Examining Bond Portfolio Trends: First Quarter 2024

Background

Beginning in May 2012, we started tracking  portfolio trends of our bond accounting customers here at SouthState|DuncanWilliams.  At present, we account for over 130 client portfolios with a combined book value of $14.2 billion (not including SouthState Bank’s portfolio), or $107 million on average per portfolio.  Twelve months earlier, the average portfolio size was also $107 million, unchanged over the year. Average portfolio size peaked at $111 million in November 2023.

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First Quarter Market Observations

• The first quarter of 2024 was characterized by hotter-than-expected inflation, and an economy and labor market that showed no signs of fading. That backdrop led to a March FOMC meeting that didn’t feature a rate cut, an expectation only a few months prior, but the updated Fed forecast still called for three cuts in 2024 with thoughts cuts may begin in June.

 

• The March CPI report, however, also came in hot and that has pushed market expectations for cuts to September, at the earliest, with only two cuts, at most, in 2024. Fed speak has turned a bit more hawkish in light of the rekindling of inflation in 2024, and we suspect their June forecast will look more like the market’s updated expectations. Thus, higher-for-longer looks to be getting longer. The caveat here is that much data remains to be seen between now and the June meeting, but to date there is little to imply a weakening in the economy and/or inflation is imminent.

 

• The rally that carried from November through year-end, reversed in January. Some of the early back-up in yields was a consequence of investors taking profits after the strong year-end rally. Then, the combination of hotter inflation readings and increasing employment gains in January fed a continued backup in yields. This continued for the balance of the quarter, and as the March FOMC meeting came and went without a cut, it was another tough quarter for bond investors. With that backdrop, let’s turn our attention to changes in portfolio allocations during the past year.

 

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Changes in Portfolio Allocations

Let’s begin our portfolio review by revisiting allocations a year ago as shown in the pie chart below. The MBS/CMO sector comprised 41% of the portfolio, municipal allocations stood at 22%, Agency/Treasury investments were 31%, and the “Other” category  (CDs, corporates, and other floaters) 5.7%.

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• Fast forward one year to March 31, 2024. The MBS/CMO sector comprised 43% of the portfolio, a 2% increase from last year. This follows the previous quarter which halted a six quarter trend of declining MBS allocations. Prior to the hiking cycle, MBS tended to lead new portfolio investments by a wide margin.

 

• The decrease in municipal investments that had been a feature over the last year or more stopped in the fourth quarter and that modest increase in allocation continued in the first quarter with 23% in the sector (15.7% tax-free, 7.3% taxable) which matches the prior quarter and a skinny 1% above the year ago level. The stable investment allocation is an improvement over the run-off that had been a feature once the hiking cycle started in March 2022.

 

• The Agency/Treasury sector had been the one area that experienced increased allocations during the hiking cycle but for the second straight quarter allocations declined from 31% a year ago to 29% this year as the MBS and muni sectors finally started to entice investors back to those sectors. The “Other” category was essentially unchanged at 5.66% a year ago to 5.48% with corporate bonds constituting more than 80% of the category at 4.44%.

 

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Changes in Portfolio Performance

Now let’s look at portfolio performance trends. The graph below tracks average portfolio tax-equivalent book yield, duration, and unrealized gain/(loss) as a percent of book value. It also tracks 10-year Treasury yields and average portfolio size over the last two  years.

• Portfolio yields were 2.37% (red line) a year ago. Yields slowly rose through the year as reinvestments were made at higher market yields, albeit on a modest basis. By the first quarter, yields increased 32bps over the prior twelve month to 2.69% and improved 7bps from the fourth quarter. With higher market yields in 2024, we expect portfolio yields to continue increasing as lower yielding legacy bonds are reinvested at higher market yields. 7 to 8bps increases in quarterly yields appears to be the current run rate.

 

• 10-year Treasury yields (green line) began the year at 3.88%, quite the rally from when yields peaked mid-October at 4.99%, the cycle high. With the hot inflation readings during the first quarter, not to mention strong jobs numbers, 10yr yields trended higher during the rest of the quarter ending March at 4.21%, up 33bps during the quarter, and those increasing yields have continued in April.

 

• Durations a year ago averaged 5.07 years and dipped during the next twelve months ending March at 4.76 years as investments focused on shorter-duration securities, and the strong year-end rally shortened durations as well. The latest duration measure is the lowest since January 2022.

 

• Despite the slight decrease in duration, the increase interest rates during the quarter resulted in larger unrealized losses. Unrealized losses increased from –10.51% to –11.33% as a percent of book. Despite the modest increase in the unrealized loss it’s still quite the improvement from the –16.00% cycle low in October.

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Portfolio Purchases During the First Quarter 2024

• New investments during the quarter increased modestly from $530 million in the fourth quarter to $683 million, or $5.25 million on average per portfolio. First quarter investments represented the highest quarterly total in over a year. For the ninth straight quarter, the Treasury/agency sector led purchases comprising 56% of the $683 million total ( 35% Treasury, 21% agency) and easily exceeded the legacy total of 29%. Next came 41% investments in MBS/CMO/SBA (27% MBS, 12% CMOs, 2% SBA). The 41% investment slightly trailed the legacy 43% total. 30yr fixed-rate pools led MBS investments at 35% and 11% of total investments.  The municipal sector was lapped by the top two categories at just 2% of purchases, practically all in the tax-free category.  The 2% in muni purchases compares to a 23% legacy muni allocation.

 

• Average tax-equivalent book yield for fourth quarter purchases was 5.18% versus 5.71% in the prior quarter. The average effective duration was 2.35 years versus 1.98 years in the prior quarter.  Negative convexity was –0.24 versus –0.34 in the prior quarter.  Compare those figures to the legacy portfolio book yield of 2.69% and effective duration of 4.76 years.

 

We will update this data again in July to track how allocations and performance characteristics trended in the first half of the year.