bond market update - 4q16 public - capital one careful employment of credit ... unable to budge core...

DECEMBER 30, 2016 | BOND MARKET UPDATE 1

BOND MARKET UPDATE

No part of this document may be reproduced in any manner without written permission from Capital One’s Wealth and Asset Management Group. For

_____________________ 1 Personal Consumption Expenditure Deflator, ex food and energy, 1.6% Y/Y change through November 2016 (U. S. Department of Commerce, December 22, 2016)

full disclosures, see last page of document.

December 30, 2016

SMPROFITABLE RISKS / UNPROFITABLE RISKS

Loss avoidance is a key to long term investment success. We deem certain risks profitable, to be exploited with sound research, while other risks are inherently unprofitable and should be avoided.

OUR RISK MANAGEMENT TENETS

A rigorous top-down approach toforecasting liquidity conditions is

an essential ingredient in fixed-income risk management

Active management of interest rate risk within modest limits is a cornerstone of successful fixed income portfolio management

Extreme variation from bench-mark duration is counter-productive

Yield curve, sector positioningand careful employment of creditrisk offer attractive cyclicalopportunities to add relativevalue

Opportunistic and modest em-ployment of high yield andinternational debt elements canadd significant value to a coreinvestment grade mandate

MONETARY POLICY AND LIQUIDITY CONDITIONS Paul Teten, CFA© Chief Investment Officer

The Federal Open Market Committee (FOMC) finally delivered on its frequently promised and often postponed increase in the Fed Funds rate on December 14, raising the rate to a target of 0.63% from 0.38%. The increase was well discounted in the markets, although the Fed surprised the markets with a hawkish projection of three additional 0.25% increases in the Funds rate in 2017. The Treasury bond market sold off in knee-jerk fashion to this expression of attitude from the Fed, although longer bonds have since retraced all of that reaction, with 10-yr. and 30-yr. yields actually trading lower than prior to the FOMC. Fed Funds futures for delivery in December 2017 are trading at 1.12% today and the 2-yr. Treasury at 1.18%, both pricing in two Funds rate increases next year and expressing skepticism about a third, which would put the Funds rate at 1.38%. It’s worth remembering that a year ago when the FOMC raised the Funds rate for the first time since 2008 to 0.38%, their assertion at the time was similarly adamant that their intention was to raise the Funds rate four times in 2016. In reality, concerns over weak global growth and deflationary currents in global markets persuaded the Fed of the wisdom in refraining from actions that potentially could destabilize global markets further, resulting in exactly one increase in the Funds rate this year, the one just recently enacted.

Since November 8, perspectives have changed in all markets as optimism that President-elect Donald Trump will usher in a new era of growth and prosperity has become epidemic. It’s likely that the markets have gotten ahead of reality as the Trump agenda appears to be crowded with complex and ambitious reforms, few of which are likely to have meaningful stimulative impact in 2017. Nevertheless, animal spirits are stirring and the opportunity set for a rejuvenation of U.S. economic growth does appear vastly improved. The Fed seems happy to get on the Trump bandwagon and use the opportunity of rising expectations for growth and inflation to project an aggressive agenda of higher Fed Funds rates in the years ahead. The uncomfortable truth is that five years of quantitative easing and endless advisories that inflation would soon rise to the Fed’s 2% target were unable to budge core inflation1 much off sluggish 1.0-1.5% trends. If Trumpuphoria can nudge inflation expectations up and help normalize interest rates the Fed appears happy to play along as that furthers the FOMC’s deflation-fighting agenda.




