Portfolio Runoff — Definition, How It Works, and Examples

Key takeaways

• Portfolio runoff occurs when assets with finite terms are allowed to mature without being replaced, shrinking the asset base that generates returns.
• Runoff can affect banks, fixed-income portfolios (ABS, MBS), insurers, and central-bank balance sheets.
• It reduces investment income over time and can be a deliberate tool (e.g., Fed balance-sheet reduction) or an unintended result of market conditions.
• Common responses include reinvestment, prepayment penalties, or active portfolio management to replace maturing assets.

What is portfolio runoff?

Portfolio runoff describes a situation in which investments with fixed maturities are not replaced after they mature. When principal from a maturing bond or loan is repaid and the proceeds are not reinvested, the portfolio’s invested capital — and the income it produces — declines.

How runoff works

• Fixed-term assets (bonds, loans, securitized products) generate scheduled repayments of principal and interest.
• If proceeds from maturities or prepayments are kept in cash or withdrawn instead of being used to buy new assets, the total invested balance falls.
• As the asset base shrinks, absolute returns decline even if yield percentages remain unchanged.

Where runoff occurs

Banks and lenders

Banks experience runoff when loans are repaid or customers withdraw deposits and the institution does not replace that exposure with new loans or deposits. Early prepayments and loan defaults accelerate runoff. Some lenders use prepayment penalties to discourage early repayment and protect interest income.

Investment portfolios (ABS, MBS, other fixed income)

Asset-backed securities (ABS) and mortgage-backed securities (MBS) have finite lives tied to the underlying loans. Principal repayments and amortization reduce the securities’ outstanding balances; if proceeds aren’t reinvested, portfolio income drops. Prepayment speeds on mortgages are a key driver of MBS runoff.

Insurance and reinsurance

A reinsurer or insurer may enter runoff by choosing not to write new policies while existing policies expire or claims are paid. The portfolio of policies shrinks, reducing future premium income and exposure.

Central-bank balance sheets

Central banks can shrink their holdings without active sales by allowing maturities of securities acquired during quantitative easing (QE) to roll off — i.e., not reinvesting principal repayments. This passive reduction is commonly called balance-sheet runoff.

Examples

• A fixed-income fund holds mortgage-backed securities. Rising prepayment rates send larger principal repayments to the fund. If the fund manager leaves proceeds in cash, the fund’s invested assets and coupon income fall over time.
• A bank’s loan book declines when borrowers repay or refinance and the bank tightens lending standards; without new loan originations, interest-earning assets shrink.
• After QE, a central bank lets Treasuries and MBS mature and does not buy replacements, gradually reducing its balance sheet.

Managing and responding to runoff

• Reinvest proceeds into new assets to maintain the asset base.
• Adjust portfolio strategy (shift duration, credit exposure, or asset mix) to compensate for declining principal.
• Use contract features such as prepayment penalties to stabilize cash flows for lenders.
• For institutions deliberately liquidating exposure (e.g., insurers in runoff), focus on claims management, liquidity planning, and capital adequacy.

Conclusion

Portfolio runoff is a common outcome whenever finite-term assets mature without replacement. It can be a deliberate policy tool or an unintended consequence of market dynamics. Recognizing runoff and implementing reinvestment or structural strategies helps preserve income, manage liquidity, and align portfolios with financial objectives.