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ABA Stonier Graduate School of BankingCapstone
Managing a Bank Securities Portfolio
By: Derek J. LaurSenior Vice PresidentParkside Financial Bank & Trust
March 1, 2018
Table of Contents
1. Executive Summary 3
2. Introduction and Background 5
3. Strategy/Implementation 10
4. Financial Impact 27
5. Non-Financial Impact 43
6. Conclusion 48
References 50
Appendix A: UBPR Reports: Parkside Financial Bank & Trust and Peer Group Averages
Appendix B: Business Model Peer Group Analysis Appendix C: Stifel Nicolaus & Co. “Unlocking the Secrets of High Performance Bank
Portfolios”
Appendix D: Parkside Financial Bank & Trust – Investment Policy
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Executive SummaryParkside Financial Bank and Trust is a commercially-focused community bank and trust
company located in Clayton, MO. Founded in April of 2008, the Company operates out of a
single location with a relationship-based approach and a focus on locally owned commercial and
industrial businesses. Total assets, deposits, and loans for the Bank as of June 30, 2017 were
$424 million, $301 million and $347 million, respectively. In addition, Parkside’s trust division
now reports in excess of $1 billion in assets under management.
Like virtually all banking institutions, Parkside’s balance sheet includes a securities
portfolio comprised of various bonds which serve as a less risky and more liquid alternative to
loans; but which generate greater interest income than holding cash. The Bank’s securities
portfolio is relatively small at around ~$26 million as of June 30, 2017 and representing ~6% of
the Bank’s total assets. By comparison, peer group bank balance sheets report average securities
portfolios of around 18% of total assets.
In terms of income generation, Parkside’s securities portfolio generates less than 3% of
the Bank’s total interest income– significantly less than peer group averages. This fact can be
largely attributed to the relative portfolio size differences (as noted above), however, the yield on
Parkside’s portfolio also trails that of its designated Business Model peer group with an LTM
yield of 1.69%, vs. 2.72% for the peer group. This 103 bps difference in yield is likely due to a
combination of differences in asset allocation and duration, and would equate to $267M of
additional annual interest income were Parkside’s portfolio yield to match that of the peer group.
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The goal of this Capstone Project will be for the writer to assume responsibility for
ongoing management of the portfolio and implement a more strategic approach to the process in
an effort to improve yields, manage risk, and ultimately grow the portfolio over time. While
there is no single “optimal” portfolio allocation or management methodology, there are
characteristics of the portfolio compositions of peer group institutions which could be imitated
and utilized in managing Parkside’s portfolio. In addition, a long-term bank security portfolio
performance study by Stifel Nicolaus & Co showed that for banks of between $100 million and
$500 million of assets, top quartile portfolios outperformed bottom quartile portfolios by 1.95%
per year (which would equate to more than $500M of additional interest income when applied to
the Bank’s ~$26 million portfolio).
The recommendations found herein are made in attempt to incorporate findings from
both the peer group analysis and Stifel performance study (in addition to conversations with
Bank management, the writer’s Capstone advisor, Paul Ratterman, and 3rd party advisors) to
make a recommendation of near-term changes to the portfolio in an attempt to both grow the
portfolio (to a total of $35 million) and also more closely align the portfolio with those of the
higher performing institutions. Based on market rates as of the time of this writing, the impact of
such a strategy would increase the annualized interest income by more than 50% - from
approximately $500M today, to $785M going forward. And given that approximately $16
million of the Bank’s portfolio (~60% of the total) will mature between 6/30/17 and 12/31/2018,
the opportunity now exists to reposition the portfolio as securities mature and thus avoid the
impact of any capital gains or losses which could arise from the sale of securities.
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Introduction and BackgroundParkside Financial Bank & Trust (“Parkside,” “PFBT,” “Bank,” or “Company”) was formed in
mid-2007 and raised approximately $21MM in capital through year-end 2007 in anticipation of
de novo in early 2008. The Company’s banking charter was granted in April 2008, and business
operations began on April 23, 2008. Parkside operates from a single location in Clayton, MO,
which is located approximately 10-miles west of downtown St. Louis and is the county-seat for
St. Louis County.
Parkside offers a range of commercial banking, trust, and family office services to privately
held businesses, their owners and families, as well as high net worth individuals – primarily in
the St. Louis MSA. Services are provided through two main operating divisions: the
Commercial Banking division and the Trust and Family Office (“TFO”) division. While
Parkside does offer consumer depository services (e.g. personal checking accounts, CDs, etc.), it
does not provide consumer lending services of any kind (e.g. residential mortgages, HELOCs,
personal loans, etc.). The Company operates with a relationship-based approach intended to
provide outstanding service to its clients by providing them with on-demand access to
relationship managers and senior management who, in turn, provide fast response times to the
clients. This strategy is part of a comprehensive “fewer-but-larger”, high margin and revenue-
per-client focus.
The Commercial Banking division focuses its marketing and calling efforts on privately held
Commercial and Industrial (“C&I”) businesses in the greater St. Louis MSA and provides
depository, treasury, and commercial lending services to privately held companies. The Bank
also finances a significant amount of owner-occupied real estate (often related to operating
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companies which bank with Parkside via common ownership) and has a relatively small
portfolio of commercial real estate loans (mostly stabilized industrial/warehouse and multi-
family properties).
The Commercial Banking and senior management teams are comprised of individuals with
significant experience in the C&I space who strive to provide lending and treasury management
capabilities comparable with much larger financial institutions, while maintaining a relationship-
based approach to lending often associated with community banks. A typical lending
relationship for PFBT would be between $1 million and $7 million in borrowing needs, and the
majority of the Bank’s clients generate between $5 million and $50 million in annual revenues.
Parkside does not have a specific industry focus and the majority of the loan portfolio
consists of banking relationships with manufacturing, distribution, and service companies. In
addition, the Bank also has a significant portfolio of leveraged finance assets resulting from
relationships with a handful of private equity firms based both in St. Louis and around the U.S.
As of 6/30/2017, Parkside’s commercial loan book totaled $347 million.
The TFO division provides a fee-based approach to wealth management and focuses its
calling efforts on high net worth individuals (primarily in the St. Louis MSA) with a particular
focus on business owners who have the majority of their net worth tied up in illiquid privately
held businesses. In addition to traditional asset-management / investment management services,
Parkside’s TFO advisors work with clients to strategically position themselves to maximize
liquidity events (i.e. sale of their business) when they do occur. This is accomplished through
extensive consultation for things such as: asset titling, insurance needs, estate planning,
establishing trusts, and tax planning.
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The logic behind the TFO’s strategy is two-fold: (1) individuals with significant
concentration in illiquid assets are not typically pursued by more traditional wealth management
firms which focus primarily on investment management (which makes Parkside’s TFO services a
bit unique); and (2) this strategy marries extremely well with the Bank’s focus on the C&I space,
whereby business owners who make banking decisions for their companies also frequently have
a significant portion of their net worth tied up in their companies. Parkside has had significant
success to-date in crossover marketing to clients of both divisions: the Bank now maintains more
than 80 relationships (defined as a client which produces in excess of $2,000 in annual revenue)
which are clients of both the Commercial Banking division and the TFO division.
In addition to primary day-to-day responsibilities as a commercial banking relationship
manager, the writer also currently serves as the chair of the Bank’s ALCO committee, which
oversees the ongoing management of Parkside’s balance sheet. Other members of the committee
include the Bank’s CEO, CFO, President and COO. ALCO meetings are also generally attended
by the Bank’s senior credit officer, commercial banking RM’s, and a handful of other bank
officers and support staff. Historically, securities purchases have been directed by the Bank’s
CEO in a largely ad hoc manner through broker/dealers (primarily Sandler O’Neil and Stern
Brothers). In addition, Parkside utilizes a 3rd party custodian and consultant – Detalus Advisors
– who assist with price discovery and execute securities trades on the Bank’s behalf.
Through the implementation of this project, the plan is to transition the ongoing
management of the securities portfolio into the purview of the writer. As part of this process, the
ALCO committee will be fully informed as to the proposed strategy for the portfolio and will be
updated quarterly (at minimum) as to the condition and yield of the portfolio, the state of the
interest rate environment, and any opportunities or risks which have been identified. By
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incorporating the ongoing management of the portfolio into regularly scheduled ALCO
meetings, the hope will be to institutionalize the strategy in such a way that it is no longer being
driven solely by a single individual. This should provide greater insight for the entire
management team and also allow for input from individuals who aren’t active participants in the
portfolio management process.
As of 6/30/2017, Parkside’s balance sheet has grown to $424 million in total assets, with
$347 million in total loans and $301 million in client (non-wholesale) deposits. Total assets
under management for the TFO division now exceed $1 billion, and the Company’s YTD net
income was ~$2.6MM – an ROAA of 1.24%. Parkside’s balance sheet regularly reflects total
loans to deposits ratios in excess of 100% and total loans to total assets in excess of 80% (as was
the case at 6/30/17). While relatively high as compared to most community banks of similar size
(see Strategy/Implementation section below for greater detail), these ratios are driven largely by
the Bank’s single location and commercially focused business model (and are expected to remain
in a similar range going forward). With loans comprising a larger than average portion of the
balance sheet, the securities portfolio has historically been relatively small – generally occupying
between 5% and 10% of total assets). As of 6/30/17, the securities portfolio was $26 million in
aggregate – 6.3% of the Bank’s total assets.
The primary focus of this capstone project is to create a high-level framework for managing
and growing the securities portfolio in a calculated attempt to: improve the weighted-average
yield in the portfolio (thus increasing contribution margin to the Bank’s earnings), while
simultaneously managing various forms of risk that the portfolio poses to the balance sheet. Such
framework will include an analysis of the portfolios of peer group institutions and will ultimately
drive the process of determining the appropriate allocation for the portfolio given the nature and
9
composition of Parkside’s balance sheet. Ultimately, the goal of both this project, as well as the
ongoing portfolio management moving forward, is to generate the greatest yield possible while
simultaneously quantifying and minimizing risk.
10
Strategy/ImplementationLike most community banks, Parkside’s earning assets fall into three primary categories:
cash/equivalents, securities, and loans. Accordingly, the securities portfolio serves as an
alternative to holding cash or funding loans, and performs three primary functions: preservation
of capital (securities are generally safer than loans), liquidity (securities are generally easier to
sell than loans) and income generation (while lower than loan yields, securities typically provide
higher yields than holding cash). While the relative size of a portfolio varies by institution,
securities portfolios are typically the 2nd largest component of a community bank’s earning assets
behind loan portfolios. This being the case, income generated by the securities portfolio is an
integral component of most banks’ overall net interest income (“NII”). At Parkside, however,
the securities portfolio has historically functioned mostly as a de facto holding place for non-
seasonal excess liquidity (as opposed to being viewed as an important piece of the Bank’s
revenue generating capabilities) and totals ~$26 million in size as of June 30, 2017 (~6.3% of
total assets). As a result, the portfolio has been conservatively allocated – i.e. it has consisted
mostly of securities which are both: relatively short in duration (i.e. ~2 years) and reliably liquid.
In addition, Parkside’s portfolio is relatively small which – as noted above – results from the fact
that the Bank’s loan portfolio (as a percentage of total assets) is significantly larger than peer
averages (see peer comparison analysis below for details).
For these reasons, the securities portfolio has never been a significant focus of Parkside’s
senior management, nor has it historically provided a meaningful contribution to the Bank’s
interest income (for the first half of 2017, the securities portfolio generated $223M of interest
income, which comprised only 2.6% of the Bank’s $8.5 million of total interest income). With a
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maturing balance sheet approaching $500 million in total assets, senior management now
acknowledges that a properly managed and growing securities portfolio presents an attractive
opportunity to provide a boost to the Bank’s NII1. Conversely, a loosely managed and growing
securities portfolio would result in a greater amount of unintended risk to the balance sheet and /
or earnings. It should also be noted that additional yield from the securities portfolio is highly
accretive to the Bank’s bottom-line as it requires significantly less overhead to manage than a
commercial loan portfolio of comparable size.
While there isn’t any singular “right” or “wrong” way for a bank to manage its securities
portfolio, a comprehensive 12-year study by Stifel Nicolaus & Co. showed that - for banks of
between $100 million and $500 million in total assets - bank portfolios in the top quartile of
performance outperformed those in the bottom quartile by 1.95% per year: 4.57% total annual
returns for the top quartile vs 2.62% for the bottom quartile (the Stifel Nicolaus & Co study is
called Unlocking the Secrets of High Performance Bank Portfolios and is included hereto as
Appendix C for reference). This difference equates to an additional $19,500 in annual income
for every $1 million of securities owned. For Parkside, a 1.95% improvement in yield would
result in more than $500,000 in additional annual yield on its existing $26 million portfolio
which would provide a boost of nearly 10% to projected 2017 earnings of ~$5.5 million. While
such a dramatic difference in yield will be difficult to achieve in the near term (particularly in
light of the current interest rate environment), it is quite apparent that returns generated from a
1 Assuming the Bank’s balance sheet continues to grow in a manner consistent with past trends, the securities portfolio will have capacity to increase in size without consuming a greater portion of the Bank’s liquidity or occupying a larger piece of the Bank’s balance sheet. Management’s 3-year plan for the 2017-2019 timeframe shows the securities portfolio growing by ~$5 million per year, to a total of ~$40 million as of 12/31/2019 (estimated to be ~7.1% of total assets).
12
well-managed securities portfolio can be a significant factor in a bank’s overall financial
performance.
Given the above, this project will include an examination of the various types of
securities available for inclusion in the portfolio and compare the relative size and asset mix of
Parkside’s existing portfolio in relation to peer banks (note that the peer bank analysis will
include both the FDICs UBPR2 peer group as well as a Business Model3 peer group). The
project will also include an analysis of recent portfolio performance metrics as compared to the
Business Model peer group; as well as to a set of general attributes of higher performing
portfolios found in Stifel’s long-term performance study. This information can then be analyzed
within the context of the Bank’s investment policy (Appendix D), balance sheet composition,
and the current interest rate environment in an effort to better position the portfolio in the near
term and improve the portfolio’s contribution to NII going forward.
Security Types and Issuer Sectors
According to SIFMA’s4 2017 Fact Book, the United States fixed income market is
approximately $39.3 trillion in size and with a virtually limitless range of fixed-income issuances
available for investment. Banks, however, typically invest in securities which fall into one of six
2 Peer group average information taken from the FDIC’s UBPR Peer Group Average Report for commercial banks of $300 million to $1 billion in assets. Full balance sheet info for both Parkside and the Peer Group can be found in Appendix A.3 Parkside’s management team selected the “Business Model” peer group a number of years ago by applying four criteria to the ~7,800 banks chartered in the USA at that time: assets of between $200 million and $1.5 billion, trust revenue equal to at least 0.25% of bank assets, minimum 20% of the loan portfolio is composed of C&I loans (or, C&I loans plus owner-occupied real estate loans total at least 40%), and a minimum of 5% average annual growth in both loans and assets for either the prior 3 or 5-year periods. At the time they were selected, only 16 banks fit eachof these criteria and are thus used by the Bank’s management for comparison purposes when reviewing various bank performance metrics. See Appendix B for a full Business Model peer group analysis (including a list of institutions included in the analysis) as prepared by Stifel Nicolaus & Co.4 Securities Industry and Financial Markets Association
13
general categories or asset classes – each of which denotes a specific type of issuer and carries its
own attributes and associated risks. Following is a list of these asset classes followed by a short
description of each (descriptions are paraphrased and taken from a number of publicly available
resources – including FINRA5’s bond tools and education resources and Investopedia.com):
- US Treasury Securities: direct obligation of the U.S. government and thus carry the
highest possible credit quality with interest earned on US Treasuries exempt from state
and local taxes. These securities are considered to be “riskless” from a repayment
perspective and are thus used as the industry benchmark off of which other securities are
priced.
- Government Agency Securities - issued by US government agencies and/or Government
Sponsored Enterprises (“GSEs”) such as Ginnie Mae, Fannie Mae, Freddie Mac, the
Farm Credit Administration and the Federal Home Loan Bank. While not direct
obligations of the US government, these securities carry the second highest credit quality
and are backed (either explicitly or implicitly) by the US government.
- Municipal Bonds - issued by state and local governments, these bonds can be either
taxable or tax exempt. Municipal bonds can also be general obligation bonds, which are
backed by the full balance sheet of the issuing municipality (and thus carry the credit
rating of the issuer), or revenue bonds, which finance income-producing projects and are
thus secured by income produced by the project with credit ratings based on the risk of
the cash flows associated with the project.
- Corporate Bonds - issued by corporations with credit quality tied to the credit rating of
the issuing entity and the seniority of the specific security relative to other obligations of
5 Financial Industry Regulatory Authority
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the issuer. Generally speaking corporate bond issues are unsecured obligations of the
issuer, however, collateralized corporate bonds do exist in some instances
- Asset-Backed Securities - “ABS” represent a pro-rata ownership interest in a pool of
loans – often originated by an unrelated 3rd party (or parties). These pools may include
assets such as: student loans, credit card receivables, home equity loans, automobile
loans, etc. Because of this structure, ABSs pass through both principal and interest
payments as they are received from borrowers of the underlying loans6. Prepayments can
– and often do – occur as borrowers refinance, sell assets, prepay principal, etc. As a
result, ABSs generally include both a final maturity and an average life calculation which
attempts to estimate the expected prepayment rate of the underlying loans based on
historical prepayment rates. Credit ratings of ABSs are based upon the credit quality
(e.g. credit scores, loan-to-value, etc.) of the underlying loans.
- Mortgage-Backed Securities – “MBS” are a specific type of ABS and represent pools of
loans secured by real estate mortgages. A MBS can include either residential or
commercial mortgages and MBSs are often issued by U.S. Gov’t Agencies (Fannie Mae,
Freddie Mac, et al). When issued by an Agency, MBSs will carry the credit rating of the
issuer – otherwise the security’s credit rating will reflect the aggregate credit quality of
the underlying mortgage loans.
The following table reflects the relative sizes of each of these security types as a percentage
of the entire ~$40 trillion U.S. fixed-income market:
6 As a result of this feature, ABS securities are often colloquially referred to as “pass-through” bonds.
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Treasury securities are by far the largest category – consuming more than a third of the
entire market. Mortgage related and corporate securities each roughly comprise another quarter
of the market, and the other four categories combine for around 20%.
Bond Attributes and Corresponding Risks
Generally speaking, there are five primary attributes of a security – regardless of which class of
issuer it falls under – which ultimately determine its price and corresponding yield. These
attributes also correspond to specific risks associated with each security:
- Credit quality – reflects the creditworthiness of a particular bond, with relative credit
quality often expressed via ratings provided by third party rating agencies such as
S&P or Moody’s.
- Liquidity – the extent to which a security can be bought or sold without materially
impacting its price. The larger the market for a security, the greater the liquidity.
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- Duration – in its simplest form, duration is a measurement of how long (in years) it
will take for the price of a bond to be repaid by its internal cash flows. There are a
number of different methodologies for calculating duration given a specific bond’s
attributes; however, generally speaking duration is a reflection of a bond’s estimated
price sensitivity to a change in interest rates. In most cases, bonds with greater
durations will exhibit greater price volatility (all other things being equal).
- Optionality – refers to the structure of a security which allows the issuer or owner to
take some action with respect to the other party. Callable bonds are the most
common form of optionality.
- Convexity – a measure of the non-linear relationship of bond prices to changes in
interest rates. Whereas duration reflects a linear measurement of interest rate
sensitivity, convexity accounts for the curvature of the relationship between a bond’s
price and its corresponding yield. Convexity is often used in tandem with duration to
offer an approximation of the percentage of price change resulting from a change in
yield.
Each of these specific attributes can apply to a bond of any asset class and presents a specific
set of potential risks. A bond with a lower quality credit rating, for example, has a higher risk of
default and potential for a missed interest payment or loss of principal. A bond’s liquidity is
generally a reflection of the overall size of the market for that particular security and a relatively
illiquid bond may be difficult to sell in a short timeframe without taking a significant discount
due to a wider bid/ask spread. Generally speaking, bonds with higher duration will have greater
fluctuations in price than bonds with lower duration and thus greater susceptibility to unrealized
gains or losses as interest rates move and the shape of the yield curve changes over time.
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The most significant focus for PFBT will be on liquidity and duration. Keeping at least a
portion of the portfolio highly liquid is necessary as it may be needed to fund other cash needs
that could arise through the course of business. While Parkside generally holds more on-balance
sheet liquidity than its peers (see Peer Balance Sheet Analysis section below for additional
details) and securities have not historically been proactively sold to meet liquidity obligations,
the portfolio does remain an important component of the Bank’s back-up liquidity funding
sources. Having said that, some portion of the portfolio can likely be carved out for less liquid
instruments which may offer a more attractive yield. Today, ~65% of the Bank’s overall
portfolio is held in highly liquid Agencies or ABS securities with underlying loans backed by
government agency guarantees, and the majority of the Corporate securities are from issuers
which carry sizable markets for their obligations (e.g. American Express, JP Morgan, Goldman
Sachs).
Duration is also a primary consideration for the Parkside portfolio – particularly given the
current state of the yield curve and likelihood of a higher interest rate environment in the future.