CURRENT RISK ASSESSMENTS

Duration strategies neutral to modestly long v. benchmarks

ATTRACTIVE SECTORS: 5-7 Yr Treasuries for optimum

roll-down returns Investment grade Finance credits

Super-senior commercialmortgage-backed securities

High quality Municipals with nopension funding challenges

UNATTRACTIVE SECTORS: Modestly defensive within

Investment Grade credit, tiltedto higher quality

Emerging Market credit andcurrency exposure

Developed Market creditexposure

The chart below exhibits the FOMC’s dot-plots for the expected future course of the Fed Funds rate. Note that the red line is the projection in the Fed Funds futures market on December 14 and the purple line points to the downward drift in futures market expectations since then, similar to the retracement in long Treasury yields in the last two weeks. The futures market projection of a 1.80% Funds rate in December 2019 is consistent with the thesis we have reviewed in recent communications that the Funds rate will eventually rise to approximate parity with core inflation, constituting an inflation-adjusted Funds rate, or “real” rate, around zero. Our view has been that the Fed’s unstated agenda has been to move the real Funds rate up to zero, based on their assessment that zero is also the equilibrium real rate, neither easy nor tight monetary policy. As the last year has proven, the global economy may well offer a series of obstacles and distractions to the Fed’s goals, but if they are able to reach that goal it will be a notable achievement and qualify as a return to a normal interest rate environment. What’s new now is that the bond market is getting in sync with this view.

Elsewhere, liquidity conditions abroad continue to be driven by quantitative easing programs in Europe and Japan. These programs have fostered the prevalence of negative interest rates in their regions and have been sources of capital flow into U.S. markets. The European Central Bank (ECB) is likely to tread lightly on the path to normalization of monetary policy with several national parliamentary elections coming up in Europe, with political currents in virtually all of these elections including surging populist and anti-EU factions. The ECB took a baby step earlier in December toward phasing down its quantitative easing program, however in comparison to the Fed’s taper of QE in 2014, in which the entire program was wound down in less than one year, at the present rate of deceleration the ECB will not have terminated its program until 2020.

China has been attempting to gently reign in its overheated property market and manage a gradual devaluation of the Yuan’s exchange value in Dollars. The Yuan’s 10% devaluation since August 2015 has reflected a shortage of Dollars in the Chinese economy and led the People’s Bank of China to sell about $150 Billion of its U.S. Treasury bond holdings over the last year and a half, enabling it to manage the Yuan’s descent and supply Dollars to Chinese investors eager to diversify their currency risk. China’s Treasury bond sales have contributed marginally to the recent rise in U.S. Treasury yields, along with the more dominant reallocations from bonds to stocks in the U.S. as the perceived economic outlook has improved. Overall, central banks in the developed economies continue to be net suppliers of liquidity and drivers of continuing strength in the Dollar, conditions we expect to persist in 2017.

High Yield corporate bonds



Treasury bond yields corrected up to more normal yield levels with a vengeance in the second half of 2016, rising gradually following the BREXIT shock in late June and more abruptly after the Presidential election surprise that brought the Trump growth agenda to the fore. 10-yr. Treasury yields dropped below 2.0% in January 2016, previously a sign of intense global stress; reached a nadir of 1.36% in early July, and stayed under 2.0% until November 9, subsequently rising to a high of 2.60% on December 15. We rode yields down with a +10% long duration strategy v. benchmarks from June 2015 through August this year, at which point we covered that tactic and have since vacillated between marginally short to marginally long v. benchmark duration; attempting to get a handle on the direction of interest rates. The macro-economic and liquidity weathervanes were indicating continuing sluggish economic conditions up until the elections, after which optimism toward a presumed Trump agenda overwhelmed the tea leaves. The market equivalent of a sudden spring storm broke out, an intense flurry of weather heralding new growth; and forcing economic, inflation and interest rate expectations significantly higher. With 10-yr. Treasury yields in the 2.50-2.60% area, our assessment is that the markets have run too far too fast in discounting the Trump Administration’s expected impact on economic growth and inflation in 2017. While we do see the economic policy outlook as greatly improved due to the election outcome, likely to eventually drive economic growth and interest rates modestly higher, we are exercising patience with relatively neutral duration policies and expecting a better opportunity to reposition to short duration tactics in the months ahead.

