Banks and the Bond Market
Selling bonds to banks takes creativity. Banks are in business for one thing - to earn more money. Generating greater returns on their loans and their investments is what they are in business for. Loan demand is your biggest objection. Banks feel obligated to push for greater loan demand from their customers. Mortgages, car loans and other loans generate income for long periods of time.
The available funds not used for loans are used for investments. Banks will keep a certain amount of money in Federal Funds or “Fed Funds” as they are usually called. Fed funds is an overnight bank to bank lending rate. Banks with excess money can sell fed funds to their banks. Banks with low liquidity will borrow through it. Either way, it is a formidable competitor for bond brokers. The ease of fed funds allows for quick and easy, overnight rate of returns. However, the fact that fed funds is overnight, presents a problem too. Banks should not have an over abundance of money in overnight accounts, simply because it does not allow them a chance to “lock in” a fixed rate if interest rates decline. They will just “drift” downward as interest rates decline. Simply put, fed funds should be for reserves and convenience, but not a long term investment policy. If the bank is going to hedge themselves against interest rates rising (which brings bond prices down), then they need to move some money out of there.
Banks can buy almost any debt (bonds, notes CD’s). Most will not buy low grade corporate bonds, but pretty much everything else is open. What they each buy depends on a few things:
Asset size of a bank is important when determining whether you should contact them. Your best chance for success, if you are looking to work independently, or for a firm is Banks with assets between $100 million - $700 million. A bank with $100 million in assets may have $15 million in investments for instance. Portfolio sizes of $15 million to $100 million should be your target. You want to stay away from pursuing accounts much smaller than that, because the amount of time and work you put in trying to get them to work with you will not be worth the payout. Banks that are over 1 billion in assets are simply too big for most. Not for the reason you may think. They are not that much more
complicated, but they have in-house direct investment officers that do it themselves. You may get lucky where they call you back and buy something, but you will be working so “thin” (price/mark up), that it will be hard to make money. Bonds are based on “mark ups”, if a firm is offering the bond to you at $97 ($970 per $1000 bond), you can mark the bond up in price from their. ¼ of a point to a ½ a point is a normal mark up for most bonds. With the bigger banks, it will be hard to get that much into the bond. They are usually being called by a lot of brokers, and may be seeing the same thing. You don’t want to be showing a bond that is overly marked up in price. He may not want to talk to you anymore. So, the rule with the big banks ($1 billion+) is, work thin, don’t overwork, and just hope that he calls you back on occasion over the “other guy”.
Smaller to medium size banks are passed over by the large primary brokerage firms. So, not only, can you get in easier, it is more potentially rewarding. These banks can be educated, they won’t have a “team” of investment pros at the bank, so your suggestions and education presentations may pay off. It is also rewarding in that these smaller banks will put more “Stock” in personal relationships. You won’t get a lucky 2nd phone call trade, like you could get with a big bank buying everyday, but once they are opened, you can bring them into your philosophy and strategy. Personal relationships have a much better chance to grow, and your chances of always being undercut on price from other brokers, won’t happen as often. The smaller banks do not have the time to talk to 10 brokers every day. What you want, and this applies to any institution, is to be either their only broker (not likely in the beginning), or be one of three that he is dealing with. A sophisticated bank will spread the trades so that all of you get something.
Know the bank before you call
What can make institutional prospecting easier than retail prospecting is the “qualifying phase”. Retail or private companies do not have readily available, detailed financial information that you can obtain. Retail brokers will rely on a basic introductory call of qualifying questions, or they have someone do the “cold calling” first. Since individual investors are normally approached with equity investors, and are many times caught “off guard”, this part of the prospecting can be difficult. Questions like “How much money do you have invested?” or “What types of investments have you bought in the past?” can be not only intrusive to certain people, but time consuming. You are also speaking about someone’s personal holdings, thus they might not even tell you. They also will be “guarded” as I said before. Also, what if you get all the information you wanted, and the person ends up not having any money that is worthwhile for you to pursue. Retail brokers have to face that all the time. You call the person, leave a message. Call again, another message. Then he decides to picks up the phone and cuts you off after your “pitch”. Finally!, he picks up the phone, or even calls you. You talk with him, break his guard down, and then you find out he has a $5000 portfolio! Yikes, what a waste of time right?
Banks are much different and much better in the prospecting qualifying area. All FDIC insured banks must report their entire financials, including investments to the FDIC. These reports are readily accessible. You can see everything about the institution before contacting them. This not only helps you contact banks that are proper in size, but as I will mentioned in more detail soon, you can study the banks financials, portfolio etc. and come up with a presentation based on your studying of it. A bank will be much more receptive, and respect your service if you include specific observations (do not try to sell him a particular bond the first call) on the bank. He knows you have access to the information. The bank is a federally regulated institution. You are getting into private information.
Note: To see financial information on any bank, got to FDIC.GOV. You will then see a link for “bank data”. From there, you have many options. Search by state, view or print reports etc.
You will be able to access the asset size, the loans, and the investments held, as well as many other items that may not be of use to you. Pay attention to the portfolio. It will list CD/bank deposits, mortgage backed securities, treasuries and anything else they own. It will not list price paid though. For this, you will need to request a copy from the customer or prospect. This may take a call or two, or maybe they don’t want to send it. Usually it is no big deal, and is very important to you. You will have a good idea on what they own, and the types of loans and investments they hold, but if you are going to propose trade ideas (swaps, selling of existing holdings), and you want to run the numbers before presenting the trade, you need to know what they paid for the bonds you are looking to swap out of. You don’t want to propose a swap out of a bond, buying another and not see that the bank is taking a $300,000 loss because of it! In a casual way, just ask him to fax you over their most recent portfolio. It is not a big deal. It is usually on one or two pages that he can just print and send over. Remember, these guys are paid to maximize income on the investment portfolio. If you come up with a good trade idea, and he does it, he will get credit for it also.
What you also want to pay attention to is the percentage of assets that are in investments and loans. Meaning, if a bank is 90% loaned, that means they only have 10% in investments. Sure, that could turn around and you could still call them to begin a relationship, but keep in mind, loans are what they push if they can get it. If he is 90% loaned out, it doesn’t look good for investment potential. Now, the good news in that situation. There is always a way to make money off of banks. Why not? They certainly make money off of us at every turn. Here is the deal. If a bank has high loan demand, that means the bank is probably aggressively seeking deposits. They need more money. They have loan demand, and that demand can only be met by raising deposits. You should check what their deposit rates are for large deposit accounts. Jumbo CD’s as they are
called are $100,000 CD accounts that usually pay a higher rate than traditional CD’s.
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