Fighting Margin Compression in a Zero Rate Environment

Transcription

1 FHLBank Topeka 2013 Annual Management Conference Fighting Margin Compression in a Zero Rate Environment April 25, 2013 Presented by: Ryan Hayhurst, Manager Financial Strategies Group ryan@gobaker.com

2

3 Economic Conditions & Fed Policy: 2 nd Quarter 2013 US Economy: Slow and Steady Fed 2013 GDP Forecast: 2.55% Housing & Autos Strong Job Growth Weak Healthy Profits, Rising Stocks No Inflation Determined Fed Fiscal Cliff Effects Rate Hike, Payroll Tax Hike, UE Insurance Extension Weaker 2 nd Half Growth Sequester Budget Cuts Sequestration =.6% GDP effect Fed Policy Guidance, No Change As Long As Unemployment remains above 6.5% (Currently 7.7%) Projected inflation below 2.5% (Currently 1.5%); and Longer term inflation expectations continue to be well anchored. Translation: No Change Until yr T-Note Yield: Jul 08 Today S&P Downgrade, European Debt Crisis, Original Fed 2013 Pledge (since revised) QE3 QE1 QE2 3

4 Broad Investment Themes for 2013 Fed Policy Still Benign New forward guidance is helpful, but rates have reacted accordingly Flat Yield Curve, Low and Range Bound Rates Curve will steepen in advance of Fed change, not expected in 2013 Tight Spreads Flat yield curve and low yield volatility means tight spreads Margin Compression Continues Cost of funds is nearly at a floor Competition for loans putting pressure on asset yields Fed eroding bond yields Focus on Best Relative Value High performance portfolio tend to have higher concentration of Munis and do a better job of managing prepayment risk with the right MBS/CMO attributes Interest Rate Risk Continues to be a regulatory focus But not just a compliance issue understand your bet and manage your risk! 4 Bank Performance Trends: US Banks 50mm 1bil Yield on Earning Assets Loan / Deposit Ratio Yield on earning assets Loan / Deposit ratio Rate on Interest Bearing Liabilities Net Interest Margin Rate on Interest Bearing Liabilities Net interest margin Tax equiv. 4 per. Mov. Avg. (Net interest margin Tax equiv.) 5

5 Earnings Simulation NIM 24 Months 1 Base Case 2 6 7

6 Investment Portfolio Risk / Reward: 2012 Monthly History from APM 8 Investment Strategy Summary Stay Fully Invested Continue to deploy excess liquidity (simulate through IRRM) Greatest risk for many institutions is if rates do not rise Take Advantage of the Range Trade Consider market selloffs as opportunities to improve yield/margin Focus on the best relative value not all sectors selloff the same Resist the urge to wait for even higher rates unless loan demand accelerates, even more liquidity may be available soon Security Selection in this Environment is Critical! The worst bonds are normally bought at peaks and troughs in rates those are the bonds you will live with for years! Do not chase yield in alternative products, stick with liquid and marketable Structure, credit, loan attributes, cashflow stability, price volatility Maintain a Neutral Duration, Don t Stay Too Short It s too early to cut duration, continue to deploy funds onto the curve Build a Diversified Portfolio of Stable Cash Flow Bullet Agy/CDs, 1X Call Agy, Short CMOs, Defensive MBS, Hybrid ARMs 9

7 Bond Sector Spreads to Treasuries: Muni, Agency, MBS 10 Yr Muni 15Yr MBS 5Yr Bullet Agency 10 Marginal Tax Rates & TEYs 2013 Income Range (Married) Marginal Tax Rate $0 8,300 0% $8,300 26,150 10% $26,150 80,800 15% $80, ,700 25% 2.00% Tax Equivalent Yields Various Possible Tax Rates 2.78% 2.98% 3.08% 3.31% 3.53% $154, ,350 28% $231, ,650 33% $406, ,300 35% $458, % Net Yield TEY 28% TEY 33% TEY 35% TEY 39.6% TEY 43.4% * Additional 3.8% Medicare Tax on unearned income (bond portfolio) for incomes $250,000+. Applies to passive Sub S shareholders (<500hrs in bank). 11