FOMC Member Projections – Federal Funds % Rate at Year Ending

Source: Bloomberg, Federal Reserve, December 30, 2016


INTEREST RATE OUTLOOK AND DURATION STRATEGY Paul Teten, CFA© Chief Investment Officer




U.S. Treasury bond yields went on a wild ride in the 4th quarter. After plummeting in the days following the U.K. Brexit vote, yields were on a course to rise gradually, benefitting from a slightly more robust U.S. economy, a rise in crude oil prices, and some soft comments from foreign central bank leaders about the limitations of excessive monetary easing (in the form of negative interest rates and quantitative easing). It could also be argued that a sense of complacency was at play, as the market fully expected a Clinton win, and a continuation of policies that contributed to years of low rates and slow uninspiring economic growth. Conditions in the market were turned upside down by the surprise election of Donald Trump. In a wave of pro-growth/pro-inflationary optimism, 10-yr. Treasury yields were pushed higher, reaching 2.60% as recently as mid-December after being as low as 1.75% pre-election. The Federal Reserve Bank responded to the shift in post-election sentiment, as well as to ongoing improvement in the labor market, by raising interest rates at the December meeting and slightly increasing their projections for the Fed Funds rate at the end of 2017. This slightly more hawkish tilt has had the effect of lifting short-term interest rates in the 2 to 3-yr. sector as well, where investors had previously incorporated a more gradual pace of rate hikes. But the rise in 7 to 10-yr. yields has been more pronounced, forcing the spread between 2-yr. and 10-yr. yields to reach approximately 1.30%, which is the highest level in over a year. There are adequate reasons to be skeptical of the recent rise in rates, but valid reasons as well to believe that we are in the process of turning the page on the low rate environment that has existed throughout this recovery. We conclude that the rise in U.S. rates in comparison to other developed nation rates should continue to bolster non-U.S. demand for safe dollar-denominated assets, and keep U.S. yields from ascending much higher in the near term. Policy makers outside the U.S. remain dependent on radical monetary policy and will be challenged to wean their economies off of easy money and low-rates while growth remains weak and structural imbalances remain. Given this view, we choose to be overweight U.S. Treasury and Agency bonds with our portfolios. Domestically, deficit spending expectations and concerns about higher Treasury bond issuance will percolate, but will ultimately be determined by decision makers outside the Executive branch. Strategically, we view the long end of the curve as a relatively safer spot to add duration, especially after the selloff. On the other hand, the middle of the curve continues to underprice a pickup in inflation that appears to be gradually under way. This part of the curve is also heavily owned by banks, which may be granted some relief under the Trump presidency from bank regulatory requirements to hold liquid assets. A barbell approach to bringing portfolio duration in line with policy appears to be the optimal strategy at this time for intermediate and longer duration investment strategies.

U.S. TREASURY AND AGENCY BONDS Gilbert Braunig, CFA© Senior Portfolio Manager

Returns on Agency Mortgage Backed Securities (MBS) have been fairly close to Intermediate Treasuries during the late year selloff in bonds, but are carrying a small lead into year end. MBS spreads to Treasuries have tightened for much of the year. In a world starved of yield, investors have increasingly looked for ways to earn excess yield above what’s offered by Treasury and Agency bonds and have found the answer in safe “government guaranteed” MBS. The demand for additional yield has persisted even as rates have risen, which likely means that investors have been reluctant to sell their MBS, even as they have repriced lower along with the broader market. The MBS market today looks quite different than earlier in the year. A significant amount of MBS supply came to the market in recent years, as mortgage rates have been low, the housing market has been healthy and lenders actively sought to gain market share by promoting refinancing. Today much of the recent MBS supply is carrying a 3% or 3.5% coupon, with little or no incentive for borrowers to seek a refinance (refi). The prevailing 30-yr. mortgage rate sits at 4.17%, according to Bankrate.com. As a result of fewer prepayments and refis, the projected average life of most recently produced MBS has extended and the present value of future cash flows has declined. The result is lower dollar prices for MBS, and less additional yield over a Treasury bond with an equivalent average life. The challenging recent performance notwithstanding, we view MBS as attractive. With the exception of periods of extreme interest rate volatility, MBS consistently provide excess return compared to other sectors of the bond market. Unlike other sectors, liquidity in the agency MBS market is deep, and is rarely challenged given the broad investor base for MBS. We recognize that the relative value optics of MBS are not as compelling as they have been in recent years. MBS spreads when compared to spreads on high quality corporate bonds are not currently at an elevated level. But as we explain in more detail later, we have a higher degree of concern about current '

