation to interact with financial institutions via online and/or mobile services,” he says. “Digital lending is one specific area where community banks can improve customer satisfaction by reducing paper-intensive processes. Additionally, it allows community banks to retain existing small business customers while improving efficiencies.”

“There are numerous reasons to support a digital lending solution,” says Michael Haedrich, a senior product manager at Finastra. Doing so can help community banks:

• Optimize the loan cycle
• Offer the ability to speed up the entire process
• Make it easier to capture applicant information
• Make quicker decisions
• Ensure a more consistent lending process
• Provide convenience by offering its use across multiple devices
• Take advantage of analytics

According to Haedrich, it’s critical for community banks to offer digital signature as an option. “Not everyone wants to sign electronically, but it needs to be offered,” he says. “As our customer base changes, convenience becomes more critical, and electronic signature is synonymous with convenience.”

Offering a combination of digital, hybrid and paper closing options is also critical, according to Wilzbach. “This allows the lender to meet every client’s needs,” he says. “We believe having a flexible digital closing workflow will deliver the best borrower experience, while creating operational efficiencies for each participant throughout the lending ecosystem.”

“When you go digital, you open new opportunities that you may have found unprofitable in the past because of manual intervention.”
—Michael Haedrich, Finastra

According to Potts, the most important aspect to any digital lending solution for a community bank is making sure there is always a way for the customer to engage with the banker. “At all stages of the lending process, the customer must know there is a banker available to them whenever they wish,” he says. “While creating a frictionless, efficient and seamless experience is critical to the overall efficiency of a digital lending, there should never be any technology disintermediating the uniquely important relationship a community bank has with its customer.”

Rolling out digital lending

What strategies can community banks introduce to make their digital lending program as seamless and easy for small business customers as possible? “When you go digital, you open new opportunities that you may have found unprofitable in the past because of manual intervention,” says Haedrich. He says it can enable opportunities such as microloans in the range of $100 to $1,500, bundled products offered at point of sale and preapproved credit card offers when a customer applies for a loan.

“Banks can apply internal data to make preapproved offers that customers can accept online with a few clicks,” he says. “This is taking advantage of the analytics you now have access to because of your digital lending.”

It is also important to select a provider that offers digital solutions throughout the lending process, according to Wilzbach. “This will create a more seamless borrower experience and provide significant operational efficiencies to the lender,” he says. “Selecting a trusted provider with deep expertise in the digital lending space, and one that can provide solutions for all asset classes, is a huge benefit in helping simplify a lender’s digital transformation.

He adds that community banks should focus on solution providers that can handle all variations associated with a digital lending closing. “Lenders may be hybrid-oriented today or may need to support wet-sign options as necessary,” he says. “It’s important to look for solutions that support you across the digital lending landscape as your needs change.”

---

---

William Atkinson is a writer in Illinois.

Upside-down yield curve offers some possibilities.

By Jim Reber, ICBA Securities

---

Some rumors are true: There is an historical relationship between the phenomenon known as an inverted yield curve and a subsequent recession. This isn’t any idle talk among Fed watchers and other pundits this time around, nor is it peripheral to the management of financial institutions, including community banks.

Being the Master of the Obvious, I’ll point out the treasury yield curve has been inverted since July, often by as much as 40 basis points (0.40%). This presents dilemmas, and opportunities, for bond portfolio managers. And for those keeping score, every curve inversion in the past four decades has been followed by a recession within a year.

It occurs to me that the conversations my associates at Stifel and I have had recently with our customers have followed a pattern, driven by the interest rate cycle. Rates fall and the curve steepens, and bankers need reminding how to lock in yield and harvest gains. Rates rise and the curve flattens, and bankers want to know how to manage their unrealized losses. And then, the curve inverts, and it seems that everything we learned about risk/reward has gone haywire. So we will devote the rest of this column to discussing why curves invert and where value may appear in the various investment sectors that matter to community banks.

The what and why of inversions

When the Fed determines it’s time to begin raising rates, the most visible tool at its disposal is to increase the effective fed funds rate. Whenever the overnight rate increases, so do other shorter-term yields, which most analysts take to mean two years and less. Longer-term buyers, which include, but aren’t limited to, depositories, have wholly different investment objectives and risk tolerances. Long investment yields, the proxy for which are 10-year bonds, are more affected by inflation expectations.

Every Fed fund hike should, in theory at least, give longer buyers some added comfort that inflation will be well behaved. In a year like 2022, which has seen three full percentage points in rate hikes on the short end, we’re almost certain to see the curve flatten, and possibly invert. As investor sentiment by a number of measures now expects inflation to remain off its peak from earlier this year, the final component for a curve inversion has entered the mix.

Here’s the dilemma: If an inverted yield curve is a reliable predictor of an impending recession, and interest rates both short and long are going to fall soon, where should investors place their bets today? In theory, it should be on the long end, which leaves money on the table—today.

MBS, too

As we dig into the less-is-more narrative of upside-down curves, we can now add mortgage-backed securities (MBS) to the list, which is highly unusual. It is a rare condition indeed when shorter MBS out-yield longer ones, and this has to do with prepayment expectations. As home mortgage rates have doubled this year, anyone with an existing loan is going to sit tight and pay only the minimum amount of principal each month.

That means the lower rate pools will be longer in duration, and also lesser in yield, than more current ones. To put a pencil to it, a FNMA 15-year pool with a 4% stated rate will yield about 4% at the moment, whereas a 15-year 3% pool will produce about a 3.5% return. When we add that the 4% MBS is expected to be nearly a year shorter in average life, one can see why the “up in coupon” trade makes full economic sense in 2022.

Muni curve still steep

I need to mention that a sector that is quite important to community banks is not now, nor has it ever recently been, inverted. Tax-free munis appeal to many buyers, including individuals. In fact, most of that sector is owned by retail investors, whose needs (and marginal tax brackets) are different than your bank’s. Retail demand sets the yield curve for all muni buyers, and mom and pop tend to load up on short bonds, which keeps short yields under wraps.

As of October 2022, the investment-grade muni curve was positively sloped by about 70 basis points (0.70%) for C corps, and even more for S corps. This is proof that the municipal sector has a mind of its own. It is the least affected, for better or worse, by Fed activity.

Equal amounts of short- and long-term investments … will work out fine, if either a) the curve inverts further; b) the curve begins to steepen; or c) the curve remains flat.

Here’s a thought

So what do we make of all of this inversion business? The yield curve is on a 40-year winning streak of predicting slowdowns. It’s also clear that short yields have gotten to levels that can make some money for community banks, whose deposit costs have remained quite low. So how about this as a suggestion: a barbell structure.

Equal amounts of short- and long-term investments (you get to define those limits) will work out fine, if either a) the curve inverts further; b) the curve begins to steepen; or c) the curve remains flat. And I’d say there’s a good chance of one of those results occurring. So my advice (no surprise here!) is to invest at different parts of the curve, in a variety of products. And you can leave the tumult of the yield curve’s shape to the pundits.

---

Jim Reber, CPA, CFA (jreber@icbasecurities.com), is president and CEO of ICBA Securities, ICBA’s institutional, fixed-income broker-dealer for community banks