Management has intentionally positioned the Bank’s balance sheet to be asset sensitive (i.e.
assets will reprice faster than liabilities as interest rates change) in order to benefit from
anticipated interest rate increases. Not only would adding duration to the portfolio reduce the
Bank’s asset sensitivity, it would also likely result in unrealized losses to the portfolio in a rising
rate environment. As such, adding additional duration to the portfolio must be considered
carefully and balanced against the potential for downside risk. As of 6/30/2017, the Bank’s
portfolio reflected average duration of 2.39 years.
While credit quality is obviously important, the Bank’s investment policy (Appendix D)
requires that all securities be investment grade (generally defined as having a BBB- or Baa3
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rating or higher by S&P or Moody’s, respectively) which means that a default on any individual
security is relatively unlikely. When applicable, optionality will be evaluated and included in the
analysis of a security under consideration for the portfolio, however, in many cases the risks
imposed by optionality apply mostly to when a security is repaid (i.e. whether or not a call option
is exercised) rather than exposing the Bank to potential losses of principal due to a lack of
liquidity or unrealized losses resulting from a higher interest rate environment. Having said that,
any optionality affecting yield (e.g. bonds converting from fixed to floating or vice versa) will
certainly be weighed against potential risks as well.
Peer Group Balance Sheet Analysis
As noted above, Parkside’s securities portfolio totaled ~$26 million in assets as of June
30, 2017, which represents 6.2% of the Bank’s total assets of $424 million. By comparison,
UBPR peer group banks have securities portfolios representing an average of around 18% of
total assets and thus comprise a much more significant portion of an average community bank’s
earning assets. Additionally, the “Business Model” peer group also reflects average securities
portfolios comprising 19% of total assets, meaning that both peer groups hold average securities
portfolios that are approximately three-times the relative size of Parkside’s portfolio.
The following tables illustrate these differences, and compare Parkside to the peer group
averages in each earning asset category (note that each of these items is reflected as a percentage
of total assets):
Parkside 6/30/2017 6/30/2016 12/31/16 12/31/15Cash7 9.51 10.74 12.15 12.30Securities 6.15 5.97 6.07 6.48Net Loans & Leases 79.89 80.62 78.85 78.46Securities + Loans 86.04 86.59 84.92 84.94
7 “Cash” includes both cash deposits held at other financial institutions, as well as Fed Funds sold.
19
UBPR Peer Group Average 6/30/2017 6/30/2016 12/31/16 12/31/15Cash 4.76 4.77 4.81 4.85Securities 17.92 18.47 18.29 19.30Net Loans & Leases 68.17 67.25 67.51 66.17Securities + Loans 86.09 85.72 85.80 85.47
Business Model Peer Group 6/30/2017Cash 4.54Securities 19.08Net Loans & Leases 69.70Securities + Loans 88.78
As shown above, there are significant differences between Parkside and both peer groups
in terms of balance sheet composition. In round number terms, both peer groups average around
5% cash, 69% loans, and 18% securities, whereas Parkside averages around 10%, 80% and 6%,
respectively. The sum of securities and net loans was fairly consistent across Parkside and both
peer groups at between 86% and 89%; however, Parkside holds ~80% of its assets in the form of
loans vs. ~69% for the peer groups, which explains the difference in relative size of the securities
portfolios. It is also worth noting that Parkside also carries nearly double the on-balance-sheet
liquidity as the peer groups (~10% vs. ~5%).
The differences in balance sheet composition are largely a function of Parkside’s single
location and commercial lending-focused business model. The organization and its personnel
are primarily tasked with growing and managing the Bank’s commercial loan portfolio. While a
loan portfolio requires more staffing capacity and overhead cost to service than a comparable
securities portfolio, management believes that the higher yields generated from a quality loan
book will more than offset the additional overhead. As a result, Parkside has always – and is
likely to continue to – hold a higher than average portion of its total assets in the form of loans.
As it relates to the differences in average on-balance sheet liquidity, Parkside’s apparent
excess liquidity is both intentional and reflective of the Bank’s client mix on both sides of its
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balance sheet. On the asset side, the Bank’s C&I focused lending operations result in a
significant portion of the loan portfolio being comprised of revolving lines of credit to operating
companies (as of 6/30/2017, commercial line of credit balances comprised ~40% of the Bank’s
total outstanding loan portfolio). Due to their revolving nature, line of credit balances can swing
significantly from day-to-day or month-to-month with borrowers making frequent draws and pay
downs. On the liabilities side of the balance sheet, the majority of Parkside’s deposits are
generated by operating accounts of the Bank’s commercial clients. As is the case with lines of
credit, these account balances often increase or decrease over relatively short periods of time and
typically decrease in lockstep with increasing line of credit balances (thus doubling the liquidity
impact on the Bank’s balance sheet). It is important for the Bank to be able to absorb these
swings in line of credit and deposit balances, and thus Parkside carries nearly double the industry
average in on-balance sheet liquidity8. With loans and on-balance sheet liquidity averages for
Parkside being higher than peer group norms, less of the balance sheet is available for holding
securities.
Peer Group Securities Portfolio Analysis
The following table and corresponding graphs illustrate the composition of the PFBT securities
portfolio as compared to the Business Model peer group as of 6/30/2017:
8 In addition to on-balance sheet liquidity, Parkside also utilizes significant wholesale funding sources which can provide the Bank with off-balance sheet liquidity. As of June 30, 2017, the Bank had $23 million of outstanding fundings (i.e. loans) from the Federal Home Loan Bank, with an additional $47 million of borrowing availability. The Bank has also issued ~$47 million in Brokered and Rateline CD’s resulting in ~$70 million of total wholesale fundings. In aggregate, these fundings represent ~17% of total assets vs. a policy maximum of 35%. As such, the Bank could effectively double the amount of funding it is currently utilizing from wholesale sources and remain within policy guidelines.
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*High performing and Low performing metrics above represent the 1st and 4th quartiles of the Business Model peer group, respectively, as measured by return on average equity.
As shown above, Parkside’s existing portfolio currently includes securities from only
three asset classes: ABS, Agencies, and Corporate securities (reflected in the graph above as
“Other Debt Secs”). By comparison, the Business Model peer group includes a more diverse
collection of securities, including significant holdings in Municipals and RMBS (38% and 35%,
respectively), minimal Corporate securities (5% of Other Debt Secs), and 0% in the ABS
category. Parkside management notes that there has never been a philosophical aversion to
adding Municipal or RMBS securities to the portfolio – to the contrary, management has in fact
indicated that they would be very interested in specifically adding some exposure to Municipals
– however, the extended durations common to both of those asset classes have made it difficult
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to find any securities which met Parkside’s desire to remain on the shorter end of the yield
curve9.
In terms of income generation, the following table reflects Parkside’s portfolio income
and yield as compared to the Business Model peer group:
Through June 30, 2017, Parkside’s portfolio generated YTD and LTM interest income of
$223M and $434M, respectively. These amounts equate to 2.59% of the Bank’s total interest
income for those respective time periods. By comparison, the Business Model peer group
banks’ portfolios are generating, on average, 12.59% of their respective total interest income.
The significant difference is likely driven primarily by the relative differences in portfolio size
when comparing Parkside’s portfolio to the Business Model peer group, however, the table
above also shows that the peer group’s portfolios were generating an average yield of 2.72% as
of June 30, 2017, which is 103 bps greater than Parkside’s LTM yield of 1.69%. Converting this
103 bps difference to income equates to $267M of additional annual interest income when
applied to Parkside’s existing $26 million portfolio.
9 Both Municipal and RMBS securities tend to be relatively long-term at initial issuance (i.e. 10+ years) which is a reflection of the long-term nature of the underlying assets financed by the bonds (i.e. capital improvement projects for Municipals and residential homes in the case of RMBS securities). Discussions with management and Parkside’s representative with Detalus also reveal that Municipal bonds and RMBSs are frequently purchased by banks at initial offering with the intention of holding to maturity – which makes it difficult to purchase them once they roll down the yield curve (since there is not a lot of product available for purchase).
23
While the relative differences in portfolio composition noted previously do not take into
account average duration within the portfolios (longer average durations could be the primary
reason for the higher yielding portfolios of the Business Model peer group), they do illustrate
that banks within the Business Model peer group are generating significantly higher yields from
their portfolios, and are doing so while primarily investing in asset classes not found in the
Bank’s portfolio. The Financial Impact section below includes a more comprehensive analysis
of the Bank’s existing portfolio along with a comparison to the portfolio composition of higher
performing portfolios from Stifel’s long-term study. This analysis is then used to create a sample
“pro forma” portfolio which attempts to incorporate some of the attributes of higher performing
portfolios into a re-balancing of the Bank’s portfolio.
Strategic Conclusion
As discussed above, Parkside is somewhat dissimilar from peer group averages in terms
of both balance sheet and securities portfolio compositions. Understanding the reasons why will
be an important consideration for making recommended changes to the securities portfolio in an
attempt to improve its overall yield, while minimizing additional risk to the Bank’s balance sheet
and/or earnings. In terms of how the Bank’s balance sheet construction impacts a logical
strategy for securities portfolio management, two differing philosophies could be cogently
argued:
- With a larger portion of the Bank’s assets comprised of loans (which are generally riskier
than securities), the securities portfolio should be positioned more conservatively than a
peer group average to balance out the overall risk profile of the Bank’s balance sheet. In
addition, a smaller than average securities portfolio will inherently be a smaller
24
contributor to the Bank’s NII than a more typically sized portfolio and thus the lower
yield of a conservatively structured portfolio would have less impact to earnings.
- Conversely, a portfolio occupying a smaller-than-average portion of a balance sheet will
inherently have less of an impact on the Bank’s earnings or balance sheet simply as a
function of relative size. Shifting portfolio values due to changing interest rates will have
a smaller impact to the Bank’s net equity position, so an argument could be made that a
smaller portfolio could be positioned more aggressively than a typical portfolio, simply
because the impact of the downside risk is less meaningful to the Bank’s overall
profitability or balance sheet equity position.
For the purposes of this project, the writer will argue for a moderately more aggressive
positioning of the portfolio in an effort to improve its weighted-average yield and income
generation. The argument for moving into a more aggressive posture is supported by the
following:
- Parkside’s balance sheet is currently in an asset sensitive position which means that rising
interest rates (which are likely to negatively impact the values of fixed-rate assets in a
securities a portfolio) would have an overall positive effect on the Bank’s profitability. A
more aggressive allocation of the portfolio (to potentially include extending the overall
duration) would allow the Bank to increase its interest income in the short term and
would also serve as a bit of a hedge against the continuation of the current prolonged
period of depressed interest rates. And if/when rates do begin to rise as anticipated, the
Bank would still stand to benefit overall (as it would remain in a net asset sensitive
position were the proposed allocation changes to be implemented) – primarily due to the
25
amount of floating-rate assets in its loan portfolio and non-interest bearing commercial
demand deposits.
- The portfolio is already allocated in a fairly conservative manner with an average
duration of only 2.39 years as of 6/30/2017. As such, proposing a conservative allocation
going forward is unlikely to look materially different than the existing allocation in terms
of weighted-average yield or duration.
- The Bank’s asset quality is currently strong with $0 in non-performing loans or OREO10
and a loan loss reserve (“LLR”) equal to 1.40% of total assets as of 6/30/2017, compared
to a UBPR Peer Group average of 0.87%. Because of this, the writer would argue that
Parkside’s balance sheet is well-positioned to absorb a moderate degree of asset quality
degradation within the loan portfolio without causing a significant disruption to earnings
or the balance sheet. As such, there should be some capacity to add a degree of risk to
the securities portfolio without causing overwhelming concern as to the potential
negative impact of a steepening yield curve.
Ultimately, the goal will be to try and find a “best both worlds” scenario and construct a
portfolio which takes on some risk (in return for higher yield), but is done so in a calculated way
so as to quantify and minimize the downside. While creating a perfect allocation is practically
unachievable, the Stifel Nicolaus study of high performing bank portfolios does reveal that there
are some shared characteristics of highly performing portfolios regardless of interest rate
environment. As such, the proposed pro forma portfolio included below will attempt to
incorporate some of the characteristics reflected in the Stifel study, while balancing the reality of
10 OREO = Other Real Estate Owned. Assets in this category generally denote real estate assets which are on a Bank’s balance sheet due to foreclosure or other form of repossession as a result of non-payment and/or underperformance on the part of the Borrower.
26
Parkside’s balance sheet construction and limitations imposed on the portfolio by the Bank’s
investment policy.
27
Financial ImpactThe purpose of the Financial Impact section will be to evaluate the potential impact to revenue
from improved returns in the securities portfolio. In addition, it will also include a specific
rebalancing strategy for the management of the Bank’s existing securities portfolio, and estimate
the potential increase to earnings that such an exercise would be likely to generate. Given the
readily quantifiable nature of securities yields, calculating the difference in income generation
between the Bank’s existing securities portfolio and a theoretical, or, “pro forma” portfolio is a
relatively straightforward exercise.
Further, adoption of the recommendations made herein regarding management of the
portfolio (including increasing the total size) would not require any cash investment in additional
infrastructure or overhead. And while one could argue that there could be lost opportunity cost
to the Bank given the potential for distraction from the writer’s primary responsibilities as a
commercial lender, the actual ongoing time commitment for portfolio management is expected to
be relatively insignificant once a more clearly defined strategy is implemented. As such, the
financial impact to the Bank in this instance is essentially just the difference in annualized
income generation when comparing Parkside’s existing portfolio to a pro forma portfolio.
In light of the factors noted above - and given the fact that a more significant projected
financial impact might seem more likely to be implemented by senior management - it could be
tempting to create a pro forma portfolio which prioritizes current yield over prudent balance
sheet and risk management practices. This would be a fairly simple way to “maximize” the
financial impact of such an undertaking and could be done in a number of ways (e.g. adding
significant duration and/or materially reducing the liquidity or credit quality of the portfolio).
28
To the contrary, however, the goal of this project will be to present a pro forma portfolio which
accomplishes the following: (a) reflects a realistic allocation of securities and corresponding
yields as they exist in the market today, (b) remains compliant with all of the Bank’s Investment
Policy guidelines and limitations, (c) fits within the Bank’s overall balance sheet management
strategy, and (d) incorporates some of the asset types and strategies found within higher-
performing portfolios highlighted in the Stifel bank performance study.
While such a strategy is likely to result in a less significant positive financial impact to
the Bank in the short-term (as compared to a more aggressive positioning of the pro forma
portfolio which could have negative long-term consequences), it is anticipated that many of the
recommendations made herein will be adopted by the Bank and used to guide real-world
portfolio decisions moving forward. As such, it is imperative that any strategy proposed herein
be made with a long-term vision of the portfolio management, as opposed to attempting to
maximize immediate financial impact as window-dressing for an academic exercise.
In light of the above, this section will be broken into four sub-sections below: (1) an
examination of the Bank’s existing portfolio, (2) a summary of strategies employed by banks
with higher performing portfolios (as identified by Stifel in its long term study) along with an
analysis as to the suitability of those strategies as it relates to Parkside, (3) a hypothetical pro
forma portfolio as of December 31, 201811, and (4) a comparison of the existing and pro forma
portfolios, including differences in annualized revenues. Information provided for both the
existing and hypothetical portfolios includes: Book Value, Identifier, Issuer Name, Credit
11 December 31, 2018 was chosen as the date for the pro forma portfolio to allow a realistic amount of time for portfolio rebalancing. With a significant portion of the portfolio set to mature in 2018, using year-end 2018 as a target date allows for rebalancing to occur as part of replacing existing runoff and avoid potential gains/losses associated with selling bonds from the portfolio.
29
Rating, Coupon, Maturity, Price, Market Value, each bond’s respective size relative to the total
portfolio, Yield-to-Worst12, Modified and Effective Duration13, Convexity and Book Yield. In
addition, bonds are grouped by issuer type (i.e. corporate, agency, etc.) with sub-totals by group
and references to policy maximums as allowed by the Bank’s Investment Policy (included as
Appendix A, below).
Existing Portfolio – June 30, 2017
12 Yield-to-Worst represents a “worst case scenario” for the holder of a security and incorporates the potential downside of certain optionality features such as call or prepayment provisions. YTW is generally the lower of a bond’s yield to maturity or yield to call and by definition a security’s YTW can never be higher than its current yield.13 Modified duration measures a bond price’s responsiveness to interest rate change and effective duration essentially just refines the modified duration calculation to account for imbedded options such as calls or interest rate resets. The software used for this analysis was provided by Detalus and the duration calculations above differ somewhat from those used by Stifel for the portfolio analysis provided in the Strategy and Implementation section above. As such, duration comparisons should not be made between sections; however, all analysis and comparisons made within the Financial Impact section will be made using the Detalus software and thus will be made on an “apples to apples” basis.
6/30/2017 Total Capital (Total Equity + Loan Loss Reserve): 47,827$
Book Value (000) Identifier Issuer Name Quality Coupon Maturity PriceMkt Val
(000) % Held (MV) YTWMod Dur Eff Dur Conv Bk Yld
Corporate:1,000 0258M0DR AMERICAN EXPRESS CR CORP M A2 1.550 09/22/2017 100.008 1,004 3.78 1.508 0.226 0.228 0.001 1.3371,018 949746NX WELLS FARGO CO NEW A2 5.625 12/11/2017 101.835 1,021 3.84 1.490 0.444 0.446 0.002 1.4551,001 61761JVM MORGAN STANLEY A3 1.875 01/05/2018 100.128 1,010 3.80 1.624 0.505 0.509 0.003 1.5021,032 073902RU BEAR STEARNS COS INC A3 7.250 02/01/2018 103.290 1,063 4.00 1.585 0.565 0.570 0.003 1.757
999 233851BU DAIMLER FINANCE NORTH AMER L A2 1.650 05/18/2018 99.973 1,002 3.77 1.680 0.872 0.870 0.006 1.8041,007 38147MAA GOLDMAN SACHS GROUP INC A3 2.900 07/19/2018 101.066 1,024 3.85 1.872 1.022 1.021 0.008 2.2071,002 406216BC HALLIBURTON CO Baa1 2.000 08/01/2018 100.008 1,008 3.80 1.992 1.061 1.027 -0.020 1.735
500 046265AG ASTORIA FINL CORP Baa3 3.500 06/08/2020 100.737 505 1.90 3.228 2.769 2.746 0.021 3.499499 23204GAC CUSTOMERS BANCORP INC N/A 3.950 06/30/2022 99.775 499 1.88 4.000 4.495 4.515 0.110 4.000
1,077 337930AC FLAGSTAR BANCORP INC N/A 6.125 07/15/2021 107.255 1,101 4.14 4.156 3.492 3.507 0.072 4.0409,135 Percent of Total Capital: 19% 34.76
Investment Policy Maximum 25%Agency:
1,507 3135G0YM FEDERAL NATL MTG ASSN Aaa 1.875 09/18/2018 100.689 1,518 5.71 1.302 1.195 1.197 0.010 1.4651,999 3135G0YT FEDERAL NATL MTG ASSN Aaa 1.625 11/27/2018 100.431 2,012 7.57 1.315 1.387 1.389 0.013 1.6651,502 3135G0YT FEDERAL NATL MTG ASSN Aaa 1.625 11/27/2018 100.431 1,509 5.68 1.315 1.387 1.389 0.013 1.5421,993 3137EADP FEDERAL HOME LN MTG CORP Aaa 0.875 03/07/2018 99.792 2,001 7.53 1.180 0.680 0.678 0.004 1.4141,988 3135G0WJ FEDERAL NATL MTG ASSN Aaa 0.875 05/21/2018 99.630 1,994 7.51 1.293 0.884 0.882 0.006 1.5261,995 3135G0ZE FEDERAL NATL MTG ASSN Aaa 1.750 06/20/2019 100.685 2,015 7.58 1.397 1.933 1.932 0.024 1.8641,993 3135G0ZG FEDERAL NATL MTG ASSN Aaa 1.750 09/12/2019 100.673 2,024 7.62 1.438 2.142 2.144 0.028 1.905
12,977 Percent of Total Capital: 27% 49.20Investment Policy Maximum 100%
Asset Backed Securities:1,972 66704JBC NEF 2004-2 A4 Aaa 1.402 07/28/2021 98.416 1,973 7.43 1.930 3.967 -0.010 -0.004 1.888
163 452281JC ISAC 2010-1 A2 Aa1 2.220 04/25/2022 100.465 165 0.62 2.253 4.564 0.025 -0.005 2.332610 546398K4 LPFA 2011-A A2 Aa1 2.070 04/26/2027 99.813 615 2.32 2.225 8.843 -0.008 -0.011 2.273
1,472 452281JD ISAC 2010-1 A3 Aa1 2.070 07/25/2045 99.943 1,505 5.66 2.207 20.928 0.222 -0.046 2.2944,217 Percent of Total Capital: 9% 16.03
Investment Policy Maximum 100%26,329 Aa2 2.255 3.344 100.557 26,568 100.0 1.743 2.854 1.153 0.009 1.902%
30
As noted in the Strategy/Implementation section above, the Bank’s existing portfolio totals $26
million and includes asset from three categories: Corporate (~35%), Agency (~49%) and ABS
(~16%). Please note that securities in highlighted rows are set to mature prior to December 31,
2018 and all securities are held as Available for Sale (“AFS”) for the purposes of GAAP
accounting14.