U.S. 10-yr. Treasury Bond Yield – since 2006




Source: Bloomberg, December 30, 2016

AGENCY MORTGAGE BACKED SECURITIES (MBS) Gilbert Braunig, CFA© Senior Portfolio Manager


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bonds spreads not matching the fundamentals. Fundamentally we view the mortgage and housing markets positively, punctuated by recent strength in new and existing home sales, stable price growth, and homebuilder optimism which is showing itself in new construction starts and permits. Despite the slow continuation of the Fed’s normalization plan, we expect that MBS principal pay downs on the Fed’s balance sheet, while somewhat diminished by slower prepayment speeds, will continue to be reinvested for the foreseeable future. This remains a key source of MBS demand that will help keep the market functioning smoothly. Our relative value analysis indicates that investors are placing an outsized premium on Ginnie Mae (GNMA) MBS, given the perceived higher quality of the FHA collateral. As a result, we have sought to use this as an opportunity to trim back some exposure to GNMA bonds. Additionally, we view 30-yr. mortgages as optimal in comparison to 15-yr. mortgages and have been focusing our attention in this space on seasoned (more aged loans), lower coupon bonds such as 30-yr. 3% MBS. MBS exposure will be kept at neutral in portfolios where the benchmark contains an allocation to the asset class. MBS should be owned opportunistically in portfolios where they are permitted, even if the benchmark index does not have an allocation. We recently set the MBS allocation for such accounts at 10%.

While the year is not yet over, it is a sure bet that investment grade corporate bonds have scored a victory over Treasuries. Through the middle of December, intermediate corporate bonds have returned 2.85% while Treasuries have returned 0.40%. The spread on intermediate corporate bonds started the year at 126 basis points (bp) and that now stands 97 bp. As stated in prior notes, we are not constructive on corporate credit, and therefore prefer to underweight the sector in favor of Treasuries. Our thesis, simply stated, is that leverage in corporate America is rising, which is tantamount to increased risk for bond investors and thus worthy of higher spreads to compensate them for baring that risk. As we go into 2017, we remain underweight.

There are some moving and inter-connected changes in 2017 that have been precipitated by the election results. The President Elect has promised to allow corporations to repatriate cash held in foreign subsidiaries without a material tax penalty. The politicians would have us believe that the cash will be brought home and used by corporations to expand Research and Development (R&D), build new factories, and create jobs. We are less optimistic. Corporate America has had unimpeded access to cheap borrowing for years and that low cost capital has not been used for R&D, new factories or job creation. Instead, it has been used to buy other companies and repurchase stock. That is the likely outcome of repatriation and many CEOs have said as much in recent public comments. While it is good news that cash, instead of incremental borrowings, will be used to fund these bondholder unfriendly initiatives, it is too early to call it a net positive. First, a good portion of overseas cash is invested back into the domestic bond market. The “cash” is held overseas, but it is used to buy U.S. Dollar denominated debt, much of it in the form of corporate bonds and commercial paper. If the cash is to be spent,

CORPORATE BONDS: INVESTMENT GRADE AND HIGH YIELD Scott Brecher, CFA ©

Senior Portfolio Manager




the bonds, most of which have maturities under 5 years, will have to be sold which could lead to spread widening as the market reprices to absorb the selling. Second, it can’t be assumed that the pace of buybacks and Mergers and Aquisitions (M&A) will remain the same. If we see accelerated buybacks, special dividends, and a spike in M&A with repatriated cash, the benefits to debt holders could evaporate at lift off. The President Elect is also proposing to lower corporate tax rates. Some on Wall Street are suggesting that lower tax rates will make the use of debt less attractive as the benefits of deducting the interest costs for taxes will fall, thus making the after tax cost of debt more expensive. If this is true, then Corporate America will use less debt, thus starting a period of balance sheet deleveraging after years of increasing leverage. We have two fundamental problems with that view. First, debt remains the lowest cost form of financing available to Corporate America and rates are still cheap. Today, a company can borrow for 3% and that same borrowing would have cost on average 5% in the prior decade. Second, Corporate America is buying back their stock as aggressively as ever before, so it is hard to imagine that they want to do a 180 degree turn and halt buybacks in favor of reducing debt or to use for productive reasons. Another initiative the President Elect plans to pursue is the roll back of regulation, particularly as it pertains to banks. This is an area that we will have to keep a keen eye on because bank regulation has served to reduce risk to bondholders of banks by improving capital levels and lessening bank exposure to risky activities. We will watch these developments closely as we are currently overweight financial institutions in our portfolios, largely based upon current regulations, balance sheets, and operating exposures in the sector. As we go into 2017, change is in the air and there is great optimism for renewed economic growth. As corporate bond investors, we welcome economic growth as it improves corporate finances. However, it remains far too early to draw any broad conclusions on the impact of the election on the corporate sector. As the year progresses, we look forward to updating you on the President Elect’s proposals and their impact on your bond portfolio.

