investment strategies for 1 quarter 2015 - the baker group · · 2015-02-19investment strategies...

Investment Strategies for1st Quarter 2015Conference Call will begin at 11:00am CT, lines open at 10:50am CT

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Presented by:Jeffrey F. Caughron, Managing Director & COO [email protected] W. Hayhurst, Managing Director [email protected]

A. Weak (Declining) – 5%

B. Flat – 32%

C. Moderate – 40%

D. Strong – 23%

How Would You Describe Your Local Economy?

21st Quarter 2015 Investment Strategies

Polling Answers from 4th Quarter 2014 Conference Call (10‐9‐14)

A. 2015 – 57%

B. 2016 – 39%

C. 2017+ – 4%

When Will The Fed Begin Raising Rates?



A. 1% – 3%

B. 2% – 18%

C. 3% – 36%

D. 4% – 37%

E. 5% – 5%

F. 6%+ – 1%

Where Will the Fed Stop Tightening?



The US Economy:Growing Faster, but All Alone Third Quarter = 5.0% Year over Year = 2.8%

Labor Market Improvement 3mo Avg. Payrolls Growth 288K 5.6% Unemployment Rate Labor Participation still weak Anemic Wage Growth

Incomes and Spending Still Modest Growth

Housing Sector Growing, but much more slowly

Global Economies on the Brink Japan in recession, Europe barely

growth, and China rolling over Dollar strength and the oil price

collapse: Double‐edged swords Deflation: Real and Feared

Economic Conditions & Fed Policy:1st Qtr 2015


Fed Policy:Preparing to Normalize Monetary Policy When to Tighten and How Fast?

FOMC intent on raising rates, but markets not convinced

Dollar Strength acts as tightening

5

10yr T-Note Yield: Jan ’12 - Today

Driven Primarily by …1. Less Treasury Issuance2. Strong International Demand

• Relative Value• Safe Haven

3. Low Inflation / Deflation Threat

1st Quarter 2015 Investment Strategies 6

2yr T-Note Yield: Jan ’12 - Today

Driven Primarily by…Expectations of Fed Tightening


US vs German Yield Curve Comparison

US 10yr T-Note Yield = 1.83%CPI Inflation = 1.3%

Germany 10yr “Bund” yield =.47%CPI Inflation = 0.1%

Even when adjusted for inflation, US yields are far better


Trade-Weighted Dollar:Jan 2011 - Today


Dollar Strength produces tightening-like conditions:

• Hurts US exports• Reduces real earnings of US corporate sector (via

overseas operations)• Decreases inflation pressures domestically

9

Fed Five Year Forward Inflation:Fed 5yr Forward Inflation Rate: 2012 – Today


Produced by the Fed Research Staff, this is the FOMC’s measure of inflation expectations.

10

Fed Funds Futures: Dec ‘15 Contract


FOMC Median Projection = 1.00%

11

Returns are as strong as they’ve been in five years Asset Quality Improvement

Non‐Performing Assets / Equity + LLR down to 19.7 from 31.5

Higher Yield on Investments Investment yield 30bps higher than

1yr ago

Margin creeping up from historically low levels Cost of Funds as low as they can

go More lending, but no higher loan

yields Loans / Deposits over 75%, highest in

over 4yrs Loan yield 20bps lower than 1yr ago

Bank Performance Trends:ROA and Net Interest Margin



Save the date! Feb 10… Baker Group Interest Rate Risk Conference Call

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FDIC Supervisory Insights: Winter 2014


Non-Maturity Deposit Trends: 2010 - Today


Mar ’1054.48%

Sep ’1469.45%

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“Institutions should incorporate “stressed” assumptions for non‐maturity deposits in IRR models” …FDIC

Three Ways to Stress NMD Assumptions1. Ratchet up pricing betas (shift sensitivities) and reduce time

lags in order to mimic an aggressively competitive environment for NMD

2. Reduce Average Life (and Duration) Assumptions in order to assess the EVE impact of lower duration liabilities

3. Simulate a “migration” of NMD balances into more rate sensitive funding (time deposits or wholesale funding)… considered to be the most realistic depiction of what may happen in the next rate cycle Demographics Access to information

Continuing “Hot Topic”: Non-Maturity DepositsWhatever Baseline Assumptions You Use, Stress Test Them


Bank Total Assets NMD/TDM 12mo NIC NP 12mo ROA NP EVE NP1 70mm 37.2% ‐7.72 ‐0.06 7.622 850mm 61.0% ‐10.45 0.75 ‐8.123 80mm 55.0% ‐4.47 1.02 20.484 120mm 51.2% 4.51 1.52 ‐0.665 200mm 57.2% ‐1.18 0.71 ‐6.576 325mm 44.3% ‐7.96 1.22 ‐19.287 100mm 44.7% ‐4.16 1.29 ‐19.858 550mm 42.5% ‐5.75 0.91 ‐2.39