A summary of securities held in the portfolio as of 6/30/2017 is as follows:
- Corporate securities are predominately issued by financial services institutions and can be
split into two primary sub-categories: large (i.e. Fortune 100) size companies, and
smaller, regional financial institutions. Corporate bonds have provided the greatest
spread relative to comparable maturity bonds from other issuer classes in recent quarters,
and thus the Bank has remained relatively close to its policy maximums in this category.
Securities from the larger corporations provide relatively good liquidity and price
transparency, while securities from the lesser-known entities provide yields which are
~150-200 bps higher by comparison. Maturities are heavily weighted in 2017 and 2018
(~$7 million rolling off before 12/31/18) with only ~$2 million of maturities in 2019 or
after.
14 The Financial Accounting Standards Board (“FASB”) provides guidance on accounting for securities via the Statement of Financial Accounting Standards 115 (“FAS 115”). This guidance allows for the characterization of securities in one of three categories – each of which requires a different accounting methodology. Those categories are: Held to Maturity (“HTM”), Available for Sale (“AFS”), and Trading Account. From a practical perspective, virtually all community banks will hold their securities as either HTM or AFS and Parkside has elected to hold all of its securities as AFS. HTM accounting treatment means that assets are held at amortized cost and unrecognized gains/losses do not have to be reported, however, it does not allow for active trading within the portfolio. AFS securities are reported at market value with unrecognized gains/losses reported as an adjustment to net equity on a bank’s balance sheet (by comparison, Trading Account securities are reported at market value with unrealized gains/losses being reported through a bank’s income statement). While Parkside does not regularly trade securities as part of its business model, securities are occasionally sold for liquidity or other purposes and thus the AFS accounting treatment provides the most flexibility for managing the portfolio in tandem with the overall balance sheet.
31
- The Bank’s agency-issued securities are primarily issued by Fannie Mae, with one
security issued by Freddie Mac. The agency portfolio is very short-term in nature with
~$9 million maturing in 2018 and ~$4 million in 2019.
- Parkside’s asset backed holdings consist of four securities - each backed by a pool of
student loan debt. These bonds are all floating-rate in nature (repricing quarterly) with
interest rates based off of LIBOR (which explains why the effective durations are
essentially zero). In addition, the underlying loans comprising the collateral for each of
the securities are guaranteed by a guaranty agency and reinsured by the Secretary of
Education under the Higher Education Act. None of the ABS securities mature prior to
2021 and one security does not mature until 2045, however, the floating-rate nature of the
bonds means that the Bank’s risk of incurring unrealized losses due to rising rates is
minimal. In addition, modified durations within this asset class are shorter than the stated
maturities due to principal prepayment occurring within the collateral pool.
Applying the weighted-average book yield of 1.902% to the total portfolio of $26,329M results
in annualized interest income of $501M. This compares favorably to the $434M of interest
income generated by the portfolio for the twelve month period ending June 30, 2017.
Summary of Higher Performing Bank Securities Portfolio Attributes
As noted in the Strategy/Implementation section above, there are myriad strategies for
how best to manage a bank’s securities portfolio and Stifel’s long-term performance study notes
that different styles of portfolio management can have a dramatic impact on performance. That
being said, higher performing portfolios over long time horizons share certain attributes as it
relates to asset allocation and duration when compared to lower performing portfolios. For
instance, the Stifel study notes that higher performing portfolios have a higher allocation of long-
32
duration securities and utilize an above-average allocation to municipal securities and a below-
average allocation to Treasuries and Agencies. In addition, the higher performing portfolios also
tend to comprise a larger portion of a bank’s balance sheet. It should also be noted that over
longer-term time horizons, income is the primary driver of portfolio returns and shorter-term
price fluctuations tend to cancel out over time.
The following tables illustrate these findings by reflecting asset allocations, average
durations and relative portfolio size for each of the securities portfolio performance quartiles for
banks with total assets of between $100 million and $500 million. The tables also include
Parkside’s position as of June 20, 2017 for comparison purposes:
Average Portfolio Composition – Banks $100MM to $500MMTreasuries Agencies MBS CMOs CMBS Munis ABS Corporate/Other
1st Quartile 1.15% 17.13% 19.65% 8.46% 0.68% 49.55% - 3.38%2nd Quartile 1.27% 22.51% 27.39% 10.77% 0.70% 34.85% - 2.51%3rd Quartile 2.26% 30.85% 26.91% 10.33% 0.90% 26.07% - 2.68%4th Quartile 7.12% 45.83% 18.06% 6.71% 0.53% 19.00% - 2.76%PFBT – June 2017 - 49% - - - - 16.03% 34.76%
Average Portfolio Composition – Banks $100MM to $500MM0-3 Years 3+ Years Securities / Total Assets
1st Quartile 24.04% 75.80% 25.19%2nd Quartile 29.69% 70.21% 23.46%3rd Quartile 36.68% 63.24% 22.87%4th Quartile 56.01% 43.92% 18.27%
PFBT – June 2017 78.00% 22.00% 6.15%
The most notable information from the above tables is the linear relationship between
each of the factors of higher performing portfolios noted above (i.e. duration, asset allocations,
and portfolio size) and the ascending and descending quartiles of performance. It is also notable
that - as was the case with the peer group analyses performed in the Strategy / Implementation
section above - Parkside’s securities portfolio differs significantly from each of the performance
quartiles in terms of asset allocation, average duration, and portfolio size as a percentage of the
33
Bank’s balance sheet. And perhaps most importantly, if one were to assume that the linear
relationship between the higher performing portfolio attributes and historical performance were
to extend to Parkside’s portfolio, it could be rationally assumed that Parkside’s long-term
performance would be well below those of even the bottom-quartile performers.
While this is not entirely surprising given the Bank’s business model and lack of historic
focus on the securities portfolio, this information can be used to guide future investment
decisions within the portfolio in an attempt to more closely mirror the higher performing
portfolios. In the Pro Forma Portfolio sub-section below, some of these factors are incorporated
into a pro forma portfolio as of December 31, 2018 in an attempt to improve future performance
Pro Forma Portfolio – December 31, 2018
The following pro forma portfolio represents a hypothetical portfolio as of December 31,
2018 which attempts to incorporate some of the findings above regarding the composition of
higher performing portfolios (highlighted rows denote new securities to the portfolio).
34
Assumptions/guidelines used for creating the portfolio are as follows:
· Portfolio increased in size to ~$35 million (from $26 million at June 30, 2017). This
increase is based upon the Bank’s projected balance sheet growth over the same time
period, whereby the $35 million portfolio would represent ~6.7% of the Bank’s total
assets which is consistent with the historical relative portfolio size.
· In addition to the net increase, ~$16 million of securities in the existing portfolio
mature prior to 12/31/18. For the purposes of this exercise, it is assumed that these
securities are held to maturity and then subsequently replaced (resulting in no realized
gains or losses from sales). This means that gross securities purchases (and thus new
additions to the portfolio) total ~$25 million.
· Total investments in corporate securities are pushed close to investment policy
maximum. Corporate securities currently reflect the highest spreads relative to
12/31/2018 Total Capital (Total Equity + Loan Loss Reserve): 55,000$
Par (000) Identifier Issuer Name Quality Coupon Maturity PriceMkt Val
(000) % Held (MV) YTWMod Dur Eff Dur Conv Bk Yld
Corporate:2,000 61747YCJ MORGAN STANLEY A3 5.625 09/23/2019 105.730 2,136 6.06 2.38 1.72 1.71 0.019 2.3772,000 759351AG REINSURANCE GROUP AMER INC Baa1 6.450 11/15/2019 107.535 2,156 6.12 2.48 1.85 1.85 0.022 2.4832,000 38141EA5 GOLDMAN SACHS GRP INC MTN B A3 5.375 03/15/2020 106.360 2,150 6.10 2.50 2.14 2.14 0.028 2.500
500 046265AG ASTORIA FINL CORP Baa3 3.500 06/08/2020 100.738 512 1.45 3.18 2.36 2.32 0.009 3.4992,000 95763PAJ WESTERN ALLIANCE BANCO FXFL N/A 5.000 07/15/2020 100.250 2,043 5.80 4.90 2.39 2.39 0.033 4.8952,000 06051GFT BANK AMER CORP Baa1 2.625 10/19/2020 100.392 2,014 5.72 2.48 2.76 2.76 0.041 2.4831,000 337930AC FLAGSTAR BANCORP INC N/A 6.125 07/15/2021 99.999 1,023 2.90 6.12 3.14 3.14 0.057 4.041
500 23204GAC CUSTOMERS BANCORP INC N/A 3.950 06/30/2022 101.250 514 1.46 3.65 4.10 4.09 0.081 3.999500 23204GAC CUSTOMERS BANCORP INC N/A 3.950 06/30/2022 101.250 514 1.46 3.65 4.10 4.09 0.081 3.724
1,000 38148TMM GOLDMAN SACHS GROUP INC[4] A3 3.022 05/17/2026 101.540 1,016 2.89 2.87 7.38 0.35 -0.011 2.91013,500 Percent of Total Capital: 25% 39.96
Investment Policy Maximum 25%Agency:
2,000 3135G0ZE FEDERAL NATL MTG ASSN Aaa 1.750 06/20/2019 100.274 2,021 5.74 1.57 1.52 1.52 0.015 1.8632,000 3135G0ZG FEDERAL NATL MTG ASSN Aaa 1.750 09/12/2019 100.234 2,012 5.71 1.62 1.74 1.74 0.020 1.9052,000 3137EAEJ FEDERAL HOME LN MTG CORP Aaa 1.625 09/29/2020 98.993 1,985 5.64 1.99 2.74 2.75 0.040 1.9922,000 3135G0Q8 FEDERAL NATL MTG ASSN Aaa 1.375 10/07/2021 97.761 1,959 5.56 1.98 3.72 3.73 0.075 1.9818,000 Percent of Total Capital: 15% 22.65
Investment Policy Maximum 100%Asset Backed Securities:
1,647 66704JBC NEF 2004-2 A4 Aaa 1.610 07/28/2021 100.003 1,650 4.68 1.72 3.57 0.12 -0.009 2.007517 546398K4 LPFA 2011-A A2 Aa1 2.280 04/26/2027 99.933 518 1.47 2.40 8.44 0.07 -0.010 2.459
1,500 452281JD ISAC 2010-1 A3 Aa1 2.280 07/25/2045 100.075 1,505 4.27 2.39 20.25 0.27 -0.040 2.483103 452281JC ISAC 2010-1 A2 Aa1 2.430 04/25/2022 100.339 103 0.29 2.46 4.18 0.11 -0.007 2.519500 317579AA FINS 2015-1A Aa2 5.000 07/30/2026 100.500 478 1.36 4.93 6.86 6.91 0.289 4.589
4,267 Percent of Total Capital: 8% 12.07Investment Policy Maximum 100%
US Treasuries:2,000 912828D2 UNITED STATES TREAS NTS Aaa 1.625 04/30/2019 99.840 1,999 5.68 1.74 1.39 1.39 0.013 1.7392,000 912828X2 UNITED STATES TREAS NTS Aaa 1.500 04/15/2020 99.184 1,987 5.64 1.85 2.32 2.32 0.031 1.8534,000 Percent of Total Capital: 7% 11.32
Investment Policy Maximum 100%Municipals:
5,000 546415M6 LOUISIANA ST GO BDS 2013-B Aa3 2.480 05/15/2024 98.371 4,924 13.98 2.76 5.92 5.96 0.199 2.7575,000 Percent of Total Capital: 9% 13.98
Investment Policy Maximum 100%34,767 Aa3 3.066 4.510 100.820 35,220 100.0 2.57 3.95 2.60 0.053 2.258%
35
benchmark rates and thus provide opportunity to add additional yield without adding
significant duration. Corporate maturities are barbelled somewhat with $4MM
maturing in 2019 & 2020, $2MM in 2025, and $1MM in 2026 (note that the 2026
maturity has a floating rate coupon and thus does not add interest rate duration to the
portfolio). Additionally, corporate holdings of higher-yielding but less liquid
securities issued by financial institutions are expanded by an additional $2 million to
include approximately $4.5 million.
· Total Agencies decreased by ~$5 million due to $9 million in maturing bonds which
are replaced by two new bonds - issued by Freddie Mac and Fannie Mae – with a par
value of $2 million each, and which mature in 2020 and 2021, respectively (see
discussion on Treasuries below for additional details on Agencies/Treasuries).
· Within the ABS category, a single $500M security (FINS 2015-1A) was purchased to
serve as an “alternative” investment that differs slightly from other assets currently in
the portfolio. This bond represents the A-tranche of a securitization which combines
~25 different debt issuances by various financial institutions around the U.S. The
security carries a Moody’s rating of Aa2 and a corresponding book yield of 4.59%.
While it is not anticipated that Parkside would purchase a lot of these types of
securities, it is an illustration of how higher yields can sometimes be achieved by
investing in assets which are a bit unique and/or potentially less liquid than some of
the more standardized asset classes.
· $4 million of Treasuries are added to the asset allocation via two purchases of $2
million each, with maturities in 2019 and 2020. It should be noted that these purchases
– when combined with the $4 million of new Agency purchases - essentially serve as
36
replacements for the ~$9 million of Agency bonds which mature prior to year-end
2018. While Parkside management would not necessarily oppose replacing all of the
Agency runoff with new Agency-issued securities, the decision to instead to split it and
buy $4 million each of both Treasuries and Agencies for this exercise was made in
light of management’s desire to eventually add some exposure to Treasury’s in the
portfolio, and given that Agency spreads relative to similar duration Treasuries are
currently tight and thus provide minimal additional yield. Actual purchases may
include only Agencies if spreads loosen through 2018 and additional yield
opportunities present themselves in the Agency sector. Regardless of whether these
purchases are made in Agencies or Treasuries, the total of these two categories is
unlikely to shrink materially as these assets are highly liquid and can also be pledged
to the FHLB with minimal discounting for collateral margin purposes15.
· Finally, exposure was added to the Municipals sector in the form of a $5 million Aa3-
rated taxable general obligation bond from the state of Louisiana with a maturity in
2024. In practice, additions to the Municipal sector will more than likely include
multiple purchases in the $1-$2 million range for a total of ~$5 million, however,
yields for bonds with the same ratings and durations within this sector do not generally
deviate materially. As such, the single Louisiana bond was chosen as a proxy for this
sector. It should also be noted that any purchases of Municipal bonds in the near term
would likely include only taxable bonds given the anticipated impact of the Tax
15 Funding advances from the FHLB require that collateral be pledged in support of loan draws. Specific advance rates vary by asset type, however, Agencies and Treasuries have the highest advance rates and thus provide the greatest value for pledging purposes.
37
Reform and Jobs Act to the market for tax exempt bonds16. Potential alternatives to
exposure in this sector could include pass through bonds such as additional exposure to
ABS or introducing some exposure to MBS or RMBS securities – including those
backed by adjustable rate mortgages which have a fixed-rate lockout period and then
subsequently convert to floating (thus minimizing long-term interest rate risk).
Portfolio Comparison
Below is an illustration of asset allocations by sector for both the 6/30/17 actual portfolio and the
proposed 12/31/18 portfolio as compared to the portfolios of the performance quartiles in the
Stifel long-term performance study:
Average Portfolio Composition – Banks $100MM to $500MMTreasuries Agencies MBS CMOs CMBS Munis ABS Corporate/Other
1st Quartile 1.15% 17.13% 19.65% 8.46% 0.68% 49.55% - 3.38%2nd Quartile 1.27% 22.51% 27.39% 10.77% 0.70% 34.85% - 2.51%3rd Quartile 2.26% 30.85% 26.91% 10.33% 0.90% 26.07% - 2.68%4th Quartile 7.12% 45.83% 18.06% 6.71% 0.53% 19.00% - 2.76%PFBT – June 2017 - 49.20% - - - - 16.03% 34.76%PFBT – Dec 2018 11.32% 22.65% - - 13.88% 11.43% 41.16%
While the Bank’s Treasury exposure is exceptionally high as compared to other
portfolios, as noted above the Agency and Treasury sectors are largely interchangeable from a
credit quality and yield perspective at this time. As such, it is helpful to combine the two sectors
for asset allocation comparison purposes. With combined Treasury/Agency paper totaling ~34%
in the pro forma portfolio, Parkside would be roughly on par with the 3rd quartile performers in
16 The Tax Reform and Jobs Act, passed in December 2017, eliminates advance refundings (i.e. accelerated payment of a serious of bonds via the issuance of a new series of bonds) from retaining tax exempt status beginning in 2018. The impact of this change has not yet been fully realized, however, SIFMA data for Municipal issuances shows that advance refundings made up more than half of the total issuance of Municipal bonds in 2017. As such, new supply of Municipals is likely to be severely diminished moving forward. In addition, the reduction of corporate tax rates from 35% to 21% reduces the competitiveness of tax exempt bonds and will likely lead to higher borrowing costs for issuers moving forward which could further diminish supply.
38
this regard. This is down from 49% in the 6/30/17 portfolio which would put Parkside below the
4th quartile averages.
With ~14% of the Bank’s pro forma portfolio moving into Municipals, Parkside remains
below the averages in each of the performance quartiles, however, by establishing a significant
investment in the sector the gap is reduced significantly compared with 0% at 6/30/17. ABS
securities decrease from 16% to a little more than 11% in the pro forma portfolio, however, the
actual amount of ABS owned does increase slightly between the two periods. Finally, Corporate
debt remains the highest allocation within the portfolio, as corporate spreads remain the most
attractive in the market today.
Average Portfolio Composition – Banks $100MM to $500MM0-3 Years 3+ Years Securities / Total Assets
1st Quartile 24.04% 75.80% 25.19%2nd Quartile 29.69% 70.21% 23.46%3rd Quartile 36.68% 63.24% 22.87%4th Quartile 56.01% 43.92% 18.27%PFBT – June 2017 78.00% 22.00% 6.15%PFBT – Dec 2018* 72.33%* 27.67%* 6.70%** Percentages based on $35 million pro forma portfolio above as compared to the Bank’s projected total assets of $522 million as of December 31, 2018.
In terms of portfolio duration and relative size, Parkside is again below each of the four
quartiles in both measurements. With 78% of the securities portfolio set to mature in 3 years or
less as of 6/30/17, Parkside has 22% more securities maturing in that timeframe than the average
of the 4th quartile performers. Additionally, at just over 6% of total assets, Parkside’s portfolio is
roughly one-third the size of the 4th quartile portfolios (in relative terms) and is less than one-
fourth the size of the portfolios in the 1st quartile of performance.
As was the case when comparing asset allocations, the pro forma portfolio also improves
the Bank’s position in each of these categories, with ~28% of securities maturing beyond 3-years
from 12/31/2018; and closer to 7% of the Bank’s assets held in the form of securities. While
39
these percentages would still rank the Bank below the 4th quartile performers, making significant
alterations to the composition of the portfolio is going to be a long-term process and even
incremental improvements over a relatively short time horizon can yield measurable
improvements to portfolio performance. And while a more significant proposed change to the
portfolio would have likely had a more dramatic effect on the Bank’s rankings within these
categories, it should also be noted that the study used to derive this information was performed
over a period of 13 years and thus represents long-term averages of portfolio composition and
does not necessarily reflect a specific point-in-time positioning of securities portfolios. In light
of the current interest rate environment in which the yield curve is extremely flat (3mo/2yr/5yr
Treasury rates of 1.29% / 1.73% / 2.06%, respectively as of 11/17/2017), there is minimal upside
to taking on additional duration risk and potentially significant downside if one believes that the
market is set to begin a period of rising interest rates.
Following is a side-by-side comparison of pertinent attributes of the Bank’s actual 6/30/17
portfolio and the proposed 12/31/18 portfolio:
As shown in the table above, the proposed portfolio would generate ~$785M of annual
interest income vs just over $500M for the 6/30/17 portfolio (an increase of ~$285M and more
than a 50% improvement). While a significant portion of the uptick in revenue is due to the
increased size of the portfolio, the book yield of the pro forma portfolio is ~36 bps higher than
($000's) 6/30/2017 12/31/2018Total Portfolio 26,329 34,767Credit Quality Aa2 Aa3Weighted-Avg. Maturity 3.344 4.510Yield to Worst 1.743 2.573Modified Duration 2.85 3.95Effective Duration 1.15 2.60Convexity 0.009 0.053Book Yield 1.902% 2.258%Annualized Interest Income 500.78$ 785.04$
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the 6/30/17 portfolio. Applying the higher yield from the pro forma portfolio to the $26 million
6/30/17 portfolio would result in approximately $95M of additional revenue (an increase of
~19%).
To achieve these improvements in yield, the portfolio credit quality decreased slightly
(from Aa2 to Aa3), however, it remains a very highly rated portfolio overall. The weighted-
average maturity and each of the duration measurements expanded somewhat, however, each
remains relatively short term in nature, with the overall effective duration of the portfolio (which
accounts for call features and re-pricing events) of less than 3 years. Lastly, convexity increased
slightly for the portfolio, but remains less than 0.1.