It has been a banner year for high yield with returns topping 16%. Particularly during the back half of the year, the asset class has performed impressively. 10-yr. government bond yields have risen from a low of 1.38% in early July to near 2.60% as of this writing, causing losses for investment grade bonds and other yield-oriented sectors such as REITS and utilities. Generally, interest sensitive sectors move together, but high yield has separated itself from the pack as spreads on high yield bonds have fallen over 100 bp. since July, the vast majority of which has occurred since the election. As it stands now, high yield spreads are down to 403 bp. over Treasuries, a fairly low level relative to their historical norm of about 584 bp. The high yield market, a crowd that migrates rapidly between extreme optimism and pessimism, is pricing in a lot of optimism for next year. The optimism can be seen in the form of improved economic growth expectations, higher corporate profitability estimates, and projections that high yield defaults will fall to half their normalized levels. From our perspective, the case to continue to invest in high yield bonds relies on economic optimism becoming reality, defaults falling back to cycle low levels, and spreads maintaining these low levels, outcomes that we are not particularly confident about individually or collectively. Accordingly, we are using this recent rally in the asset class to reduce our exposure from 5% to zero. We will monitor the market closely going forward to determine when conditions provide us with a compelling re-entry point to the sector.


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While investment grade municipals bond returns were barely positive in 2017, a lot still happened in the municipal bond market. The market experienced record issuance, strong 4th quarter mutual fund outflows, the steady meltdown in municipal pension funding levels continued, Puerto Rico began the process of restructuring its debt, and of course the election of Donald Trump, to name a few. Through the middle of October mutual funds experienced an amazing streak of 54 consecutive weeks of inflows, then briefly fund flows were flat before experiencing a spike in weekly outflows to just over $3 Billion the week following Trump’s election (Bloomberg Breif, Lipper US Fund Flows Data 12/22/16). The outflows and the corresponding rise in municipal interest rates seemed to be driven by the market’s expectation for lower marginal tax rates. Our thinking is that the market is close to having fully priced in a reduction in tax rates. However, low interest rates and high passage rates for bond measures contributed to a record $427 Billion of new municipal supply in 2016. The expectation is that 2017 will be another record year for the issuance of new debt.

Despite recent out flows, the existence of negative interest rates overseas has led to an increased presence of non-US buyers in the municipal market place. The presence of non- traditional buyers is likely helping to mask moderating municipal credit fundamentals. As we have regularly pointed out, many municipalities are facing ever larger pension funding shortfalls and a slowing in the growth of tax receipts. According to Bloomberg, during 2016 the credit rating of 8 states were lowered and the credit rating of 2 states were raised. This is an extremely high downgrade to upgrade ratio. A 4 to 1 downgrade to upgrade ratio is more often seen following a recession, not in the midst of a recovery. Today’s elevated ratio comes as we reach the seventh year of economic expansion. Despite weakening credit fundamentals, investor behavior has been bullish on municipal credit. This can be observed in the table below which shows that the returns of lower quality municipals were materially better than the returns of higher quality municipals in 2016.

