A moderate size community bank’s investment portfolio was
liquidated to create additional liquidity to support its operating capital
needs and to allow it to borrow less. In
this liquidation, the senior management initially just wanted to liquidate the
securities at market or what’s worse at market established by just one
broker. In other words, just letting the
broker who called to discuss rebalancing the portfolio provide that day’s bids
and execute a multi million dollar trade.
You might say: So?!
The management knows what they are doing and the brokers will always
give a fair bid! This may be the correct
assessment some times but not always (actually almost never.)
While a miniscule example, what’s $10 or $15 million to a multi
million dollar institution you would say?
Well, it may mean a lot. If the
bank has not made money for the past 3 to 4 years a difference of $50 to $75
thousand may mean a lot to its bottom line.
The better approach to such a trade would be:
First management should review the most recent security
valuation report from the bank’s bond accounting provider. This would provide an idea of the most recent
market value for the bonds (by the way most banks can only hold bonds in their
investment portfolios).
Next management should assess if the bonds to be traded are
used as collateral (some depositors require for their accounts to be secured by
bond collateral to some degree) or are part of a repurchase agreement. If so to find other bonds or find out what is
necessary to notify the depositors or repurchase agreement administrators.
The following step, management should to determine the true
market value of the bonds by either allowing a broker (or a few approved
brokers) to list the bonds on the bond trading board (PIC), which would allow
the “market” to bid on them. In this
move management would have to communicate the desired price to the broker so
that when the bonds are listed the open
bids are close to target.
Alternatively, management could contact a few brokers and
ask them to bid the bonds for their own portfolios. In other words the bond would not get listed
in the market. Often the brokers will
have other institutional clients looking for bonds in a specific market or by a
specific issuer and will be able to provide bids that are competitive.
Once management get an idea of the minimum sell price they
should create a report of the possible gain/loss for the full trade. This report should be updated as the bonds
sell.
Using this approach for a bond trade management will be
organized and accountable for the trade.
Additionally the transaction becomes transparent (if reported correctly)
to the board and other users of this information by clear documentation of the
fact that management in no way forgone the interest of the bank or its
shareholders.
But does this always happen?
What does your bank’s policy or procedures state about how such trades
should be handled?
Resources:
OCC’s Bulletin 2002-19 Unsafe
and Unsound Investment Portfolio Practices: http://www.occ.gov/news-issuances/bulletins/2002/bulletin-2002-19.html