More important than a single measurement comparison of the 6/30/17 actual portfolio to
the 12/31/18 pro forma portfolio, however, is the idea of improving portfolio performance over
the long-term. The following table summarizes the total average annual return of each of the
four quartiles of bank securities portfolios discussed above over the entirety of the 12-year study:
As noted in the Strategy and Implementation section above, the total returns of the 1st
quartile portfolios average 1.95% more than their 4th quartile counterparts. While it is unlikely
that Parkside will ever have the relative portfolio size or allocation mix of the 1st quartile
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performers, the pro forma portfolio above could continue to evolve in coming years to look more
and more like the higher performing portfolios. Assuming that the Bank’s portfolio size also
continues to grow over time, the impact of those improved yields will continue to grow in
significance. And, as noted above, every 1% improvement in annual returns provides $10,000 of
additional revenue for every $1 million of portfolio size.
It is also worth noting that the Bank’s strategy for positioning of the portfolio will change
over time as the macroeconomic environment dictates. A strategy for purchasing securities in a
relatively steep yield curve environment, for example, would be different than a strategy within a
relatively flat yield curve environment. Similarly, the Bank’s preference for purchasing
securities (or not) within a specific asset class will likely change over time, as credit spreads
within asset classes expand and contract throughout the course of a credit cycle. What is not
likely to change, however, is that Banks with longer duration portfolios and a lower allocation of
Treasuries and Agencies will outperform their counterparts over the long haul. The goal for the
Bank’s portfolio over the long-term should be to balance these facts against the macroeconomic
and interest rate conditions of a given time to continually manage the portfolio composition to
maximize returns within a given set of risk tolerances. It is also possible that - with additional
experience and education - the writer could become savvy enough to manage the portfolio
without the help of Detalus as a 3rd party advisor. Detalus charges a blended/tiered
management fee of ~11bps against the average balance of the portfolio, so a $35 million
portfolio would be subject to nearly $40,000/year in advisory fees in the near term, and even
more as the portfolio grows moving forward.
While a ~$95M increase to annual interest income (the increase derived from applying
the yield of the proposed pro forma portfolio to the $26 million portfolio balance as of June 30,
42
2017) would not be considered overly significant for an institution that will make ~$5.5 million
in net income for 2017, it is difficult to envision an undertaking that would require less
disruption or overhead costs than simply re-allocating the securities portfolio in a sensibly
strategic manner as existing securities mature and need to be replaced. Furthermore, the pro
forma portfolio is expected to be roughly equivalent in size (relative to the Bank’s balance sheet)
as the existing June 30, 2017 portfolio and would generate almost $300M of additional income.
While still not an earth-shattering amount, this increase to interest income effectively represents
“free money” given that the portfolio will exist regardless of how it is allocated. As such, it
seems logical that additional attention to strategic allocation of the portfolio going forward is
warranted.
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Non-Financial ImpactAs noted in the Financial Impact section above, calculating the revenue and/or earnings impact
of a proposed change to the securities portfolio is a relatively straightforward exercise. While
the possibilities for a specific portfolio allocation recommendation are virtually boundless and
there is no singular “correct” way to manage the portfolio, the actual revenue calculations
themselves are quite simple once a given allocation is chosen. Furthermore, comparisons across
portfolios or proposed allocations are relatively straightforward as well, given the various
metrics (e.g. duration, credit quality, etc.) used to analyze portfolios. The contraposition of the
relatively simple nature of calculating a financial impact, however, is that the non-financial
impact of such an undertaking is more difficult to quantify.
In reviewing a list of sample measures for the Non-Financial Impact section included in
the Capstone writing guidelines provided by Stonier, there are two primary constituencies for
whom special attention is paid: clients and employees. And for good reason: while all banks
(ostensibly) offer depository and lending services, it is the employees and clientele which
ultimately separate one institution from another. As such, it would seem logical to pay particular
attention to metrics such as: client retention, market share, depth of relationship, employee
satisfaction and retention, productivity, etc. when evaluating a proposed change within an
organization. Having said that, the impact of the proposed re-allocation of the Bank’s securities
portfolio outlined herein would have virtually no impact whatsoever on either clients or
employees (aside from freeing up capacity for the Bank’s CEO who has historically managed the
portfolio), and thus requires that the evaluation of its non-financial impact be bit more subjective.
44
Having said that, the writer would argue that there are a couple of positive and
complimentary non-financial aspects to the project proposed herein: continuing education and
career development potential (for the writer) and management succession planning (for the
Bank). Given the relatively flat organizational structure at Parkside (whereby the writer reports
directly to the Bank President, Andrew Hereford, who in turn reports directly to the CEO, Jim
Wagner), “career advancement” in the traditional sense of being promoted to a more senior
position in the commercial banking group’s chain of command is not practically achievable. At
the same time, the vast majority of the Bank’s high-level strategic and operational functions are
the direct responsibilities of either Mr. Wagner or Mr. Hereford, which has resulted in a lack of
bench strength in areas such as finance and balance sheet management.
Career Development
As noted above, the writer’s primary responsibilities are as a business development
officer / relationship manager within the commercial banking division. In addition, the entirety
of the writer’s career in banking has been as part of a commercial lending group, with a sizable
portion of it working for banks with balance sheets in excess of $100 billion in total assets17.
While this background is suitable for a career in commercial banking, it leaves significant blind
spots as it relates to other non-lending banking functions – many of which are critical to
managing a community bank. And while Parkside is hyper-focused on commercial banking as a
primary line of business - which makes it a bit unique in the broader landscape of community
banks - it remains similar to other community banks with regard to things like employee and
balance sheet management, filing of call reports, meeting with and ensuring adherence to the
17 The writer’s banking career began with commercial lending credit training at LaSalle Bank in Chicago, IL in 2002, and continued with Bank of America’s commercial real estate lending group in St. Louis, MO in 2005 before joining Parkside prior to the Bank’s official opening in April 2008.
45
requirements of examiners and auditors, and reporting to the board of directors and shareholders.
Successful fulfillment of each of these items is critical to sustaining the Bank’s long-term
success and requires a broader skill set than a typical commercial banking officer would possess.
So while the writer believes his background has prepared him well for the challenges of
procuring, underwriting and managing a commercial loan portfolio, there are admittedly
significant knowledge gaps as it relates to managing the institution overall. This being the case –
and coupled with the writer’s desire to prepare himself for an executive management role in
banking at some point in the future - the writer would argue that the project outlined herein
represents a unique opportunity to expand his professional skill set while simultaneously helping
to manage an important piece of the Bank’s overall balance sheet strategy. Furthermore, the
project proposed herein is a natural continuation of the writer’s development outside of his
capacity as a commercial lender, given his existing role as chair of the Bank’s ALCO committee
which ultimately oversees and reports to the board of directors on matters related to the securities
portfolio.
Succession Planning
The second non-financial impact of the project proposed herein is with regard to
management succession planning for Parkside as an institution. As noted above, many of the
critical areas of the Bank’s management and decision making functions remain concentrated
within the CEO and Bank President roles. While it would seem likely that this is somewhat
commonplace for organizations of ~50 employees, it does present challenges to both long and
short-term succession planning in the event of executive retirement or sudden incapacity/death.
And while the Bank’s existing CEO and President are relatively young by industry standards (i.e.
52 and 50 years old, respectively), they have been consistent in their messaging to employees
46
and shareholders that there are no plans to sell the bank anytime in the foreseeable future. In light
of this fact, it would seem prudent to begin cross training individuals for management functions
as both a hedge against unforeseen circumstances, as well as to provide a viable option of
transitioning the bank to new management in lieu of a 3rd party sale.
Succession planning of this kind would also put Parkside in a minority vis a vi its
community banking peer group. A survey conducted by BankDirector.com in 2016 and
referenced by J. Scott Petty in his posting “Bank Succession Planning Made Simple” from
BankDirector.com on October 17, 2016, found that 60% of community Banks expected their
CEO and/or other senior executives to retire within five years. In addition, only 45% of
surveyed institutions have both a long-term and emergency succession plan in place for the CEO
and all other senior executives. While external candidates could be a part of the solution in
filling senior manager roles vacated via retirement, etc., filling these roles via promotion of
existing personnel is generally considered less disruptive and less expensive. In addition,
Parkside’s unique business model means that there are fewer existing bank executives at
institutions of comparable size who would possess the requisite commercial banking skillset to
lead the organization.
While it is unlikely that any one individual could fill all of the responsibilities of either
the existing CEO or President (at least not at present), the writer would argue that continuing to
increase his overall skill set as it relates to bank management would be a prudent component of
the Bank’s succession planning efforts. Particularly given that - as one of eighteen original
employees from Parkside’s de novo nearly ten years ago – the writer possesses an inordinate
amount of “institutional knowledge” of the Bank and its internal culture and could thus help
ensure continuity moving forward. While Parkside has begun some steps to segregate
47
managerial duties, the writer would argue that the project proposed herein would be a non-
disruptive continuation of those efforts and pose minimal (if any) downside risk to the Bank.
48
ConclusionAs noted above, securities portfolios generally comprise the 2nd largest component of a bank’s
earning assets (behind loans) and thus represent an important source of revenue for a given
institution. As such, management of portfolios in an attempt to maximize revenue and deter
potential downside is therefore a critical undertaking within most banking institutions. And
while the size and composition of portfolios can differ dramatically across organizations, the
portfolios of higher performing institutions generally share certain attributes as it relates to asset
type, duration, etc. that have consistently shown to outperform their counterparts over long time
horizons.
While Parkside has a unique business model which lends itself to a substantially smaller
securities portfolio (as a portion of the overall balance sheet) than peer group averages, the
portfolio does conform with industry norms in that it is still the Bank’s 2nd largest earning asset
category. Historically, Parkside’s securities portfolio has not been managed with a particular
focus on driving on long-term returns – largely because of management’s focus on the
commercial loan portfolio which is by far the Bank’s largest revenue generator. With the
securities portfolio now approaching $30 million (and expected to grow by an additional $5
million/year for the next several years), however, the size of the portfolio is reaching a point
where incremental improvements in performance can result in significant real-dollar increases to
the Bank’s net interest income.
Given that the portfolio will exist (to one degree or another) regardless of how it is
managed, and the fact that it is a fairly simple exercise to incorporate some allocation
characteristics into the portfolio to more closely mirror the portfolios of higher performing
49
institutions, the argument for doing so is compelling. And with the Bank’s portfolio set to lose
~60% of its balances to runoff prior to year-end 2018, making tweaks to the allocation and
duration profile of the portfolio will not require significant “noise” in the P&L as a result of
realizing gains and losses by selling existing securities. Instead, securities can simply be
replaced as they mature to gradually shift the portfolio composition over time.
In light of the above, the writer would argue that a more hands-on management of the
securities portfolio – to include a gradual shifting of the portfolio to an allocation more closely
mirroring the pro-forma allocation outlined herein - would be a prudent undertaking at this time.
There is no incremental investment or up-front cost to the Bank (since the proposed portfolio
size essentially mirrors what is already budgeted in terms of growth) and any increase in
earnings from the portfolio effectively goes straight to the bottom-line. Furthermore, the
inclusion of the writer in this process is a natural extension of his existing role as chair of the
Bank’s ALCO committee and would constitute another step in his professional development
along with the Bank’s ongoing succession planning efforts.
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References1) Financial Accounting Standards Board “Statement of Financial Accounting Standards
No. 115 – Accounting for Certain Investments in Debt and Equity Securities” (1993) http://www.fasb.org/jsp/FASB/Document_C/DocumentPage?cid=1218220123971&acceptedDisclaimer=true (Accessed September 1, 2017)
2) Securities Industry and Financial Markets Association (“SIFMA”) 2017 Fact Book https://www.sifma.org/wp-content/uploads/2016/10/US-Fact-Book-2017-SIFMA.pdf (Accessed on December 10, 2017)
3) Stifel Nicolaus & Co. “Unlocking the Secrets of High Performance Bank Portfolios” (2017) (Accessed on multiple occasions throughout the capstone project)
4) Financial Industry Regulatory Authority (“FINRA”) Market Data Center http://finra-markets.morningstar.com/BondCenter/Default.jsp
5) US Municipal Bond Issuance – Securities Industry and Financial Markets Association (January 2, 2018) https://www.sifma.org/resources/research/us-municipal-issuance/(Accessed February 1, 2018)
6) Petty, J. Scott “Bank Succession Planning Made Simple” (October, 17, 2016) https://www.bankdirector.com/committees/governance/bank-succession-planning-made-simple/ (Accessed December 7, 2017)
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Appendix A: UBPR Reports: Parkside Financial Bank & Trust and Peer Group Averages
1/10/2018 Print UBPR Report - FFIEC Central Data Repository's Public Data Distribution
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FDIC Certificate # 58796 FRB District/ID_RSSD 8 / 3688043 PARKSIDE FINANCIAL BANK AND TRUST ; CLAYTON , MO Summary RatiosOCC Charter # 0 County: ST LOUIS Summary Ratios--Page 1 1/10/2018 11:07:15 AMPublic Report
6/30/2017 6/30/2016 12/31/2016 12/31/2015 12/31/2014Earnings and Profitability BANK PG 3 PCT BANK PG 3 PCT BANK PG 3 PCT BANK PG 3 PCT BANK PG 3 PCTPercent of Average Assets: Interest Income (TE) 4.08 3.98 59 4.11 3.93 63 3.97 3.94 52 3.94 3.92 52 3.93 3.97 46
- Interest Expense 0.42 0.41 53 0.42 0.40 56 0.42 0.40 55 0.43 0.40 58 0.52 0.43 67 Net Interest Income (TE) 3.66 3.56 60 3.69 3.53 64 3.56 3.53 53 3.51 3.51 53 3.41 3.53 41
+ Noninterest Income 1.60 0.73 91 1.41 0.75 87 1.42 0.76 87 1.43 0.76 88 1.34 0.75 86- Noninterest Expense 3.17 2.79 73 3.01 2.84 62 2.97 2.84 60 3.19 2.86 70 3.03 2.89 61- Provision: Loan & Lease
Losses 0.17 0.10 77 0.31 0.11 89 0.29 0.12 87 0.20 0.10 78 0.27 0.12 84 Pretax Operating Income(TE) 1.93 1.43 82 1.79 1.37 77 1.71 1.38 73 1.55 1.36 64 1.45 1.34 57
+ Realized Gains/LossesSec 0.00 0.01 60 0.00 0.02 43 0.00 0.02 36 0.00 0.02 45 0.00 0.02 38 Pretax Net OperatingIncome (TE) 1.93 1.44 81 1.79 1.41 76 1.71 1.41 72 1.56 1.39 62 1.45 1.37 55 Net Operating Income 1.23 1.06 69 1.08 1.05 58 1.09 1.05 59 0.93 1.04 45 0.87 1.02 41 Adjusted Net OperatingIncome 1.43 1.12 76 1.35 1.11 71 1.37 1.10 74 1.03 1.06 51 1.11 1.01 61 Net Inc Attrib to Min Ints 0.00 0.00 99 0.00 0.00 99 0.00 0.00 98 0.00 0.00 99 0.00 0.00 98 Net Income Adjusted Sub S 1.23 0.94 80 1.08 0.93 67 1.09 0.93 69 0.93 0.93 51 0.87 0.91 47 Net Income 1.23 1.06 69 1.08 1.05 58 1.09 1.05 59 0.93 1.04 45 0.87 1.02 41
Margin Analysis:Avg Earning Assets to AvgAssets 97.35 94.55 86 99.02 94.22 97 99.05 94.22 98 98.81 94.03 97 98.59 93.92 96Avg Int-Bearing Funds to AvgAssets 85.21 74.58 85 85.27 74.85 86 85.35 74.49 87 61.96 75.04 9 65.44 76.15 13Int Inc (TE) to Avg EarnAssets 4.19 4.22 49 4.15 4.18 49 4.01 4.19 37 3.99 4.18 35 3.99 4.24 33Int Expense to Avg EarnAssets 0.43 0.44 51 0.42 0.42 53 0.42 0.42 51 0.43 0.42 53 0.52 0.46 63Net Int Inc-TE to Avg EarnAssets 3.76 3.77 51 3.73 3.75 50 3.59 3.76 39 3.56 3.74 35 3.46 3.77 29
Loan & Lease Analysis:Net Loss to Average TotalLN&LS -0.04 0.07 12 0.04 0.07 55 0.02 0.11 32 0.12 0.12 62 0.04 0.18 32Earnings Coverage of NetLosses (X) N/A 56.23 N/A 55.17 49.86 71 119.49 39.71 89 17.50 35.31 50 53.17 27.09 81LN&LS Allowance to LN&LSNot HFS 1.77 1.30 85 1.65 1.35 77 1.67 1.32 81 1.54 1.37 70 1.62 1.45 67LN&LS Allowance to NetLosses (X) N/A 32.70 N/A 36.80 30.29 73 86.94 24.30 90 13.50 21.61 56 40.89 17.09 84LN&LS Allowance to TotalLN&LS 1.77 1.29 86 1.65 1.34 78 1.67 1.30 81 1.54 1.35 71 1.62 1.44 69Total LN&LS-90+ Days PastDue 0.00 0.05 46 0.00 0.05 46 0.00 0.05 47 0.00 0.04 45 0.00 0.05 45
-Nonaccrual 0.00 0.64 6 0.00 0.70 5 0.00 0.67 6 0.00 0.78 4 0.00 0.95 4-Total 0.00 0.77 4 0.00 0.84 4 0.00 0.80 4 0.00 0.87 3 0.00 1.06 3