MUNICIPAL BONDS Eric Reynolds Senior Portfolio Manager

MTD QTD YTDMunicipal Returns: 12/28/16 12/28/2016 12/28/2016 12/28/2016Muni, High Yield 0.09% -4.56% 5.99%Broad Muni Market 1.03% -3.68% 0.25%Muni, A 0.89% -3.97% 0.86%Muni, AA 0.96% -3.50% -0.02%Muni, AAA 0.90% -3.29% -0.16%

Source: Bloomberg & Bank of America Merrill Lynch Indices

Credit concerns should begin to be priced into the market if record new supply continues to come into the market and pension funding levels continue to deteriorate. Regardless, the additional yield received for accepting more credit risk in the municipal market is modest, which means that higher-quality municipals are undervalued. Valuation and moderating credit trends has led us to maintain very high levels of portfolio quality and liquidity. This is consistent with our goal of preserving client capital and should position us to take advantage of new




Despite a difficult 4th quarter that witnessed both rising interest rates and currency depreciation relative to the dollar, developed and emerging market bonds had a decent 2016. Non-U.S. developed market bond rates benefitted from continued central bank accommodation but were hurt by currency movements which accompanied higher U.S. growth expectations and an acceleration in the expected cadence of future U.S. Fed Funds rate hikes. A basket of developed market 10-yr. government bonds rose by 43 bp to yield 0.76% during the quarter. Whereas 10- yr. Treasury rates rose by 84 bp to 2.44% during the quarter. Currency losses on developed market non-Dollar bonds more than offset any relative price gains during the quarter. Unhedged developed market fixed income provided about a 0.50% return advantage relative the broad U.S. investment grade market in 2016.

The prospects for future returns of the asset class are unfavorable as strong current period performance reduces the prospects for future returns in the absence of ever more aggressive activity on the part of central banks. As foreign central banks slowly approach the end of their quantitative easing, there will be no natural buyers of these securities at their current levels and their yields will move higher. Our concern is that negative and near-zero rates are causing material distortions, most notably a massive magnification of pension underfunding, the punishment of savers relying on bonds and other securities to provide income, and the general misallocation of capital. Despite this reality, most risk assets have recouped losses sustained following the U.K.’s decision to exit their 43-year relationship with the European Union. The snapback of risky asset prices contrasts with the flight to safety trade that appears to be occurring between the Euro and the Swiss Franc. The Swiss Franc has advanced relative to the Euro by about 2% in the wake of both Brexit and the Trump victory. With a yield of just 0.76%, the compensation provided by the basket of non U.S. developed market government debt provides only about 30% of the yield provided by a 10-yr. Treasury. This scant compensation combined with currency vulnerability are major factors in our decision to steer clear of Non U.S. Developed Market debt for the foreseeable future.

On a trade-weighted basis, the dollar was up by more than 5.7% in the 4th quarter and is up nearly 5% on a year-to-date basis. Emerging market currencies lost about 3.0% versus the dollar during the quarter and have gained about 3.4% versus the dollar since the beginning of the year. In the months ahead, we expect the dollar to be volatile and slightly higher in the context of a relatively narrow trading range. We also expect that China will continue on its path of steady and modest devaluation versus the dollar in 2017. A wrinkle to our outlook could be caused by the erection of tariffs by the U.S. The markets response would likely be dollar appreciation which would offset the benefit of the tariffs.

Turning to Emerging Market (EM) debt, Dollar-denominated sovereign and local currency denominated sovereign EM debt were down a significant 5.9% and 7.3% ''''' '''''

INTERNATIONAL BONDS: Developed and Emerging Markets Eric Reynolds Senior Portfolio Manager

opportunities in the event that municipal bond investors overreact when growing credit risk is eventually recognized and priced back into the market.




respectively during the 4th quarter. On a year-to-date basis, both were up a little more than 5.0%. In our view, the strong annual performance reflects that investors are underestimating the risk and overreaching for return in a world that is starved for yield. Our goal is to allow emerging world debt markets to continue to clear before taking a more strategic allocation.

Current and historical yield and yield spreads across fixed income asset classes.

* Percentile ranks based on historical period from 12/31/2006 to 12/31/2016. Citi, Capital One AssetMangement

Sector Yields are displayed as part duration-adjusted Treasury yield and part option-adjusted yield premium (credit spread) over Treasuries. Absolute yields and spread yields are also displayed as percentile ranks from the last ten years’ data. Spread ranks appear low to mid-range; however, absolute yields are very low. The very low level of absolute yields suggests further credit spread compression may be minimal. Finance spreads have narrowed relative to Industrials and Utilities, reflecting improved credit quality.


ocument may

Unless otherwise noted, all return data sourced from Bloomberg, LP, December 30, 2016.