Average 287mm 49.1% ‐4.65 0.92 ‐3.60

NMD Migration Stress Test: 20%

Bank Total Assets NMD/TD 12mo NIC NP 12mo ROA NP EVE NP1 70mm 46.6% 4.95 0.05 ‐0.982 850mm 76.3% ‐3.76 0.93 ‐0.053 80mm 68.8% 0.67 1.26 15.994 120mm 64.0% 9.17 1.65 10.195 200mm 71.4% 6.08 0.96 7.196 325mm 55.3% ‐3.88 1.37 ‐9.627 100mm 55.9% 1.93 1.41 ‐9.858 550mm 53.1% ‐1.66 1.02 9.69

Average 287mm 61.4% 1.69 1.08 2.82

Static Balance Sheet

NMD Migration Simulation Results:Eight Sample Banks from TX, KS, ND, CO, OK, KY


NP = Non=Parallel Rate Scenario (+400/+100bps)

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Alternative Funding Source: Brokered CDs

Cost effective versus local markets or other wholesale funding alternatives.

Flexible maturities: 1 month to 30 years. Can match funds according to your asset/liability needs. A single certificate per maturity. Unlike FHLB advances, no collateral is required. No early withdrawal feature. Only upon death or adjudication

of incompetence declared by court of law. Excellent resource for Contingency Funding Plans Through Baker Group arrangement with Financial

Northeastern Companies


Last 3 Fed Tightening Cycles


6/30/04-6/29/0624 Months

+425bp

6/30/99-5/16/0011 Month+175bp

2/4/94-2/1/9512 Months

+300bp

Treasury Yield Curve Changes


Yield Curve Change: 1994-95


3Mo +307

2Yr +330

5Yr +289

10Yr +232

30Yr +174



3Mo +167

2Yr +233

5Yr +218

10Yr +178

30Yr +102



3Mo +410

2Yr +336

5Yr +193

10Yr +94

30Yr +17

Spread Changes


1994‐95 1999‐2000 2004‐06

Fed Funds +300 +175 +425

3‐Month +307 +167 +410

2‐Year +330 +233 +336

5‐Year +289 +218 +193

10‐Year +232 +178 +94

30‐Year +174 +102 +17

10yr‐2yr Spread ‐98 ‐55 ‐242

30yr‐FF Spread ‐126 ‐73 ‐408

5Yr Agency Spread +18 +30 0

15yr MBS Spread ‐38 ‐5 ‐45

10Yr Muni Spread ‐60 ‐29 ‐112

Yield/Spread Changes in Basis Points


* Tightening cycle dates are 2/4/94-2/1/95, 6/30/99-5/16/00, 6/30/04-6/29/06. Changes in yields/spreads are quoted in basis points and are calculated from 6 months prior to first rate hike until the day of the last rate hike.

Basel III “Opt-Out” – March 2015 CR


GASB 67/68: Pension Reporting Changes

30

• Pension liabilities must now be shown on the municipality’s balance sheet rather than as a note in their financials. This will decrease the net assets for municipality’s with pension liabilities.

• Requires a more conservative discount rate be used if benefits owed exceed the net position of the plan. Plans must also report sensitivity to a 100bp change in discount rate.

• Increased transparency and comparability of pension liabilities

• GASB 67 effective for FY2014 and GASB 68 effective for FY2015 so investors won’t notice full effects until 2016.

How Does This Affect Banks?

31

• The Baker Group has been collecting pension data for several years even though the liability was “off‐balance sheet”

• Pension information will be available more often

• No need to change benchmarks at this time, but once more data is available, we may recommend changes to your policy

You should begin to see these ratios more often

Share of State GDP From Oil & Gas


% Share of State Employment


52% of US Oil From These Counties


Counties with more than 10% of incomes from Oil/Gas/Mining according to the BEA

Counties listed in the top 20 oil producing areas accounting for more than 50% of US oil production

Counties listed is the top 10 in oil production in certain states

Results: 70 counties; 4,000 CUSIPs out of 65,000

We ran those 4,000 CUSIPs through our Municipal Credit Criterion Check spreadsheet and only 550 were outside of 2 or more of our standard benchmarks

Potential “Oil Stress” Filter



Global APM Summary

Avg. Book Yield = 2.82% Avg. Life = 4.1 years

+300bps Avg. Life = 6.1yrs

Eff. Duration = 2.43 +300bps Price Risk = 10.6%

10yr Treasury Yield2003 – Today


+160bp

-200bp

+100bp

-220bp

+195bp

-160bp

+135bp

-235bp

+150bp

-90bp

+120bp

-100bp

+135bp

-120bp

Bull Markets & Bear Markets do not happen in a straight line, but are rather a series of large yield moves followed by retracements. Portfolio performance should be evaluated in the wake of last summer’s jump in yields. Use the current retracement to make any necessary adjustments.