LiquidityNet Non Core Fund Dep New$250M 10.79 6.66 64 9.03 6.59 58 0.89 6.46 30 6.56 6.44 49 3.97 6.11 41Net Loans & Leases to Assets 81.89 68.59 86 79.43 67.79 79 76.42 68.16 70 77.74 67.05 76 75.90 65.60 76
CapitalizationTier One Leverage Capital 10.0978 10.32 51 9.8554 10.25 45 8.7041 10.27 14 9.2205 10.20 29 8.5574 10.08 17Cash Dividends to NetIncome 0.00 34.63 28 0.00 34.49 29 0.00 39.15 20 0.00 37.06 22 0.00 35.32 23Retained Earnings to AvgTotal Equity 12.78 5.65 94 11.35 5.40 92 11.91 5.14 95 9.89 5.22 88 9.63 5.37 86Rest+Nonac+RE Acq toEqcap+ALLL 0.00 8.44 3 0.00 9.69 2 0.00 9.46 3 2.64 10.57 17 0.00 12.86 2
Growth RatesTotal Assets 7.98 6.70 65 9.15 6.28 72 15.21 6.35 85 11.51 6.34 79 12.51 6.49 80Tier One Capital 13.55 7.17 85 11.33 6.76 81 12.71 6.92 85 10.51 7.71 73 10.23 7.44 75Net Loans & Leases 11.32 8.39 69 12.33 8.84 71 13.25 8.84 72 14.21 8.94 76 7.36 9.15 49Short Term Investments -17.38 25.50 29 -2.58 33.11 35 13.35 21.80 52 -0.39 19.21 46 38.67 18.94 70Short Term Non Core Funding 60.65 18.23 81 -21.76 16.75 18 -48.54 15.40 5 87.77 16.75 88 -23.64 15.88 15
Average Total Assets 418,050 373,969 400,085 349,021 330,304 Total Equity Capital 41,578 36,656 38,963 34,532 31,306 Net Income 2,574 2,021 4,371 3,260 2,869
Number of banks in PeerGroup 1,214 1,219 1,223 1,240 1,254
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FDIC Certificate # 58796 FRB District/ID_RSSD 8 / 3688043 PARKSIDE FINANCIAL BANK AND TRUST ; CLAYTON , MO Balance Sheet %OCC Charter # 0 County: ST LOUIS Balance Sheet Percentage Composition--Page 6 1/10/2018 11:07:16 AMPublic Report 6/30/2017 6/30/2016 12/31/2016 12/31/2015 12/31/2014Percent of Average Assets BANK PG 3 PCT BANK PG 3 PCT BANK PG 3 PCT BANK PG 3 PCT BANK PG 3 PCTLoans Held For Sale 0.00 0.15 45 0.00 0.17 44 0.00 0.19 42 0.00 0.18 43 0.00 0.14 43Loans Not Held For Sale 81.29 68.40 85 81.92 67.35 87 80.14 67.59 82 79.74 66.20 85 78.39 64.99 83 Less: LN&LS Allowance 1.40 0.87 93 1.29 0.89 87 1.29 0.89 87 1.28 0.92 84 1.22 0.97 76 Net Loans & Leases 79.89 68.17 81 80.62 67.25 84 78.85 67.51 79 78.46 66.17 81 77.17 64.62 81 Interest-Bearing BankBalances 9.51 4.47 84 10.74 4.47 87 12.15 4.49 90 12.30 4.48 90 13.90 4.52 92Federal Funds Sold &Resales 0.00 0.30 51 0.00 0.30 54 0.00 0.32 49 0.00 0.31 50 0.00 0.33 49Trading Account Assets 0.00 0.01 96 0.00 0.02 95 0.00 0.01 95 0.00 0.01 95 0.00 0.01 96Held-to-Maturity Securities 0.00 0.79 62 0.00 0.87 62 0.00 0.82 61 0.00 0.92 60 0.00 0.92 60Available-for-Sale Securities 6.15 17.12 19 5.97 17.58 18 6.07 17.46 19 6.48 18.37 18 6.22 19.27 15 Total Earning Assets 95.55 93.22 83 97.33 93.11 97 97.07 93.09 96 97.24 92.92 96 97.29 92.48 98 Nonint Cash & Due FromBanks 0.34 1.64 2 0.38 1.63 3 0.38 1.66 2 0.32 1.72 2 0.34 1.90 2Premises, Fix Assts & CapLeases 0.16 1.64 4 0.24 1.68 5 0.21 1.68 4 0.32 1.70 7 0.44 1.74 10Other Real Estate Owned 0.00 0.16 21 0.09 0.22 45 0.05 0.21 37 0.06 0.29 34 0.05 0.40 26Dir & Indir Inv RE Ventures 0.00 0.01 96 0.00 0.01 95 0.00 0.01 96 0.00 0.01 96 0.00 0.01 95Inv in Unconsolidated Subs 0.00 0.00 88 0.00 0.00 88 0.00 0.00 88 0.00 0.00 87 0.00 0.00 87Acceptances & Other Assets 3.95 3.03 73 1.96 3.00 27 2.29 3.03 32 2.06 2.99 29 1.87 3.07 24 Total Non-Earning Assets 4.45 6.78 16 2.67 6.89 2 2.93 6.91 3 2.76 7.08 3 2.71 7.52 1 Total Assets 100.00 100.00 99 100.00 100.00 99 100.00 100.00 99 100.00 100.00 99 100.00 100.00 99 Standby Letters of Credit 1.05 0.28 93 1.38 0.29 96 1.29 0.28 95 1.59 0.30 97 1.70 0.31 98 Liabilities Demand Deposits 6.88 13.44 31 5.56 12.84 24 6.46 13.10 29 22.89 12.52 86 25.15 11.56 90All NOW & ATS Accounts 0.88 7.73 9 0.74 7.70 7 0.77 7.82 8 5.48 7.50 48 4.82 7.19 46Money Market DepositAccounts 31.42 18.00 84 28.66 17.98 80 29.72 17.86 82 28.28 17.99 80 30.83 18.23 82Other Savings Deposits 28.77 17.77 72 29.20 17.17 73 29.53 17.20 74 7.26 16.76 32 0.27 16.49 3Time Deps At or BelowInsurance Limit 14.41 18.17 36 14.42 19.05 33 13.85 18.85 31 14.16 20.24 27 17.24 21.88 33Less: Fully Insured BrokeredDeposits 9.95 2.28 90 8.47 2.08 88 8.32 2.16 87 8.44 1.93 89 9.10 1.88 90 Core Deposits 72.41 76.79 27 70.11 76.67 20 72.00 76.59 26 69.62 76.87 18 69.21 77.28 17Fully Insured BrokeredDeposits 9.95 2.28 90 8.47 2.08 88 8.32 2.16 87 8.44 1.93 89 9.10 1.88 90Time Deps Above InsuranceLimit 2.77 4.38 36 4.04 4.20 56 3.48 4.27 47 3.86 4.19 52 3.40 4.20 47Deposits in Foreign Offices N/A 2.70 N/A N/A 0.75 N/A N/A 0.80 N/A N/A 3.73 N/A N/A 5.85 N/A Total Deposits 85.12 84.64 48 82.62 84.10 36 83.80 84.16 42 81.92 84.20 31 81.71 84.50 27 Federal Funds Purch & Repos 0.00 0.65 53 0.00 0.76 50 0.00 0.74 48 0.56 0.83 60 0.00 0.92 43Total Fed Home LoanBorrowings 4.72 2.64 73 7.31 2.78 84 6.33 2.80 80 7.47 2.76 85 8.46 2.58 90Total Other Borrowings 0.00 0.00 87 0.00 0.01 86 0.00 0.01 85 0.00 0.01 85 0.00 0.01 85 Memo: Sht Ter N CoreFunding 5.08 7.65 38 5.04 7.40 39 3.87 7.50 26 5.20 7.15 42 4.15 6.90 31 Acceptances & OtherLiabilities 0.79 0.56 76 0.83 0.59 75 0.89 0.59 79 0.88 0.59 79 0.79 0.58 73 Total Liabilities (Incl Mortg) 90.64 89.48 71 90.76 89.29 78 91.02 89.32 85 90.82 89.42 78 90.96 89.59 78 Subordinated Notes &Debentures 0.00 0.01 98 0.00 0.02 98 0.00 0.02 98 0.00 0.02 97 0.00 0.02 97Total Bank Capital & Min Int 9.36 10.51 28 9.24 10.68 21 8.98 10.66 15 9.18 10.56 21 9.04 10.39 21 Total Liabilities & Capital 100.00 100.00 96 100.00 100.00 96 100.00 100.00 95 100.00 100.00 95 100.00 100.00 92 Memo: All Brokered Deposits 9.95 2.61 89 8.47 2.35 86 8.32 2.45 85 8.44 2.19 87 9.10 2.06 89 Insured Brokered Deposits 11.06 2.33 91 8.47 2.08 88 8.32 2.16 87 8.44 1.93 89 9.10 1.88 90 Loans HFS as a % Loans 0.00 0.21 45 0.00 0.26 44 0.00 0.28 42 0.00 0.27 42 0.00 0.21 43
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FDIC Certificate # 58796 FRB District/ID_RSSD 8 / 3688043 PARKSIDE FINANCIAL BANK AND TRUST ; CLAYTON , MO Liquidity & Inv PortfolioOCC Charter # 0 County: ST LOUIS Liquidity & Investment Portfolio--Page 10A 1/10/2018 11:07:18 AMPublic Report
6/30/2017 6/30/2016 12/31/2016 12/31/2015 12/31/2014Percent of Total Assets BANK PG 3 PCT BANK PG 3 PCT BANK PG 3 PCT BANK PG 3 PCT BANK PG 3 PCTShort Term Investments 9.21 6.07 76 12.04 5.95 84 13.46 6.01 88 13.68 5.89 89 15.31 6.01 91Marketable Equity Sec (MES) 0.03 0.01 86 0.03 0.02 85 0.03 0.01 85 0.03 0.02 85 0.00 0.02 76Net LN&LS & SBLC to Assets 82.95 68.96 88 80.78 68.15 82 77.54 68.52 72 79.15 67.44 79 77.49 65.99 78Pledged Assets 83.36 30.59 98 80.76 30.24 98 77.72 30.44 96 78.95 30.23 97 77.15 30.00 97
Securities Mix% Total Securities US Treas & Govt Agencies 49.09 20.79 82 57.47 21.44 86 46.19 20.81 81 56.66 23.78 84 55.81 24.21 84 Municipal Securities 0.00 30.43 10 0.00 29.19 11 12.81 30.20 25 0.00 27.99 11 0.00 25.94 12 Pass-Through Mtg BackedSecs 0.00 20.57 10 0.00 21.59 10 0.00 21.08 10 0.00 21.06 10 0.00 22.06 9 CMO & REMIC Mtg BackedSecs 0.00 7.92 33 0.00 8.15 33 0.00 7.94 33 0.00 8.28 33 0.00 9.33 33 Commercial Mtg Back Secs 0.00 1.94 63 0.00 1.23 70 0.00 1.67 66 0.00 0.97 72 0.00 0.67 76 Asset Backed Securities 15.98 0.01 98 19.38 0.01 99 15.37 0.01 98 20.29 0.01 99 22.43 0.03 99 Structured FinancialProducts 0.00 0.16 95 0.00 0.16 95 0.00 0.15 95 0.00 0.18 95 0.00 0.00 94 Other Domestic Debt Secs 34.40 1.50 98 22.61 1.55 96 25.16 1.48 97 22.53 1.39 96 21.76 1.30 96 Foreign Debt Securities 0.00 0.00 94 0.00 0.00 94 0.00 0.00 94 0.00 0.00 94 0.00 0.00 94 Inv Mut Fnd & Oth Mktbl 0.53 0.09 89 0.54 0.13 88 0.46 0.10 88 0.52 0.13 87 0.00 0.13 76 Total 100.00 100.00 99 100.00 100.00 99 100.00 100.00 99 100.00 100.00 99 100.00 100.00 99
Liquidity/Securities Ratios:App (Dep) Hi Risk & Struc/T1Cap 0.00 -0.04 96 0.00 0.00 85 0.00 -0.08 96 0.00 -0.01 89 0.00 -0.02 86App (Dep) in AFS sec to AFSSec 0.42 0.21 61 0.72 1.72 21 0.28 -0.85 85 0.09 0.44 40 0.45 0.70 45App (Dep) in HTM Sec toHTM Sec N/A 0.90 N/A N/A 2.02 N/A N/A 0.05 N/A N/A 1.15 N/A N/A 1.55 N/AApp (Dep) in HTM Sec to EqyCap 0.00 0.04 77 0.00 0.17 71 0.00 -0.02 86 0.00 0.07 75 0.00 0.11 73Pledged Securities to Tot Sec 0.00 38.75 7 0.00 40.47 6 0.00 38.96 6 0.00 40.26 5 0.00 40.90 5Pledged Loans to Total Loans 100.00 29.60 99 100.00 29.05 99 100.00 29.59 99 100.00 29.23 99 100.00 28.71 99Loans Held for Sale to TotalLoans 0.00 0.22 50 0.00 0.29 49 0.00 0.24 51 0.00 0.24 52 0.00 0.20 51
Short Term Investments 39,051 47,263 60,364 53,254 53,460 Short Term Assets 198,270 191,960 219,632 188,155 177,113 Debt Securities 90+ Days P/D 0 0 0 0 0 Total Non-Current Debt Sec 0 0 0 0 0 Fair Value Structured Notes 0 0 0 0 0 Pledged Securities 0 0 0 0 0 Pledged Loans & Leases 353,412 317,085 348,608 307,396 269,380 Loans Held for Sale 0 0 0 0 0
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UBPR Peer Group Average Report Summary RatiosInsured commercial banks having assets between $300 million and $1 billion 1/10/2018 11:04:07 AM
Summary Ratios--Page 16/30/2017 6/30/2016 12/31/2016 12/31/2015 12/31/2014
Earnings and ProfitabilityPercent of AverageAssets: Interest Income (TE) 3.98 3.93 3.94 3.92 3.97
- Interest Expense 0.41 0.40 0.40 0.40 0.43 Net Interest Income(TE) 3.56 3.53 3.53 3.51 3.53
+ Noninterest Income 0.73 0.75 0.76 0.76 0.75- Noninterest Expense 2.79 2.84 2.84 2.86 2.89- Provision: Loan &
Lease Losses 0.10 0.11 0.12 0.10 0.12 Pretax OperatingIncome (TE) 1.43 1.37 1.38 1.36 1.34
+ RealizedGains/Losses Sec 0.01 0.02 0.02 0.02 0.02 Pretax Net OperatingIncome (TE) 1.44 1.41 1.41 1.39 1.37 Net OperatingIncome 1.06 1.05 1.05 1.04 1.02 Adjusted Net OperatingIncome 1.12 1.11 1.10 1.06 1.01 Net Inc Attrib to Min Ints 0.00 0.00 0.00 0.00 0.00 Net Income AdjustedSub S 0.94 0.93 0.93 0.93 0.91 Net Income 1.06 1.05 1.05 1.04 1.02
Margin Analysis:Avg Earning Assets toAvg Assets 94.55 94.22 94.22 94.03 93.92Avg Int-Bearing Funds toAvg Assets 74.58 74.85 74.49 75.04 76.15Int Inc (TE) to Avg EarnAssets 4.22 4.18 4.19 4.18 4.24Int Expense to Avg EarnAssets 0.44 0.42 0.42 0.42 0.46Net Int Inc-TE to Avg EarnAssets 3.77 3.75 3.76 3.74 3.77
Loan & Lease Analysis:Net Loss to Average TotalLN&LS 0.07 0.07 0.11 0.12 0.18Earnings Coverage of NetLosses (X) 56.23 49.86 39.71 35.31 27.09LN&LS Allowance toLN&LS Not HFS 1.30 1.35 1.32 1.37 1.45LN&LS Allowance to NetLosses (X) 32.70 30.29 24.30 21.61 17.09LN&LS Allowance to TotalLN&LS 1.29 1.34 1.30 1.35 1.44Total LN&LS-90+ DaysPast Due 0.05 0.05 0.05 0.04 0.05
-Nonaccrual 0.64 0.70 0.67 0.78 0.95-Total 0.77 0.84 0.80 0.87 1.06
LiquidityNet Non Core Fund DepNew $250M 6.66 6.59 6.46 6.44 6.11Net Loans & Leases toAssets 68.59 67.79 68.16 67.05 65.60
CapitalizationTier One Leverage Capital 10.3200 10.2500 10.2700 10.2000 10.0800Cash Dividends to NetIncome 34.63 34.49 39.15 37.06 35.32Retained Earnings to AvgTotal Equity 5.65 5.40 5.14 5.22 5.37Rest+Nonac+RE Acq toEqcap+ALLL 8.44 9.69 9.46 10.57 12.86
Growth RatesTotal Assets 6.70 6.28 6.35 6.34 6.49Tier One Capital 7.17 6.76 6.92 7.71 7.44Net Loans & Leases 8.39 8.84 8.84 8.94 9.15Short Term Investments 25.50 33.11 21.80 19.21 18.94Short Term Non CoreFunding 18.23 16.75 15.40 16.75 15.88
Average Total Assets 637,768,046 633,977,344 627,093,963 632,839,644 633,555,605 Total Equity Capital 71,141,009 71,520,350 69,722,639 70,931,500 70,925,741 Net Income 3,545,262 3,446,453 6,890,709 6,860,389 6,609,307
Number of banks in PeerGroup 1,214 1,219 1,223 1,240 1,254
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UBPR Peer Group Average Report Balance Sheet % Insured commercial banks having assets between $300 million and $1 billion 1/10/2018 11:04:08 AM
Balance Sheet Percentage Composition--Page 6 6/30/2017 6/30/2016 12/31/2016 12/31/2015 12/31/2014Percent of Average Assets Loans Held For Sale 0.15 0.17 0.19 0.18 0.14 Loans Not Held For Sale 68.40 67.35 67.59 66.20 64.99 Less: LN&LS Allowance 0.87 0.89 0.89 0.92 0.97 Net Loans & Leases 68.17 67.25 67.51 66.17 64.62 Interest-Bearing BankBalances 4.47 4.47 4.49 4.48 4.52 Federal Funds Sold &Resales 0.30 0.30 0.32 0.31 0.33 Trading Account Assets 0.01 0.02 0.01 0.01 0.01 Held-to-Maturity Securities 0.79 0.87 0.82 0.92 0.92 Available-for-Sale Securities 17.12 17.58 17.46 18.37 19.27 Total Earning Assets 93.22 93.11 93.09 92.92 92.48 Nonint Cash & Due FromBanks 1.64 1.63 1.66 1.72 1.90 Premises, Fix Assts & CapLeases 1.64 1.68 1.68 1.70 1.74 Other Real Estate Owned 0.16 0.22 0.21 0.29 0.40 Dir & Indir Inv RE Ventures 0.01 0.01 0.01 0.01 0.01 Inv in Unconsolidated Subs 0.00 0.00 0.00 0.00 0.00 Acceptances & Other Assets 3.03 3.00 3.03 2.99 3.07 Total Non-Earning Assets 6.78 6.89 6.91 7.08 7.52 Total Assets 100.00 100.00 100.00 100.00 100.00 Standby Letters of Credit 0.28 0.29 0.28 0.30 0.31 Liabilities Demand Deposits 13.44 12.84 13.10 12.52 11.56 All NOW & ATS Accounts 7.73 7.70 7.82 7.50 7.19 Money Market DepositAccounts 18.00 17.98 17.86 17.99 18.23 Other Savings Deposits 17.77 17.17 17.20 16.76 16.49 Time Deps At or BelowInsurance Limit 18.17 19.05 18.85 20.24 21.88 Less: Fully Insured BrokeredDeposits 2.28 2.08 2.16 1.93 1.88 Core Deposits 76.79 76.67 76.59 76.87 77.28 Fully Insured BrokeredDeposits 2.28 2.08 2.16 1.93 1.88 Time Deps Above InsuranceLimit 4.38 4.20 4.27 4.19 4.20 Deposits in Foreign Offices 2.70 0.75 0.80 3.73 5.85 Total Deposits 84.64 84.10 84.16 84.20 84.50 Federal Funds Purch &Repos 0.65 0.76 0.74 0.83 0.92 Total Fed Home LoanBorrowings 2.64 2.78 2.80 2.76 2.58 Total Other Borrowings 0.00 0.01 0.01 0.01 0.01 Memo: Sht Ter N CoreFunding 7.65 7.40 7.50 7.15 6.90 Acceptances & OtherLiabilities 0.56 0.59 0.59 0.59 0.58 Total Liabilities (Incl Mortg) 89.48 89.29 89.32 89.42 89.59 Subordinated Notes &Debentures 0.01 0.02 0.02 0.02 0.02 Total Bank Capital & Min Int 10.51 10.68 10.66 10.56 10.39 Total Liabilities & Capital 100.00 100.00 100.00 100.00 100.00 Memo: All BrokeredDeposits 2.61 2.35 2.45 2.19 2.06 Insured Brokered Deposits 2.33 2.08 2.16 1.93 1.88 Loans HFS as a % Loans 0.21 0.26 0.28 0.27 0.21
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UBPR Peer Group Average Report Liquidity & Inv Portfolio Insured commercial banks having assets between $300 million and $1 billion 1/10/2018 11:04:08 AM
Liquidity & Investment Portfolio--Page 10A 6/30/2017 6/30/2016 12/31/2016 12/31/2015 12/31/2014Percent of Total Assets Short Term Investments 6.07 5.95 6.01 5.89 6.01 Marketable Equity Sec(MES) 0.01 0.02 0.01 0.02 0.02 Net LN&LS & SBLC toAssets 68.96 68.15 68.52 67.44 65.99 Pledged Assets 30.59 30.24 30.44 30.23 30.00 Securities Mix % Total Securities US Treas & Govt Agencies 20.79 21.44 20.81 23.78 24.21 Municipal Securities 30.43 29.19 30.20 27.99 25.94 Pass-Through Mtg BackedSecs 20.57 21.59 21.08 21.06 22.06 CMO & REMIC MtgBacked Secs 7.92 8.15 7.94 8.28 9.33 Commercial Mtg BackSecs 1.94 1.23 1.67 0.97 0.67 Asset Backed Securities 0.01 0.01 0.01 0.01 0.03 Structured FinancialProducts 0.16 0.16 0.15 0.18 0.00 Other Domestic Debt Secs 1.50 1.55 1.48 1.39 1.30 Foreign Debt Securities 0.00 0.00 0.00 0.00 0.00 Inv Mut Fnd & Oth Mktbl 0.09 0.13 0.10 0.13 0.13 Total 100.00 100.00 100.00 100.00 100.00 Liquidity/Securities Ratios: App (Dep) Hi Risk &Struc/T1 Cap -0.04 0.00 -0.08 -0.01 -0.02 App (Dep) in AFS sec toAFS Sec 0.21 1.72 -0.85 0.44 0.70 App (Dep) in HTM Sec toHTM Sec 0.90 2.02 0.05 1.15 1.55 App (Dep) in HTM Sec toEqy Cap 0.04 0.17 -0.02 0.07 0.11 Pledged Securities to TotSec 38.75 40.47 38.96 40.26 40.90 Pledged Loans to TotalLoans 29.60 29.05 29.59 29.23 28.71 Loans Held for Sale to TotalLoans 0.22 0.29 0.24 0.24 0.20
52
Appendix B: Business Model Peer Group Analysis
Peer
Ana
lysi
s
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side
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anci
al B
ank
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ust
06/3
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For D
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%0.
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Net
Loa
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ies
(Exc
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260.
29Yi
eld
on In
vest
men
t Sec
uriti
es (F
TE)
1.66
1.69
1.59
1.67
1.82
1.82
2.72
2.42
2.74
This
Inst
itutio
n ha
s to
tal a
sset
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500,
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000
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h pe
rform
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Tota
l Sec
uriti
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reak
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Portf
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rtfol
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tr. A
vg.
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26,5
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100
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HTM
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0 %
00
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0 %
00
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10 o
f 19
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side
Fin
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al B
ank
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Secu
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s Yi
eld
Anal
ysis
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ome/
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ar-1
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MM
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tere
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com
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9418
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otal
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Jun-
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age
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t of F
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tial
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0.12
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2.38
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11 o
f 19
Park
side
Fin
anci
al B
ank
& Tr
ust
Cla
yton
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Loan
Por
tfolio
Com
posi
tion
Bank
Qua
rter E
ndin
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end
Peer
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paris
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RQ
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h *
Low
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n-16
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ar-1
7Ju
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Jun-
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hose
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Perfo
rmin
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Sect
or A
nal y
sis
Con
str &
Lan
d D
ev24
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24,1
5125
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23,1
1117
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5.09
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Cl-e
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amily
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11,1
5911
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ev 1
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am (H
E Li
nes)
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93,
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3,06
83,
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3,25
00.