Disclosures For informational purposes only. Neither the information nor any opinion expressed in this material constitutes an offer to buy or sell any security or instrument or participate in any particular trading strategy. Capital One, N.A., its affiliates and subsidiaries are not providing or offering to provide personalized investment advice through this communication, or recommending an action to you. Capital One, N.A., its affiliates and subsidiaries are not acting as an advisor to you and do not owe a fiduciary duty to you with respect to the information and material contained in this communication. This communication is not intended as tax or legal advice; consult with any and all internal or external advisors and experts that you deem appropriate before acting on this information or material.Wealth and Asset Management products and services are offered by Capital One, N.A. (“Bank”). All investment management clients are clients of the Bank, which has delegated the investment management services to Capital One Asset Management, LLC (COAM) via a master services agreement. Investment management services are provided to the Bank by COAM, a SEC registered investment advisor and wholly-owned subsidiary of Capital One, N.A. © 2017 Capital One. All rights reserved. COAM registered with the SEC in 2001 as a Registered Investment Adviser as a Separately Identifiable Division or Department (“SIDD”). In 2005, COAM changed its registration to a wholly owned subsidiary when it filed with the State of Louisiana as a Limited Liability Company. Please refer to COAM’s ADV Part 2, which is available upon request, for additional information on COAM. Recipients of this report will not be treated as a client by virtue of having received this report. No part of this report may be redistributed to others orreplicated in any form without the prior consent of Capital One.All charts and graphs are shown for illustrative purposes only. Opinions, estimates, forecasts, and statements of financial market trends that are based on current market conditions constitute our judgment and are subject to change without notice. The information has been obtained from sources believed to be reliable but we do not warrant its completeness, timeliness, or accuracy, except with respect to any disclosures relative to Capital One. The information contained herein is as of the date referenced, and we do not undertake any obligation to update such information.Any opinions and recommendations expressed herein do not take into account an investor’s financial circumstances, investment objectives, or financial needs and are not intended for advice regarding or recommendations of particular investments and/or trading strategies, including investments that reference a particular derivative index or benchmark.Past performance is not indicative of future results. The securities described herein may be complex, may involve significant risk and volatility, may involve the complete loss of principal, and may only be appropriate for highly sophisticated investors who are capable of understanding and assuming the risks involved. The securities discussed may fluctuate in price or value and could be adversely affected by changes in interest rates, exchange rates, or other factors. Asset allocation and diversification do not assure or guarantee better performance, and cannot eliminate the risk of investment losses. Investors must make their own decisions regarding any securities or financial instruments mentioned or discussed herein, and must not rely upon this report in evaluating the merits of investing in any instruments or pursuing investment strategies described herein. In no event should Capital One be liable for any use by any party, or for any decision made or action taken by any party in reliance upon, or for any inaccuracies or errors in, or for any omissions from, the information contained herein.Fixed Income securities are subject to availability and market fluctuations. These securities may be worth less than the original cost upon redemption. Corporate bonds generally provide higher yields than U.S. treasuries while incurring higher risks. Certain high yield/high-risk bonds carry particular market risks and may experience greater volatility in market value than investment-grade corporate bonds. Government bonds and Treasury bills are guaranteed by the U.S. government and, if held to maturity, offer a fixed rate of return and fixed principal value.Interest from certain municipal bonds may be subject to state and/or local taxes and in some circumstances, the alternative minimum tax. Unlike U.S. Treasuries, municipal bonds are subject to credit risk. Quality varies widely depending on the specific issuer.Yields are subject to change with economic conditions. Yield is only one factor that should be considered when making an investment decision.

This is only an opinion and not a prediction or promise of events to come.

Not FDIC Insured Not Bank Guaranteed May Lose Value

Not a Deposit Not insured by any Federal Government Agency

bond market update - 4q16 public - capital one careful employment of credit ... unable to budge core...

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