37


Portfolio Yield

Effective Duration

+300bp Average Life

0.0

1.0

2.0

3.0

4.0

5.0

6.0

7.0

8.0

Yield, Duration and +300bp Average LifeAll Bank Portfolios on BBA


(3.0)

(2.0)

(1.0)

‐

1.0

2.0

3.0

4.0

‐

1.0

2.0

3.0

4.0

5.0

6.0

Monthly Portfolio % Gain/Loss All Bank Portfolios on BBA

Fed Fund

s Rate (%

)

Gain / Loss

(%)


Agency

MBS

CMO

Muni

‐6

‐4

‐2

0

2

4

6

Gain/(Loss) %

Monthly % Gain/Loss by Sector All Bank Portfolios on BBA

Bull/Bear markets do not happen in a straight line, but are rather a series of large yield moves in one direction, followed by a retracement in the other

The worst bonds are nearly always bought at peaks/troughs in rates and/or when spreads are tight – don’t chase yield!

We really do need a written investment strategy Low coupon bonds have significantly more volatility than high

coupon bonds It pays to pay up for prepayment protection Callable agencies always get called…until they don’t! During the recent market volatility, CMO’s owned by our clients had

the least price volatility, least extension risk and shortest average, but yields are similar to MBS and above Agencies

The opportunity cost of staying too short and/or buying too many floaters has been high, better to “buy the curve & limit extension”

Lessons Learned in a Volatile Market


Refis Finally Spiked Last Week


30Yr Mortgage Rates

Refinance Index

42

Refi Index vs. Avg Refi Loan Size


During 2011‐13, mortgage rates were falling to record lows, HARP 2.0 allowed underwater mortgages to qualify and nearly everyone could refinance. As shown in the chart, the average loan size of refis fell from 2011‐13 since even the smallest mortgages could save. Now the mortgage industry has cut capacity, so when rates fall today, they are focusing attention mainly on those loans that can benefit the most – jumbos!

LLBs Cont. To Offer Good Call Protection


* Prepay speeds are for January payments and do not take into account this weeks’ spike in refi index.

FHA MIP Reductions

Effective Immediately, Annual MIPs for both purchase and refis reduced to 85bps (from 135bps)

Lowest Since April 2011


FHA Now More Competitive With GSEs


Potential Prepayment Impact

47

To minimize the potential impact of the cut in FHA MIPs, scrub your portfolios for MBS and CMO with GNMA 30yr 3.5‐4.5% collateral. Some of these pools could see spikes of 20+ CPR with 1yr increases of 5‐7CPR.


Investment Strategy Summary Yields Are Low and Spreads Are Tight, But This Is Not The Time to

Chase Yield – Stick To Your Strategy!– The worst bonds are almost always bought during times like this, the modest yield pickup in

“alternative sectors” is not worth the risk

The Market Is Giving Your Portfolio a “Do‐Over” – Use It– Review your portfolio’s performance in 2013 and use the current market rally to make

adjustments. Consider selling bonds/sectors that did poorly and adding those that performed well the last time rates rose.

– Bull/Bear market do not happen in a straight line, eventually long yields will bounce.

Consider Adding CMOs – They Performed Best During Selloff in ‘13– The right CMO can help to reduce extension risk, lower price volatility, lower premium risk and

still provide a better yield than other low duration alternatives

Consider Scrubbing Your Municipal Credits for Potential Oil Stress– Use Municipal Credit Criterion Check spreadsheet to isolate weak credits in oil counties/states

Prepayment Risk Has Risen Sharply, Focus on Call Protection Attributes

– Combination of falling mortgages rates and FHA MIP cut mean refis should rise in coming months. Focus on MBS/CMO loan attributes that provide the best protection like LLB, shorter WAMs, investor, NY/TX, retail, high LTV, etc.


Thank You For Attending

Investment Strategies for 1st Quarter 2015

If you have any additional questions or if you would like to receive more information on any of the topics discussed today, please call your representative or:

Jeff Caughron @ 800‐937‐2257 [email protected] Hayhurst @ 800‐962‐9468 [email protected]

investment strategies for 1 quarter 2015 - the baker group · · 2015-02-19investment strategies...

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