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4.37
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1.67
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rm L
oans
00
00
720
0.20
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0.39
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Com
m R
E(N
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69,3
9479
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78,4
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78,5
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ultif
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15,3
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14,9
7215
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Tot D
om R
eal E
stat
e Lo
ans
121,
933
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125,
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126,
648
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3 %
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3 %
Com
mer
cial
& In
dust
rial L
oans
146,
471
154,
687
159,
917
174,
132
177,
885
50.3
3 %
22.5
9 %
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2 %
28.4
9 %
Auto
mob
ile L
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00
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41,
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1,12
81,
129
0.32
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Oth
er C
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mer
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00
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ther
loan
s47
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54,6
2854
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46,6
9747
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13.4
8 %
0.96
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ase
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00
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Gro
ss L
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ease
s31
7,08
534
3,16
234
8,60
834
7,55
535
3,41
210
0.00
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0.00
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an L
oss
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erve
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55,
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5,82
56,
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6,25
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et L
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ases
311,
860
337,
612
342,
783
341,
505
347,
162
Yiel
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naly
sis
RE
Loan
s: 1
-4 F
amily
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6.20
5.96
5.89
6.28
6.28
5.12
5.25
6.14
RE
Loan
s: O
th R
E Lo
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4.60
4.61
4.53
4.41
4.43
4.43
5.02
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C&l
Loa
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704.
784.
684.
754.
994.
995.
195.
305.
72C
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514.
544.
454.
374.
564.
565.
593.
986.
67Al
l Oth
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4.06
4.16
4.43
4.36
4.46
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Yiel
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634.
684.
644.
624.
794.
795.
025.
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37
Loan
Qua
lity
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0.00
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0.80
0.56
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29Th
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stitu
tion
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l ass
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of 0
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rform
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inst
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peer
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per
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by R
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inst
cho
sen
peer
s.
12 o
f 19
Park
side
Fin
anci
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ank
& Tr
ust
Cla
yton
, MO
Dep
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& W
hole
sale
Fun
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posi
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Bank
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ndin
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end
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Cho
sen
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sPe
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Perfo
rmin
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naly
sis
Dem
and
Dep
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4932
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35,4
4126
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12.3
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17.9
4 %
NO
W &
Oth
Tra
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83,
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3,85
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109,
787
124,
262
152,
148
121,
485
132,
019
37.0
8 %
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0 %
27.5
3 %
54.1
9 %
Oth
Sav
ings
Dep
osits
109,
773
137,
735
128,
480
122,
172
120,
856
33.9
4 %
31.0
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36.3
7 %
2.76
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mbo
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e D
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12,9
3611
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11,9
2012
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3.47
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ime
Dep
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60,8
1061
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54,6
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59,9
9616
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62 %
21.4
2 %
Tota
l Dep
osits
325,
138
372,
553
385,
965
357,
034
356,
081
100.
00 %
100.
00 %
100.
00 %
100.
00 %
FHLB
Adv
ance
sFH
LB a
dvs:
Mat
urity
<=
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4,50
04,
500
00
00.
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70.9
4 %
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31.7
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FHLB
adv
s: M
atur
ity 1
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8,50
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000
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011
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47.8
3 %
11.3
7 %
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LB a
dvs:
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urity
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yrs
14,0
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11,0
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0.00
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54 %
FHLB
adv
s: M
atur
ity >
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s0
00
00
0.00
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0.00
%8.
54 %
Tota
l FH
LB A
dvan
ces
27,5
0026
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19,0
0019
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23,0
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0.00
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Bor
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tific
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Oth
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atur
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00
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00
00
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atur
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00
00
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Mat
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00
00
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0.81
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ther
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00
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tal O
ther
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row
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oney
27,5
0026
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23,0
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0.00
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0.00
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is In
stitu
tion
has
tota
l ass
ets
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0,00
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rform
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inst
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peer
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per
form
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qua
rtile
rank
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by R
OAE
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vera
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quity
) aga
inst
cho
sen
peer
s.
13 o
f 19
Park
side
Fin
anci
al B
ank
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ust
Cla
yton
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Ret
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quity
Dec
ompo
sitio
nR
etur
n on
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ity
Gai
n on
Sal
e of
Sec
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Avg
Ass
ets
12.7
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12.8
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rest
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me
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Ass
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81.
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82
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n Ex
pens
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sset
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etur
n on
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ets
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rage
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ets
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%
410
76
Non
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ratin
g In
com
e / A
vg A
sset
sN
et In
tere
st In
com
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vg A
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& O
ther
/ A
vg A
sset
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on In
tere
st M
argi
n/ A
vg A
sset
s
-0.1
9 %
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8 %
3.76
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68 %
0.66
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38 %
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3 %
-1.7
7 %
137
47
Earn
ing
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et /
Avg
Ass
ets
Net
Inte
rest
Mar
gin
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n on
Net
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rest
Pos
ition
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94.3
7 %
3.86
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0.26
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11 %
38
2
Net
Inte
rest
Spr
ead
3.60
%3.
78 %
10
Earn
ing
Ass
et Y
ield
Inte
rest
Bea
ring
Liab
ilitie
s C
ost
4.33
%4.
21 %
0.73
%0.
43 %
83
Wei
ghte
d Lo
an Y
ield
Wei
ghte
d In
vest
men
t Yie
ldW
eigh
ted
Dep
osit
Cos
tW
eigh
ted
Bor
row
ing
Cos
t
4.15
%3.
64 %
0.11
%0.
51 %
0.57
%0.
37 %
0.16
%0.
06 %
416
43
Loan
Yie
ldA
lloca
tion
Inve
stm
ent Y
ield
Allo
catio
nD
epos
it C
ost
Allo
catio
nB
orro
win
g C
ost
Allo
catio
n
4.79
%5.
03 %
86.5
7 %
72.2
2 %
1.82
%2.
26 %
6.17
%23
.08
%0.
62 %
0.39
%91
.74
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.65
%1.
89 %
0.86
%8.
26 %
5.35
%
121
1316
410
24
*Tar
get V
alue
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r Ave
rage
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king
out
of 1
6
14 o
f 19
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side
Fin
anci
al B
ank
& Tr
ust
Cla
yton
, MO
Ret
urn
on E
quity
Mea
n R
ever
sion
Act
ual
Peer
Ave
rage
Hyp
othe
tical
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er Im
pact
s to
RO
EM
ar-1
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n-17
Jun-
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OE
Peer
Ave
rage
Jun-
17 to
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-17
+1%
to V
aria
ble
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chie
ved
Varia
nce
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ieve
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ved
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nce
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4.79
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14.7
4 %
2.00
%11
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.41
%21
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%8.
45 %
Loan
Allo
catio
n82
.78
%86
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%72
.22
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58 %
-4.1
6 %
11.6
5 %
-1.1
0 %
13.0
4 %
0.29
%
Inve
stm
ent
Yiel
d1.
67 %
1.82
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26 %
13.0
1 %
0.26
%12
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%0.
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Inve
stm
ent
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catio
n6.
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6.17
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%7.
84 %
-4.9
1 %
12.6
7 %
-0.0
8 %
12.4
6 %
-0.2
9 %
Dep
osit
Cos
t0.
56 %
0.62
%0.
39 %
14.0
6 %
1.31
%13
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f 19
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al B
ank
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ank
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Pion
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ank
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Wau
kesh
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ate
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auke
sha,
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0.15
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17.5
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13.3
7%
Firs
t Bus
ines
s Ba
nk -
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ison
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1,76
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2.29
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10.5
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Sout
hwes
t Ban
k -
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ssa,
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8,45
230
7,72
51,
307
1.52
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4.73
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47%
2.17
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10%
0.15
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9.45
%11
.36%
12.6
1%9.
64%
Step
hens
on N
atio
nal B
ank
and
Trus
t -
Mar
inet
te,W
I50
8,07
535
2,82
542
4,73
31,
879
1.53
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.24%
3.83
%4.
99%
2.37
%0.
54%
1.23
%65
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9.75
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.29%
14.5
5%9.
41%
Cou
ntry
Clu
b Ba
nk -
Kan
sas
City
,MO
1,37
9,28
993
4,98
01,
163,
875
4,71
81.
35%
14.7
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65%
4.80
%1.
49%
0.11
%0.
73%
73.3
0%9.
01%
11.9
4%13
.19%
9.29
%
Hom
etow
n N
atio
nal B
ank
- La
Salle
,IL21
7,44
013
0,66
519
0,74
359
51.
09%
9.76
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47%
4.83
%2.
22%
0.28
%0.
47%
59.2
0%11
.11%
16.3
8%17
.63%
11.3
5%
Secu
rity
Nat
iona
l Ban
k of
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aha
- O
mah
a,N
E86
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0,82
83,
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1.54
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43%
2.16
%0.
13%
0.06
%63
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10.4
9%13
.58%
14.8
3%10
.48%
Pion
eer T
rust
Ban
k, N
atio
nal A
ssoc
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n -
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m,O
R45
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9,05
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52,
480
2.14
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4.01
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40%
1.46
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19%
0.11
%35
.42%
11.8
0%14
.79%
16.0
5%11
.96%
Bank
of A
nn A
rbor
- A
nn A
rbor
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1,53
4,30
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203,
075
1,33
1,58
56,
439
1.66
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2.30
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0.30
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8.59
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11.4
6%8.
69%
Nic
olet
Nat
iona
l Ban
k -
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en B
ay,W
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825,
192
2,02
4,58
62,
405,
933
8,46
41.
28%
10.1
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31%
5.23
%1.
94%
0.32
%0.
66%
55.4
6%10
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11.4
7%12
.04%
9.20
%
Ariz
ona
Bank
& T
rust
- P
hoen
ix,A
Z56
6,33
937
7,61
849
3,41
91,
073
0.73
%6.
82%
4.18
%5.
03%
2.65
%0.
20%
2.24
%66
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9.74
%13
.88%
15.0
7%9.
91%
Hom
e Sa
ving
s Ba
nk -
You
ngst
own,
OH
2,54
6,65
41,
978,
928
1,93
2,23
68,
174
1.27
%12
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3.39
%4.
24%
2.35
%0.
54%
1.18
%53
.38%
10.1
4%13
.78%
14.8
3%9.
65%
Oak
wor
th C
apita
l Ban
k -
Birm
ingh
am,A
L50
6,34
640
0,66
644
3,59
41,
481
1.17
%9.
96%
3.57
%4.
37%
2.90
%0.
25%
0.00
%58
.10%
11.6
5%12
.73%
13.6
9%11
.80%
Peer
Wei
ghte
d Av
erag
e1,
080,
258
1,18
9,86
21,
340,
094
5,07
81.
30%
12.4
9%3.
95%
5.02
%2.
23%
0.40
%0.
95%
58.8
4%10
.12%
12.6
2%13
.67%
9.89
%
Park
side
Fin
anci
al B
ank
& Tr
ust
- Cla
yton
, M
O42
3,94
635
3,41
235
6,08
11,
304
1.27
%12
.75%
3.86
%4.
79%
1.82
%0.
49%
0.00
%61
.50%
10.1
0%10
.09%
11.3
4%9.
81%
Diff
eren
ce fr
om P
eer
-656
,312
-836
,450
-984
,013
-3,7
74-0
.03%
0.26
%-0
.09%
-0.2
3%-0
.41%
0.09
%-0
.95%
2.66
%-0
.02%
-2.5
3%-2
.33%
-0.0
8%
18 o
f 19
Park
side
Fin
anci
al B
ank
& Tr
ust
Cla
yton
, MO
The
info
rmat
ion
cont
aine
d he
rein
has
bee
n pr
epar
ed fr
om s
ourc
es b
elie
ved
relia
ble
but i
s no
t gua
rant
eed
by S
tifel
Nic
olau
s &
Com
pany
, Inc
orpo
rate
d an
d is
not
a c
ompl
ete
sum
mar
y or
sta
tem
ent o
f all
avai
labl
e da
ta, n
or is
it to
be
cons
trued
as
an o
ffer t
o bu
y or
sel
l any
sec
uriti
es re
ferre
d to
her
ein.
Opi
nion
s ex
pres
sed
are
subj
ect t
o ch
ange
with
out n
otic
e an
d do
no
t tak
e in
to a
ccou
nt th
e pa
rticu
lar i
nves
tmen
t obj
ectiv
es, f
inan
cial
situ
atio
n or
nee
ds o
f inv
esto
rs.
Empl
oyee
s of
Stif
el N
icol
aus
or it
s af
filia
tes
may
, at t
imes
, rel
ease
writ
ten
or o
ral
com
men
tary
, tec
hnic
al a
naly
sis
or tr
adin
g st
rate
gies
that
diff
er fr
om th
e op
inio
ns e
xpre
ssed
with
in.
No
inve
stm
ents
or s
ervi
ces
men
tione
d ar
e av
aila
ble
to “p
rivat
e cu
stom
ers”
in th
e Eu
rope
an E
cono
mic
Are
a or
to a
nyon
e in
Can
ada
othe
r tha
n a
“Des
igna
ted
Inst
itutio
n”.
Stife
l Nic
olau
s an
d/or
its
empl
oyee
s in
volv
ed in
the
prep
arat
ion
or th
e is
suan
ce o
f thi
s co
mm
unic
atio
n m
ay h
ave
posi
tions
in th
e se
curit
ies
or o
ptio
ns o
f the
issu
er/s
dis
cuss
ed o
r rec
omm
ende
d he
rein
. Se
curit
ies
iden
tifie
d he
rein
are
sub
ject
to a
vaila
bilit
y an
d ch
ange
s in
pr
ice.
Stife
l, N
icol
aus
& C
ompa
ny, I
nc. i
s a
mul
ti-di
scip
lined
fina
ncia
l ser
vice
s fir
m th
at re
gula
rly s
eeks
inve
stm
ent b
anki
ng a
ssig
nmen
ts a
nd c
ompe
nsat
ion
from
issu
ers
for s
ervi
ces
incl
udin
g,
but n
ot li
mite
d to
, act
ing
as a
n un
derw
riter
in a
n of
ferin
g or
fina
ncia
l adv
isor
in a
mer
ger o
r acq
uisi
tion,
or s
ervi
ng a
s a
plac
emen
t age
nt in
priv
ate
trans
actio
ns.
Mor
eove
r, St
ifel
Nic
olau
s an
d its
affi
liate
s an
d th
eir r
espe
ctiv
e sh
areh
olde
rs, d
irect
ors,
offi
cers
and
/or e
mpl
oyee
s, m
ay fr
om ti
me
to ti
me
have
long
or s
hort
posi
tions
in s
uch
secu
ritie
s or
in o
ptio
ns o
r ot
her d
eriv
ativ
e in
stru
men
ts b
ased
ther
eon.
Rea
ders
of t
his
repo
rt sh
ould
ass
ume
that
Stif
el N
icol
aus
or o
ne o
f its
affi
liate
s is
see
king
or w
ill se
ek in
vest
men
t ban
king
and
/or o
ther
bus
ines
s re
latio
nshi
ps w
ith th
e is
suer
or i
ssue
rs,
or b
orro
wer
or b
orro
wer
s, m
entio
ned
in th
is re
port.
Stif
el N
icol
aus’
Fix
ed In
com
e C
apita
l Mar
kets
rese
arch
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53
Appendix C:Stifel Nicolaus & Co. “Unlocking the Secrets of High Performance Bank Portfolios”
Fixed IncomeStrategies Bank Performance Study
May 10, 2017
MICHAEL BENEDICT, CFA DIRECTOR (303) [email protected]
JAKE SAMUELS ASSOCIATE (212) [email protected]
Please see the last page of this report for important
disclosures and disclaimers.
Unlocking the Secrets of High Performance Bank Portfolios – 2017 Update
In past years, Stifel’s strategy group has published multiple reports regarding the drivers of portfolio performance at depository institutions, including several which evaluated the total return performance of bank portfolios over various historical periods. This analysis represents the eighth edition of the study and covers the period from the 1st quarter of 2004to the 4th quarter of 2016. Though the time frame has been extended compared to priorstudies, many of the same themes remain in place:
Bank portfolios in the top quartile outperformed those in the bottom quartile by anaverage of 2.12% per year since 2004. Decisions surrounding portfolio compositionand investment strategy can create meaningful differences in portfolio performance.
Over long time horizons, income is a primary driver of portfolio returns. Priceperformance is an important component of short-term returns, but variations basedon the interest rate environment tend to cancel out over time.
Top-performing portfolios have a higher allocation to long-duration securities thanlow-performing ones, potentially indicating implementation of a barbell approach toportfolio management.
Portfolio composition has meaningful implications for portfolio performance. High-performing portfolios have utilized an above-average allocation to municipalsecurities and a below-average allocation to Treasuries and Agencies.
Introduction and Methodology
Bank portfolio analysis has historically been performed with Book Yield as the primary focus. While Book Yield is an important element of portfolio performance, it does not fully represent the overall performance of a bond portfolio. Total Return is a more complete measure of portfolio performance, as it incorporates both an income return and a price return. For professional money managers, Total Return is the industry standard for measuring portfolio performance.
In this report, we calculate annual total return estimates for the 13-year period stretching from the first quarter of 2004 to the fourth quarter of 2016 for all commercial bank portfolios1. This period was selected because it covers an entire interest rate cycle thatincorporates a variety of yield curve shapes (steep, flat, inverted) and monetary policy directives (tightening and easing).
1 Includes all call report filers operating continuously from 2004 – 2016. Excludes banks without securities holdings.
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Total Return estimates were calculated using the following methodology:
Income Return = (fully taxable equivalent income from securities) / (average total securities)
Price Return = [ (realized gains/losses on securities) + (change in unrealized gain/loss on total securities) ]
/ (average total securities)
Total Return = Income Return +/- Price Return
Total returns were calculated for each year and averaged over the entire period. After generating an average annualized Total Return, the data was sorted into four quartiles, with an average being calculated for each. In addition, average sector weightings and maturity / repricing characteristics of each quartile were calculated to give a general representation of portfolio composition and maturity distribution. The data is summarized in Figures 1-3 below.
In addition to the summary-level data for all call report filers, we have included supplemental tables and data at the end of this report for the following asset size groupings (all asset sizes as of 4Q16):
Total Assets less than $100MM
Total Assets between $100MM and $500MM
Total Assets between $500MM and $1BN
Total Assets between $1BN and $10BN
Total Assets greater than $10BN
Performance Analysis
Figure 1 – Average Returns (2004-2016)
Source: SNL Financial, Stifel Fixed Income Strategy
Price Return Income Return Total Return 1st Quartile 0.10% 4.48% 4.58% 2nd Quartile -0.01% 3.77% 3.75% 3rd Quartile -0.08% 3.40% 3.32% 4th Quartile -0.28% 2.84% 2.56%
-1.00%
0.00%
1.00%
2.00%
3.00%
4.00%
5.00%
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Figure 1 shows that there is a considerable gap between top performers and bottom performers over time. Though average total returns are positive for all four quartiles in the analysis, a dollar invested in 2004 that generated the 2.56% annual return from the lowest quartile would be worth $1.39 today, while a dollar that generated the 4.58% annual return from the top quartile would be worth $1.79 today – an improvement of 29%. While price return – which may or may not be captured by bank portfolio managers – drives a component of that outperformance, the results suggest that a focus on income will drive meaningful outperformance over the entirety of an interest rate cycle. In the bottom three quartiles, Income Returns drove all positive performance, as the 1st quartile was the only one that generated a positive Pricing Return over the period, though the drag in the 2nd and 3rd quartiles was small.
These results suggest that certain portfolio managers are able to generate considerable outperformance, as the 83 basis point gap between the 1st and 2nd quartiles is nearly double the 43 basis point gap between the 2nd and 3rd quartiles. The sword cuts both ways, however, as the 75 basis point gap between the 3rd quartile and 4th quartiles almost exactly mirrors the performance differential for top-performing portfolios.
Figure 2 – Average Maturity / Repricing Buckets (2004-2016)
Source: SNL Financial, Stifel Fixed Income Strategy
Fortunately, data surrounding maturity / repricing buckets offers some insight on how to generate performance that is more consistent with the 1st quartile than the 4th. Top-performing portfolios contained a larger allocation to longer-duration securities than any other group, with nearly three quarters of the portfolio carrying a maturity / repricing profile greater than three years.
4th quartile portfolios show a much more defensive position, with more than half of the portfolio carrying a maturity / repricing profile of less than 3 years. The allocation to short-duration instruments for portfolios in the 4th quartile was more than double the 25.52% allocation seen in portfolios from the 1st quartile, and the 4th quartile’s short-duration allocation is still 49% higher than portfolios from the 3rd quartile. Considered in combination with the Total Return gap between quartiles, this suggests that defensive positioning carries a significant cost and, if extrapolated, also argues in favor of staying fully invested. However, with Securities to Assets also at the lowest level in the 4th quartile, it may be possible that banks comprising this group have a larger loan book and may rely
0-3 Years 3+ Years 2016Y Securities/Total Assets
1st Quartile 25.52% 74.33% 25.19% 2nd Quartile 30.31% 69.59% 23.46% 3rd Quartile 38.43% 61.47% 22.87% 4th Quartile 57.09% 42.82% 18.27%
0.00%
20.00%
40.00%
60.00%
80.00%
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less on portfolio income as a driver of profitability. A portfolio that comprises a smaller percentage of assets may also drive a change in strategy as pledging, cash flow, and liquidity needs may be given priority over income generation.
Data supporting a higher allocation to long-duration securities is consistent with our recommendation for utilizing a barbell structure in portfolio construction, with the income-generating effects of an outsized long-duration component providing a total return benefit over a laddered structure. We believe this suggestion is particularly relevant for flattener rate scenarios, and while the Treasury curve has flattened meaningfully since the start of 2017, the 2s-10s Treasury spread is still well above the flat – or even inverted – levels seen from 2005 to 2007.
Figure 3 – Average Portfolio Composition (2009Q2-2016)
Source: SNL Financial, Stifel Fixed Income Strategy
The final measure considered in this study is the average portfolio composition from each quartile. Here, the timeline is somewhat truncated, as data on portfolio composition gained additional specificity after the 2008 financial crisis. While this does not capture the flat / inverted yield curve environment from 2005-2007, it should provide useful insight into the portfolio composition that has been employed over the past several years.
Evaluating portfolio composition again reveals substantial differences between portfolios in the 1st quartile and those in the 4th, with lower-performing portfolios tilting more heavily towards Treasuries and Agencies. In the 4th quartile, the Treasury / Agency component of the portfolio represented 53.46% of the portfolio, while 1st quartile portfolios gave the same sectors an average allocation of 18.18% – a reduction of nearly two thirds. 3rd quartile portfolios featured an average Treasury and Agency allocation of 34.14%, still a 36% reduction over their 4th quartile counterparts. While these sectors provide excellent liquidity and are very useful for pledging purposes, the limited return profile served as a significant drag on Total Return performance for lower-quartile portfolios.
On the other hand, higher-performing portfolios tend to have a higher allocation to Municipal securities. Portfolios in the 1st quartile allocated 48.31% to Municipals, nearly triple the 18.31% allocation seen in the 4th quartile. Municipal securities frequently represent one of the longest-duration sectors in bank portfolios, and due to the
Treasuries Agencies MBS CMOs CMBS Munis Other 1st Quartile 1.53% 16.65% 19.23% 9.11% 0.90% 48.31% 4.28% 2nd Quartile 1.52% 22.97% 27.83% 10.93% 0.95% 32.77% 3.03% 3rd Quartile 2.59% 31.55% 26.20% 11.09% 1.05% 24.25% 3.28% 4th Quartile 8.42% 45.04% 16.98% 7.05% 0.70% 18.31% 3.49%
0.00%
10.00%
20.00%
30.00%
40.00%
50.00%
60.00%
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favorable tax treatment received in tax-exempt issues, many generate a greater yield than similar-duration taxable alternatives. The prospect of tax reform has created some uncertainty in the sector, but even if investors favor taxable municipals over tax-exempts, the strong income and rolldown potential in municipals can still generate outsized returns.
Residential mortgage allocations – both MBS Pass-Throughs and CMOs – remained relatively consistent across quartiles. 4th quartile portfolios allocated 24.03% to these two sectors, while 1st quartile portfolios allocated slightly more at 28.33%. RMBS is the only sector weighted more heavily in 2nd and 3rd quartile portfolios than those at the top or bottom of the Total Return spectrum. This runs counter to our findings in previous studies and suggests that high-performing institutions have reallocated a portion of their MBS portfolio to municipals in the post-crisis period.
Several other notable trends emerge when examining portfolio composition data across asset size ranges. While Total Return profile and maturity / repricing distributions remain relatively consistent across asset groupings, portfolio composition looks very different for large banks than it does for their smaller brethren. Though banks of all sizes utilize MBS securities to a degree, the allocation grows steadily as asset size increases. Banks under $100MM have an average allocation of 22.50%, while the nation’s largest institutions feature a 58.97% allocation to MBS securities – including a 25.56% allocation to CMOs that eclipses the entire MBS exposure of the <$100MM cohort. We believe the nearly threefold increase is driven by a much greater degree of involvement in the structuring and securitization of both MBS Pass-throughs and CMOs. In addition, CMBS allocations increased by a minimum of nearly 7x across all size cohorts since 2009 – though with an average allocation of 2.14%, CMBS holdings still comprise a small portion of portfolio holdings overall.
The increase in RMBS balances at larger institutions comes at the expense of the Municipal and Agency sectors. While Municipals represent an average of 35.14% of portfolio allocation at banks with <$100MM in assets, the allocation decreases to only 9.30% for those with assets of $10BN or more (although with an allocation of 17.70%, Municipals are still well-represented in 1st quartile portfolios for that size grouping). The decrease is likely caused by the lack of scalability in the sector due to smaller issuance sizes. For the Agency sector, the decrease is quite dramatic above $10BN as banks allocate more heavily to Treasuries based on Liquidity Coverage Ratio (LCR) requirements imposed as part of Basel III. Compliance with the LCR is only required for institutions with greater than $50BN in Total Assets, but we have spoken with multiple institutions under that threshold who have begun shifting portfolio allocations as a preparatory measure.
Conclusion
Different styles of portfolio management can have a dramatic impact on realized performance. While many of the points discussed in this report are not new, they may be a helpful reminder as the Fed’s tightening cycle continues to progress. Decisions made today can affect portfolio performance years into the future, and though many community banks may not have the capacity to evaluate their portfolio as a professional money manager would, it is important to consider whether your portfolio’s performance is appropriate for your institution. Stifel’s Strategy team is constantly evaluating client portfolios for ways to improve performance while being mindful of institution-specific goals and constraints, employing some of the broadest and deepest data and analytics available. Please contact your Stifel Fixed Income representative for an in-depth analysis of your bank’s portfolio.
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Supplemental Data Source: SNL Financial, Stifel Fixed Income Strategy for all data
Average Total Return – Banks <$100MM
Average Portfolio Composition – Banks <$100MM
Average Maturity / Repricing Buckets – Banks <$100MM
Price Return Income Return Total Return 1st Quartile 0.07% 4.53% 4.60% 2nd Quartile -0.05% 3.73% 3.68% 3rd Quartile -0.13% 3.32% 3.18% 4th Quartile -0.29% 2.71% 2.42%
-1.00%0.00%1.00%2.00%3.00%4.00%5.00%
Treasuries Agencies MBS CMOs CMBS Munis Other 1st Quartile 1.32% 18.77% 15.54% 5.48% 0.45% 53.77% 4.67%
2nd Quartile 1.66% 26.96% 23.79% 6.06% 0.24% 38.92% 2.36% 3rd Quartile 2.86% 39.96% 19.68% 5.62% 0.30% 28.91% 2.67% 4th Quartile 11.62% 53.50% 10.48% 3.34% 0.12% 18.96% 1.97%
0.00%
10.00%
20.00%
30.00%
40.00%
50.00%
60.00%
0-3 Years 3+ Years 2016Y Securities/Total Assets
1st Quartile 27.39% 72.45% 27.20% 2nd Quartile 32.10% 67.76% 25.51% 3rd Quartile 43.59% 56.30% 24.80% 4th Quartile 63.33% 36.55% 19.22%
0.00%
20.00%
40.00%
60.00%
80.00%
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Supplemental Data Source: SNL Financial, Stifel Fixed Income Strategy for all data
Average Total Return – Banks $100MM-$500MM
Average Portfolio Composition – Banks $100MM-$500MM
Average Maturity / Repricing Buckets – Banks $100MM-$500MM
Price Return Income Return Total Return 1st Quartile 0.08% 4.50% 4.57% 2nd Quartile 0.00% 3.79% 3.79% 3rd Quartile -0.05% 3.42% 3.37% 4th Quartile -0.24% 2.86% 2.62%
-1.00%0.00%1.00%2.00%3.00%4.00%5.00%
Treasuries Agencies MBS CMOs CMBS Munis Other 1st Quartile 1.15% 17.13% 19.65% 8.46% 0.68% 49.55% 3.38%
2nd Quartile 1.27% 22.51% 27.39% 10.77% 0.70% 34.85% 2.51% 3rd Quartile 2.26% 30.85% 26.91% 10.33% 0.90% 26.07% 2.68% 4th Quartile 7.12% 45.83% 18.06% 6.71% 0.53% 19.00% 2.76%
0.00%10.00%20.00%30.00%40.00%50.00%60.00%
Figure 2 - Portfolio Composition (2009Q2-2016Q2)
0-3 Years 3+ Years 2016Y Securities/Total Assets
1st Quartile 24.04% 75.80% 25.72% 2nd Quartile 29.69% 70.21% 24.97% 3rd Quartile 36.68% 63.24% 22.73% 4th Quartile 56.01% 43.92% 18.03%
0.00%
20.00%
40.00%
60.00%
80.00%Figure 3 - Maturity / Repricing Buckets and Portfolio Size (2004-2016Q2)
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Supplemental Data Source: SNL Financial, Stifel Fixed Income Strategy for all data
Average Total Return – Banks $500MM-$1BN
Average Portfolio Composition – Banks $500MM-$1BN
Average Maturity / Repricing Buckets – Banks $500MM-$1BN
Price Return Income Return Total Return 1st Quartile 0.18% 4.53% 4.71% 2nd Quartile -0.01% 3.79% 3.78% 3rd Quartile -0.04% 3.39% 3.35% 4th Quartile -0.30% 2.97% 2.66%
-1.00%0.00%1.00%2.00%3.00%4.00%5.00%
Treasuries Agencies MBS CMOs CMBS Munis Other 1st Quartile 2.71% 13.69% 20.45% 12.45% 0.96% 44.87% 4.88%
2nd Quartile 1.05% 21.67% 29.13% 13.57% 1.58% 29.75% 3.24% 3rd Quartile 2.54% 30.03% 25.99% 14.60% 1.48% 21.88% 3.49% 4th Quartile 6.68% 35.37% 25.65% 11.55% 1.92% 13.78% 5.06%
0.00%
10.00%
20.00%
30.00%
40.00%
50.00%
0-3 Years 3+ Years 2016Y Securities/Total Assets
1st Quartile 25.89% 74.02% 20.60% 2nd Quartile 29.44% 70.48% 19.60% 3rd Quartile 40.23% 59.65% 22.35% 4th Quartile 49.95% 49.83% 17.08%
0.00%
20.00%
40.00%
60.00%
80.00%
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Supplemental Data Source: SNL Financial, Stifel Fixed Income Strategy for all data
Average Total Return – Banks $1BN-$10BN
Average Portfolio Composition – Banks $1BN-$10BN
Average Maturity / Repricing Buckets – Banks $1BN-$10BN
Price Return Income Return Total Return 1st Quartile 0.16% 4.26% 4.41% 2nd Quartile 0.00% 3.71% 3.70% 3rd Quartile -0.08% 3.44% 3.36% 4th Quartile -0.26% 3.01% 2.74%
-1.00%0.00%1.00%2.00%3.00%4.00%5.00%
Treasuries Agencies MBS CMOs CMBS Munis Other 1st Quartile 1.82% 14.86% 24.10% 15.73% 2.93% 33.69% 6.87%
2nd Quartile 1.80% 20.56% 33.49% 14.23% 1.97% 22.09% 5.86% 3rd Quartile 3.00% 23.18% 31.70% 18.65% 1.90% 15.71% 5.87% 4th Quartile 7.79% 30.62% 24.68% 16.55% 2.09% 11.53% 6.74%
0.00%
10.00%
20.00%
30.00%
40.00%
0-3 Years 3+ Years 2016Y Securities/Total Assets
1st Quartile 26.54% 73.29% 22.42% 2nd Quartile 31.33% 68.58% 20.55% 3rd Quartile 36.68% 63.29% 18.58% 4th Quartile 49.60% 50.42% 15.68%
0.00%
20.00%
40.00%
60.00%
80.00%
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Supplemental Data Source: SNL Financial, Stifel Fixed Income Strategy for all data
Average Total Return – Banks $10BN+
Average Portfolio Composition – Banks $10BN+
Average Maturity / Repricing Buckets – Banks $10BN+
Price Return Income Return Total Return 1st Quartile 0.26% 4.24% 4.50% 2nd Quartile 0.09% 3.57% 3.66% 3rd Quartile -0.06% 3.28% 3.22% 4th Quartile -1.13% 2.99% 1.85%
-1.00%0.00%1.00%2.00%3.00%4.00%5.00%
Treasuries Agencies MBS CMOs CMBS Munis Other 1st Quartile 6.64% 6.05% 37.49% 20.73% 4.26% 17.70% 7.13%
2nd Quartile 3.02% 3.84% 43.10% 34.51% 3.71% 6.14% 5.68% 3rd Quartile 9.24% 11.67% 25.45% 28.38% 4.99% 6.69% 13.59% 4th Quartile 12.75% 13.58% 27.71% 18.63% 2.36% 6.67% 18.29%
0.00%
10.00%
20.00%
30.00%
40.00%
50.00%
0-3 Years 3+ Years 2016Y Securities/Total Assets
1st Quartile 26.38% 73.45% 17.18% 2nd Quartile 31.35% 68.61% 18.80% 3rd Quartile 40.89% 58.97% 24.77% 4th Quartile 50.36% 49.49% 18.97%
0.00%
20.00%
40.00%
60.00%
80.00%
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Disclaimer This material is prepared by the Fixed Income Department of Stifel Nicolaus & Co (“Stifel”) and intended for Institutional Use Only and is not intended for use by retail clients. The information contained herein has been prepared solely for informational purposes and is not an offer to buy or sell or a solicitation of an offer to buy or sell any security or instrument or to participate in any trading strategy. Your decision to invest in any security or instrument, liquidate or hold a current position should be made after consultation with legal, tax and accounting professionals in light of your own profile, investment strategy, and risk tolerance.
All materials, including proposed terms and conditions, are indicative and for discussion purposes only. Finalized terms and conditions are subject to further discussion and negotiation and will be evidenced by a formal agreement. Opinions expressed are current as of the date of this publication and are subject to change without notice and may differ from those of the Fixed Income Research Department or other departments that produce similar material. The information contained herein is confidential. By accepting this information, the recipient agrees that it will, and it will cause its directors, partners, officers, employees and representatives to use the information only to evaluate its potential interest in the strategies described herein and for no other purpose and will not divulge any such information to any other party. Any reproduction of this information, in whole or in part, is prohibited. Except in so far as required to do so to comply with applicable law or regulation, express or implied, no warranty whatsoever, including but not limited to, warranties as to quality, accuracy, performance, timeliness, continued availability or completeness of any information contained herein is made. Any historical price(s) or value(s) are also only as of the date indicated.
Stifel does not provide accounting, tax or legal advice; however, you should be aware that any proposed indicative transaction could have accounting, tax, legal or other implications that should be discussed with your advisors and/or counsel. The materials should not be relied upon for the maintenance of your books and records or for any tax, accounting, legal or other purposes. In addition, we mutually agree that, subject to applicable law, you may disclose any and all aspects of any potential transaction or structure described herein that are necessary to support any U.S. federal income tax benefits, without Stifel imposing any limitation of any kind.
Stifel shall have no liability, contingent or otherwise, to the user or to third parties, or any responsibility whatsoever, for the correctness, quality, accuracy, timeliness, pricing, reliability, performance or completeness of the data or formulae provided herein or for any other aspect of the performance of this material. In no event will Stifel be liable for any special, indirect, incidental or consequential damages which may be incurred or experienced on account of the user using the data provided herein or this material.
Stifel Nicolaus & Co is a broker-dealer registered with the United States Securities and Exchange Commission and is a member FINRA, NYSE & SIPC. © 2017
54
Appendix D:Parkside Financial Bank and Trust Investment Policy
Investments
Statement of Policy
Investments Policy
Table of Contents
Policy
I. Strategic Investment Strategy ........................................................…… 1
II. Authorized Personnel ..................................................................... 1
A. Investment Officer(s) ......................................................... 1
B. Investment Accountant ...................................................... 1
III. Investment Execution ............................................................……. 1
A. Approved Dealer Firms ..................................................... 1
B. Other Approved Dealer Firms ........................................... 2
IV. Authorized Investments and Limits ............................................…... 3
A. Fixed Rate Investments ……................................................. 3
B. Variable Rate Investments …................................................ 4
C. Block Sizes …………………. ..................................................... 5
V. Risk Management ....................................................................…...... 5
A. Asset Quality Limits .........................................................… 5
B. Concentration Limits ......................................................… 7
C. Credit Analysis ……………………………………………. 8
D. Shocked GAAP Capital …………………………………… 8
VI. Statement of Financial Accounting Standard #115 ......………....…. 8
VII. Safekeeping ....................................................................................... 8
Investments Policy
Table of Contents
Appendix
I. Statement of Objectives ................................................................... 1
A. Philosophy & Objectives…………………………………… 1
II. Authorized Personnel ...................................................................… 2
A. Board of Directors............................................................ 2
B.
Asset Liability Committee…………………………
3
A.
Investment Officer………………………………………
4
III. Investment Execution .................................................................….. 4
A. Approved Dealer Firms ...................................................... 4
V. Risk Management ........................................................................... 4
A.
Safety of Principal .............................................................
4
B.
Liquidity ....................................................................…..
5
C.
Interest Rate Sensitivity ....................................................
5
D.
Shocked GAAP Capital ………………………………….
5
E.
Prohibited Investments and Activities ..............................
6
VI. Valuation and Reporting ....................................................……… 6
A.
Investment Accountant ....................................................
6
B.
Valuation ...………….......................................................
7
C.
Monthly Reporting ...........................................................
7
D.
Quarterly Reporting .........................................................
7
E.
Statement of Financial Accounting Standard #115 ..........
8
VII. Safekeeping ................................................................................... 8
Investments Policy
VIII. Pledging ….................................................................................... 8
I. Strategic Investment Strategy
The Investment Policy requires management to develop a Strategic Investment Strategy to guide the investment portfolio.
II. Authorized Personnel
A. Investment Officer(s)
Jim Wagner and Jim Hannon will serve as Investment Officer(s). The Investment Officer(s) are authorized to purchase securities totaling $10 million per month. Securities sales are limited to $10 million per month in the aggregate. The Investment Officer(s) is authorized to sell investments in accordance with the Strategic Investment Strategy. However, losses on sale in excess of $50,000 must have prior ALCO approval.
B. Investment Accountant
A qualified Investment Package will be determined and utilized for the Bank.
III. Investment Execution
A. Approved Dealer Firms
The bank has approved a list of dealer firms for trade execution on its behalf. The ALCO and Board of Directors review and approve this list at least annually:
Commerce Bank www.commercebank.com 8000 Forsyth Blvd Saint Louis, MO 63105
Stern Brothers & Co. 8000 Maryland Ave Suite 800 Clayton, MO 63105
FTN Financial 845 Crossover Lane Suite 150 www.ftnfinancial.com Memphis, TN 38117
A. Approved Dealer Firms (continued)
BMO Harris Bank
www.bmo.com 13205 Manchester Rd Saint Louis, MO 63131
Detalus
www.detalus.com 383 Marshall Ave Saint Louis, MO 63119
The Charles Schwab Corporation
101 Montgomery Street www.schwab.com San Francisco, CA 94104
BNY Mellon Capital Markets, LLC 32 Old Slip, 15th Floor
www.BNYMellon.com New York, NY 10286
Zions Bank
310 South Main Street, Suite 1400 Salt Lake City, UT 84101
Raymond James
50 N. Front St. Memphis TN 38103 www.RaymondJames.com
B. Other Approved Dealer Firms
The bank also maintains separate broker-dealer relationships. These relationships are maintained primarily as a source for municipal bonds. These dealers and their individual sales representative are reviewed and approved annually by the ALCO and the Board of Directors. The approved list is as follows, however, please note that the Bank’s primary provider of securities – Detalus – maintains its own list of approved broker dealers which are reviewed and approved regularly and provided to the Bank. These broker dealers are also allowable per policy:
Commerce Bank Investments Mark Chellis Vice President St. Louis MO 63105
Stern Brothers & Co. 8000 Maryland Ave Suite 800 Clayton, MO 63105
FTN Financial 845 Crossover Lane Suite 150 Memphis, TN 38117
The Charles Schwab Corporation 101 Montgomery Street San Francisco, CA 94104
BMO Harris Bank www.bmo.com 13205 Manchester Rd Saint Louis, MO 63131
Hancock Securities www.hancocksecurities.com 383 Marshall Ave Saint Louis, MO 63119
BNY Mellon Capital Markets, LLC 32 Old Slip, 15th Floor www.BNYMellon.com New York, NY 10286
Zions Bank 310 South Main Street, Suite 1400 Salt Lake City, UT 84101
Raymond James 50 N. Front St. Memphis TN 38103 www.RaymondJames.com
D.A. Davidson & Company www.davidsoncompanies.com 611 Anton Boulevard #600 Costa Mesa, CA 92626
III. Authorized Investments and Limits
The following investments are permissible by policy, subject to the quantity limits set forth in each category:
A. Fixed Rate Investments
1. U.S. Treasury Securities - Coupon bearing and zero coupon instruments are permissible in any quantity. There are no restrictions on stated coupon levels. Maximum final maturity is 10 years.
2. Bullet Federal Agency Securities - Coupon bearing and zero coupon non-callable,
federal agency securities are permissible in any quantity. There are no restrictions on stated coupon levels. All federal agency issuers permitted by law are permissible under this policy. Maximum final maturity is 10 years.
3. Callable Federal Agency Securities - There are no restrictions on stated coupon levels.
All federal agency issuers permitted by law are permissible under this policy. Maximum final maturity is 15 years. Maximum expected duration at time of purchase is 7 years
based upon Bloomberg’s OAS model.
4. Step-up Federal Agency Securities - Step-up notes and other types of structured federal agency notes are limited to 20% of total capital. There are no restrictions on stated coupon levels or coupon formulas. All federal agency issuers permitted by law are permissible under this policy. Maximum final maturity is 10 years.
5. Mortgage-Backed Securities (MBS) - Federal agency guaranteed mortgage-backed
securities are limited to 50% of total capital. There are no restrictions on stated coupon levels. GNMA, FNMA and FHLMC are permissible issuers under this policy. Maximum base case average life at the time of purchase is 10 years. There are no restrictions on stated final maturity.
6. Collateralized Mortgage Obligations (CMOs): Agency - Federal agency issued CMOs
that are backed by federal agency guaranteed mortgage-backed pools are permissible in quantities up to 50% of total capital. There are no restrictions on stated coupon levels. GNMA, FNMA and FHLMC are permissible issuers under this policy. Maximum base case average life is 7 years at the time of purchase. There are no restrictions on stated final maturity.
7. Collateralized Mortgage Obligations (CMOs): Private - Privately issued CMOs that
are backed by either federal agency guaranteed mortgage-backed pools or pools of whole loans are permissible in quantities up to 30% of total capital, subject to the issuer size limitations set forth previously. There are no restrictions on stated coupon levels. All major private issuers are permissible issuers under this policy. Only investment grade and higher paper is permissible under this policy. Maximum base case average life is 7 years at the time of purchase. There are no restrictions on stated final maturity.
8. Asset-Backed Securities (ABSs): Private - Privately issued ABSs that are backed by
either federal agency guaranteed obligations directly or in or pools are permissible in quantities up to 30% of total capital, subject to the issuer size limitations set forth previously. There are no restrictions on stated coupon levels. All major private issuers are permissible issuers under this policy. Only investment grade paper is permissible under this policy. Maximum base case average life is 7 years at the time of purchase. There are no restrictions on stated final maturity.
9. Municipal Securities - Callable and non-callable municipal securities are limited to 50%
of total capital, subject to the issuer size limitations set forth previously. Only investment grade and higher rated paper is permissible under this policy, except in cases of non-rated local issues. There are no restrictions on stated coupon levels. Any municipal entity that meets the appropriate credit rating criteria is permitted under this policy. Maximum final maturity is 20 years. Credit quality analysis will rely primarily upon the issue's bond rating, except local issues. Annual credit reviews will be required for non-rated local issues.
10. Corporate Securities - Callable and non-callable corporate securities and commercial
paper are limited to 25% of total capital, subject to the issuer size limitations set forth previously. Only investment grade bonds arepermissible under this policy for corporate bonds. Only P1 rated commercial paper is permissible. There are no restrictions on stated coupon levels. Any corporate entity that meets the appropriate credit rating criteria is permitted under this policy. Maximum final maturity is 7 years. Maximum final maturity on uncapped floating rate Corporate securities is 30 years. Credit quality analysis will rely primarily upon the issue's bond rating.
11. Certificates of deposit - Certificates of deposit, Eurodollar CDs, Yankee Dollar CDs and bankers acceptances are limited to 10% of total capital. Uninsured balances are not permitted. There are no restrictions on stated coupon levels. All depository institutions providing deposit insurance are permitted under this policy. Maximum maturity is 5 years. Fully FDIC insured certificates have no limit.
IV. Authorized Investments and Limitations
B. Variable Rate Investments
1. Federal Agency Notes - Variable rate, non-callable federal agency notes are limited to 25% of capital. There are no restrictions on stated coupon levels. Permissible indices include any treasury based index, the 11th district cost of funds, LIBOR, and prime rate. All instruments must reset at least annually. The coupon must float directly with the index and cannot be levered or de-levered. Caps are not permissible. All federal agency issuers permitted by law are permissible under this policy. Maximum final maturity is 5 years.
2. Mortgage-Backed Securities - Federal agency guaranteed, adjustable rate mortgage
securities (ARMS) are limited to 30% of total capital. There are no coupon rate restrictions. Annual reset and lifetime caps must be at least 1.00% and 9.00%, respectively. Permissible indices include any treasury index, the 11th district cost of funds index, LIBOR, or prime rate. Instruments must reset at least annually. The coupon must float directly with the index and cannot be levered or de-levered. GNMA, FNMA and FHLMC are permissible issuers under this policy. Maximum base case average life is 10 years at the time of purchase. There are no restrictions on final maturity.
3. Collateralized Mortgage Obligations - Federal agency issued or privately issued, floating
rate CMOs backed by federal agency guaranteed obligations are permissible in quantities up to 30% of total capital. There are no restrictions on stated coupon levels. Minimum lifetime caps are 8.00%. Permissible indices include any treasury index, the 11th district cost of funds, LIBOR, or prime rate. All instruments must reset at least quarterly. The coupon rate must float directly with the index and cannot be levered or de- levered. GNMA, FNMA and FHLMC are permissible issuers under this policy. The maximum base case average life at the time of purchase is 25 years. There are no restrictions on final maturity.
4. Asset-Backed Securities (ABS) - Federal agency guaranteed, adjustable rate mortgage
securities (ARMS) are limited to 30% of total capital. There are no coupon rate restrictions. Annual reset and lifetime caps must be at least 1.00% and 9.00%, respectively. Permissible indices include any treasury index, the 11th district cost of funds index, LIBOR, or prime rate. Instruments must reset at least annually. The coupon must float directly with the index and cannot be levered or de-levered. GNMA, FNMA and FHLMC are permissible issuers under this policy. Maximum base case average life is 10 years at the time of purchase. There are no restrictions on final maturity.
5. Municipal Securities - Callable and non-callable municipal securities are limited to 50%
of total capital, subject to the issuer size limitations set forth previously. Only investment grade and higher rated paper is permissible under this policy, except in cases of non-rated local issues. There are no restrictions on stated coupon levels. Any municipal entity that meets the appropriate credit rating criteria is permitted under this policy. Credit quality analysis will rely primarily upon the issue's bond rating, except local issues. Annual credit reviews will be required for non-rated local issues.
6. SBA Pools - Guaranteed pools of SBA loans are limited to 25% of total capital There are no restrictions on stated coupon levels. Minimum lifetime caps are 9.00%. Permissible indices include prime rate. All vehicles must reset at least quarterly. The coupon must float directly with the index and cannot be levered or de-levered. Maximum base case average life at the time of purchase is 25 years. There are no restrictions on final maturity.
C. Block Sizes
The Board has set these quantity limits and constraints on investment purchases to ensure diversity and a proper balance of risk management. Securities will be purchased in minimum blocks of $500,000 whenever possible to maintain maximum marketability. The maximum that can be invested into any single issuer isdetermined by Section B “Concentration Limits” below. .
V. Risk Management
A. Asset Quality Limits
The Board of Directors permits the following maximum exposures to credit risk by investment category:
Higher of the Maximum Percentage of Investment
Portfolio or Capital
Securities backed by the Full Faith and Credit of the U.S. Treasury
100%
Federal Agencies Securities
100%
Private Issue CMOs and ABS (Total)
30%
Municipal Bonds (Total) *
50%
Corporate Bonds/Commercial Paper (Total)
25% Depository Institution Certificates of Deposit (Total) 10%
FDIC / CUSIF Insured CD Balances 100% Uninsured CD Balances 0%
Overnight Fed Funds Sold & Demand Deposits or similar bank accounts (see II.A.2 below) 100% of Capital
* Ratings are based on insured and/or credit enhanced status.
B. Concentration Limits
The Board of Directors permits the following maximum concentrations of credit by issuer:
Maximum Amount Per Issuer (of Capital)
U.S. Treasury Unlimited All Federal Agencies Unlimited Privately Issued CMOs (1) 15% Municipal Entities (2) 15% Corporate Entities 10%
(1) Private issuers produce numerous individual deals, each backed by separate pools of mortgage collateral. Therefore, the dollar limits apply to each deal individually, rather than to the issuer in aggregate.
(2) Credit ratings are based on insured/credit-enhanced status, rather than the
underlying rating if one exists. There are no minimum requirements for underlying ratings.
V. Risk Management (continued)
C. Credit Analysis
The Asset Liability Committee should perform the following credit reviews at least annually:
1. Bond Ratings – The ALCO should review all bond ratings periodically (but at least annually) to ensure that the bank is still in compliance with policy. If a bond’s rating falls below policy limits due to a downgrade, the ALCO should develop a plan for holding or disposing of the investment. This plan should be conveyed to the Board of Directors within a reasonable time period.
2. The ALCO will maintain a list of approved institutions for the purpose of selling fed funds.
The ALCO will review the financial condition of the approved institutions at least annually.
D. Shocked GAAP Capital
By policy, the Shocked GAAP Capital percentage may not decline by more than 2.50% from the actual GAAP Capital percentage assuming a 200 basis point rate shock. The test will be performed at least semiannually. If a decline of more than 2.50% occurs, the ALCO will develop a plan to reduce volatility in the AFS portfolio. The plan must include the timing of implementation and be submitted to the Board of Directors for approval at the next meeting.
VI. Statement of Financial Accounting Standard #115
Sales or transfers out of HTM are to be very rare occurrences. However, as permitted by ASC 320, when an investment is 85% paid-off or its maturity is short enough so as not to be a material factor in the mark-to- market evaluation, the investment may be considered as having matured. Therefore, it is permitted by policy
to sell investments that are at least 85% repaid or are less than one-year to maturity. Transfers between categories should also be infrequent per ASC 320.
VII. Safekeeping
The Board of Directors will review and approve the institution's safekeeping agent(s) at least annually. Investment securities will be held in safekeeping at a designated board approved entity in accordance with a written custodial agreement.
I. Statement of Objective
A. Philosophy and Objectives
The overriding objective of the Board of Directors is to optimize earnings in the investment portfolio while operating within a defined set of constraints applicable to all financial institutions. Those constraints fall into three categories:
1. Safety of Principal - Credit risk is inherent in the loan portfolio. Therefore, the Board of
Directors desires to constrain credit risk in the investment portfolio. To this end, credit risk is defined as the risk of partial or complete principal loss caused by the financial weakness of the issuer. Temporary market value depreciation caused by changing interest rates is not a form of credit risk, but rather interest rate risk. Constraints on interest rate risk are addressed elsewhere in this policy. To the extent that credit risk is constrained by the Board of Directors, the investment portfolio's earnings potential is likewise constrained. The Board of Directors views this as a necessary requirement for the safe and sound management of the bank.
2. Adequacy of Liquidity - The investment portfolio is the balance sheet's primary source of
liquidity. Therefore, the Board of Directors has set forth a definition of adequate liquidity for the investment portfolio (see Liquidity Policy). To the extent that compliance with this definition results in investment dollars being allocated into shorter term, liquid investments, the investment portfolio's earnings potential is again constrained. The Board of Directors views this as a necessary requirement for the safe and sound management of the bank.
3. Rate Sensitivity - The Board of Directors has set forth risk tolerance limits for balance
sheet mismatches. To comply with these limits, the investment portfolio is one of the balance sheet's primary tools for effecting proper asset/liability positioning. As such, the investment portfolio's maturity and repricing structure may be constrained into shorter term, rate sensitive instruments, thus constraining earnings potential. The Board of Directors views this as a necessary requirement for the safe and sound management of the bank. (see Interest Rate Risk Policy)
II. Authorized Personnel
A. Board of Directors
The Board of Directors sets forth policy as it relates to the investment portfolio, which it will review and approve at least annually. The Board's policy statement establishes directives and constraints for the safe and sound management of the investment portfolio. By establishing these requirements and monitoring the results, the Board of Directors effectively meets its fiduciary oversight obligations.
The Board of Directors delegates investment authority to the Investment Officer(s), as named in Investments policy. The Board must review and approve the professional qualifications of the Investment Officer(s) in conjunction with the annual review and approval of this policy. This approval should be noted in the minutes of the Board meeting.
B. Asset Liability Committee
Since the investment portfolio is a specialized area, direct supervision of investment activities is delegated to the Asset Liability Committee (ALCO). The ALCO responsibilities include:
1. Investment Policy - At least annually, reviewing and recommending for Board approval
changes to the Investment Policy.
2. Investment Advisor - At least annually, reviewing and recommending for Board approval the institution's Investment Advisor.
3. Performance - At least annually, reviewing the performance of the investment portfolio
against appropriate benchmarks.
4. Liquidity Levels - Reviewing and recommending to management liquidity levels and related adjustments.
5. Interest Rate Sensitivity - Reviewing and recommending to management the interest rate
sensitivity position and related adjustments.
6. Capital Adequacy and Rate Shocks - Reviewing and reporting to the Board of Directors the portfolio price shock and capital adequacy test results.
C. Investment Officer
The Investment Officer is responsible for approving specific transactions executed in connection with the Strategic Investment Strategy. The Investment Officer is authorized to execute any transaction that comply with this strategy.
Transactions that materially deviate from the Strategic Investment Strategy need to be approved at the next meeting of the ALCO. If the ALCO does not approve a transaction deviating from the Strategic Investment Strategy, the Investment Officer is required to liquidate the position in an orderly fashion as directed by the ALCO.
The Investment Officer is responsible for cash transactions, wiring activities, and settlement arrangements and credit analysis. The Investment Officer is also responsible for maintaining appropriate documentation related to the portfolio strategy and transaction activity.
Trade documentation includes confirmations and bid/offer information from the portfolio advisor. The Investment Officer is also responsible for forwarding copies of appropriate documentation to the accounting department for accounting purposes. This would include copies of trade confirmations, principal and interest reports, and safekeeping reports.
III. Investment Execution
A. Approved Dealer Firms
The names, addresses and web sites of the approved firms are contained in the Investments Policy.
V. Risk Management
Prudent financial institution management practices require that earnings objectives be balanced against risk management constraints. As described below, the Board of Directors addresses risk management in five separate areas:
A. Safety of Principal
Safeguarding of principal and accrued interest are key aspects of risk management. Therefore, the Board of Directors has established policy constraints on asset quality and concentrations to maintain appropriate credit quality.
1. Asset Quality Limitations - Financial institutions are in the business of lending which
makes credit risk an inherent part of the asset base. As such, the Board of Directors has set boundaries on credit risk within the investment portfolio to ensure an appropriate overall level of credit risk exposure. Limits are expressed by category of investment in relation to the overall portfolio.
2. Concentrations of Credit – As a further limitation on credit risk, the Board of Directors
has set limits on the level of permissible credit by issuer.
3. Credit Analysis – With respect to privately issued CMOs, Municipal Bonds, Corporate Bonds and Commercial Paper, bond ratings will be used as the basis for establishing acceptable credit quality. A pre-purchase analysis will also be performed to confirm the bond conforms to Investment Policy. This analysis will also include reviewing a prospectus, when available, and other reports needed to determine the credit worthiness of the bond. ALCO will review bond ratings periodically (but not less than annually) to ensure that the bank is still in compliance with policy.
4. Non-Rated Municipal Bonds – The bank is permitted to purchase non-rated municipal
bonds in accordance with this policy. In general, management should be familiar with the issuer and their financial condition prior to making such investments. Management is not required to perform the same level of review that would occur in connection with a loan underwriting, but management should have a reasonable basis for making such investment.
B. Liquidity
All financial institutions require adequate liquidity to operate in a safe and sound manner. Risk management as it pertains to liquidity is outlined in the Liquidity Policy.
C. Interest Rate Sensitivity
All financial institutions must manage the interest rate risk position of the balance sheet. Risk management as it pertains to interest rate sensitivity is outlined in the Interest Rate Risk Policy.
D. Shocked GAAP Capital
Policy limits are set forth in the Funds Management Policy for the leverage ratio and GAAP capital. They represent actual capital levels before and after the ASC 320 adjustment, respectively. Shocked GAAP capital is a hypothetical measure of accounting capital and does not affect actual capital measurements. Nonetheless, it is useful as a risk management tool.
Since the ASC 320 adjustment directly impacts GAAP capital, it is important to constrain the volatility of the ASC 320 adjustment. The magnitude of potential adjustments is directly related to five factors:
Size of the AFS portfolio
Product spread relationships within the AFS portfolio
Duration estimates for the AFS portfolio
Convexity estimates for the AFS portfolio
Volatility estimates for interest rates
Measuring and understanding the impact of these factors is a critical risk management practice. By controlling the degree of each, the potential size of the ASC 320 adjustment can be controlled. To this end, the Board of Directors has specified that Shocked GAAP Capital changes should be constrained for rising interest rates of a specified amount.
For example, assume that the policy limit is set at 2.50% for a +200 basis point rate shock. This means that the maximum allowable decline in the GAAP Capital percentage is 2.50%. If the actual GAAP Capital percentage were 10.00% presently, it would need to stay above 7.50% under shocked conditions assuming a +200 basis point rate shock.
The price shock is performed at the individual security level and the results are aggregated for the total portfolio. Each shock assumes an instantaneous, parallel, and sustained shift in the yield curve.
E. Prohibited Investments and Activities
The following investment activities are prohibited by policy:
Pair-offs, adjusted trades, covered calls, short selling, when-issued trading, futures, standby
commitments and option contracts are prohibited.
Stripped Mortgage Backed Securities (SMBS), residuals, mortgage-servicing, commercial MBS, small business related securities, and mortgage-related IOs and POs are prohibited.
Directors and officers may not receive any type of fee or compensation from investment related
activities.
The ALCO may not delegate discretionary investment authority to any person outside of the bank.
VI. Valuation and Reporting
A. Investment Accountant
The Investment Accountant is responsible for investment accounting. On a monthly basis, the investment accountant is responsible for the following duties:
1. Trade Activity - Posting trade activity to the general ledger.
2. Trade Confirmations - Reconciling trade confirmations with cash receipts, cash
disbursements, and the transaction summary report.
3. Monthly Accounting Entries - Posting accrual entries, cash receipt entries and monthly amortization and accretion entries to the general ledger.
4. Safekeeping Report - Reconcile the pledging report to internal records for pledged
securities.
5. Safekeeping Report - Reconcile the safekeeping agent's report of investments held in safekeeping to an internal portfolio holding report.
6. Reconciliations - Reconciling principal and interest payments to the cash receipts
statement/report. Reconciling the accruals, accretion and amortization amounts from the accounting statements to the general ledger.
7. Investment Reports - Maintain a history of the accounting and management information
reports received from the bank's investment advisor.
B. Valuation
The bank will have the valuation of its investment portfolio computed each month end. This valuation will be compiled by a qualified individual. The monthly valuations will meet the requirements of SFAS #115 as well as provide the ALCO and Board of Directors with a detailed market valuation of each investment.
C. Monthly Reporting
On a monthly basis, the ALCO will review and forward to the Board of Directors reports showing the following:
1. Description of Holdings – Investment descriptions and holdings by security and group
total.
2. Valuations – Market valuations, amortized cost, and unrealized gains or losses by security and group total, including the change in market value since the prior month.
D. Quarterly Reporting
On a quarterly basis, the ALCO will review and forward to the Board of Directors reports showing the following:
1. Market Value Volatility - Shocked market prices and market values by security and group
total for the entire portfolio, assuming rates rise or fall 300 basis points instantaneously.
2. Capital Adequacy Evaluation - A report showing the potential volatility of the GAAP capital percentage, assuming rates rise of fall 200 basis points instantaneously.
E. Statement of Financial Accounting Standard #115
The bank is an investor, not a portfolio trader. It does not acquire investment securities for the purpose of generating short-term profits through trading activity. Therefore, investments will either be classified as available-for-sale (AFS) or held-to-maturity (HTM) at their time of purchase.
The division between AFS and HTM is not specified by policy. In general, the bank will classify the highest possible portion of its investments as AFS, subject to the constraints identified in the capital adequacy section of this policy. Since interest rates move in cycles, having an AFS portfolio allows management to accomplish three specific purposes:
Protect against additional unrealized market valuation losses.
Provide more liquidity as rates rise, which often coincides with increasing loan demand and
slower deposit growth.
Generate more money to reinvest when rates are higher giving the institution an opportunity to lock in higher yields.
To the extent that the AFS portfolio becomes too large given the constraints set forth in the capital adequacy portion of this policy, investments may be classified as HTM. Held-to-maturity classifications will only be used if the institution has the positive intent and ability to hold the investment to its maturity.
VII. Safekeeping
Investment securities will be held in safekeeping in accordance with a written custodial agreement. It is permissible for the bank’s safekeeping agent to hold book entry securities in street name for the beneficial ownership of the institution. This facilitates expedited delivery and settlement activities. Securities that settle with physical delivery will be held in the institution's name. The institution will receive an individual confirmation statement for each security purchased or sold and each transaction will be settled delivery versus payment whenever possible. The bank should receive a report of investment holdings from the safekeeping agent and reconcile this report to the institution's internal records on a monthly basis.
VIII. Pledging
Certain public funds depositors require investment securities to be pledged. For this purpose, the bank will attempt to pledge the least liquid securities whenever possible.