8 Muni Spreads Widen With Maturity AAA Revenue (Tax Free) AAA General Obligation (Tax Free) Treasury 12 G.O. vs. Revenue Comparison 10 Year Water & Sewer Revenue 10 Year General Obligation Both have similar maturities and both are A rated Water & Sewer muni with 6X Revenue Coverage is potentially stronger credit than G.O. (focus on at least 1.5X coverage) Revenue muni picks up 50 60bp TEY over G.O. in 2023 With very tight supply in high quality G.O. s, Essential Purpose Revenue munis offer additional opportunities at similar credit quality and often better yield 13

9 Muni Yields Tend To Rise Less Tsy: > 6.70 = +245bp Muni: > 5.30 = +130bp Correlation: 53% 10Yr Treasury Tsy: > 4.00 = +190bp Muni: > 3.65 = +60bp Correlation: 32% 1994 Tsy: > 8.00 = +285bp Muni: > 6.00 = +175bp Correlation: 61% 10Yr Muni Tsy: > 5.25 = +215bp Muni: > 4.15 = +95bp Correlation: 44% 14 Municipal Credit Analysis Process Understand Your Exposure Municipal Holdings as a % of Capital There is no specific threshold Geographic Concentration Tax Status, Issue Type, Revenue Source, etc. Implement Credit Metric Benchmarks Develop credit criteria as part of you investment policy and/or strategy Justify metrics that are out of benchmark when appropriate Develop Municipal Bond Watch List criteria. The investment committee should review the credit of bonds on the Watch List at least quarterly. (Sample Watch List criteria is in our current policy and available on request.) Proof of an Established Credit Analysis Process Pre Purchase Documentation: Credit Profile Sheets, Financial Statements, OS Evidence of a meaningful Post Purchase Review Process 15

10 Pre-Purchase Analysis Additional Features Historical Financial Data Purpose of Bond Issue Credit Enhancement Tax Provision Tax Collection Rates Top 3 Tax Payer % Population Trends Pension and OPEB Data Personal Income Statistics Unemployment Graph Operating Profit Rainy Day Fund Analysis General Fund Trend Chart 16 Post Purchase Credit Monitoring 17

11 15yr MBS Price Volatility By Cpn Price drop when 10yr Treasury rose 130bp: 15yr 4.5 = 2pts 15yr 3.5 = 5pts When yields have risen, higher coupon MBS have seen much less price depreciation (and much less overall volatility) than low coupons. But low coupons now much cheaper Price increase when 10yr Treasury fell 235bp: 15yr 4.5 = 4.5pts 15yr 3.0 = 12pts 18 30yr and 15yr MBS Price Volatility FNMA 30 Year MBS 3.0% 3.5% 4.0% 4.5% 5.0% FNMA 15 Year MBS 2.5% 3.0% 3.5% 4.0% 4.5% 19

12 Price Limits Force You To Take More Risk 15yr 4.5% 15yr 3.5% 15yr 2.5% Fear of higher premiums forces many buyers into lower coupons. But as yields rise, lower coupon MBS tend to see much more price depreciation than higher coupons. Buying only low premium bonds can force you to take on more price risk. 15yr 4.5% 15yr 3.5% 15yr 2.5% 20 Prepayment Outlook for 2013 Mortgage rates up 25bp from record lows and refi index down 15% from recent peak HARP 2.0 is most successful program to date, refinancing nearly 1mm loans in Further expansion possible, but HARP burnout beginning QE3: Fed buying $40 billion MBS per month (50 75% of gross issuance) overwhelming supply/demand and promising tight spreads for 2013 FH/FN guarantee fees and GN MIPs should continue rising in 2013 Prepayments highest since 2004, but market has once again become bifurcated: Pre and Post HARP/MIP, i.e. May/June 2009 Specified pools (LLB, Investor, High LTV HARP, etc.) with good prepayment protection have become cheaper with recent selloff Prepayment Risks for 2013 Fed purchases Higher origination capacity Improving macroeconomic indicators (housing and employment) FHFA Director DeMarco & further expansion of HARP (cross servicer refis, date) 21

13 Prepay Risk Has Become Bifurcated FNMA 30yr Speeds: HARP Eligible vs Non-HARP Eligible Yr. 4.0% Max Loan Size Prepays Prepayments on FN 15yr 4% MBS surged in 2010 and (blue line). However, if you break out 15yr 4% MBS that had a maximum loan size of $85k /$110k/ $150k you see much less prepayment response to record low mortgage rates. Low loan balance pools (LLB) provide excellent call protection and significantly reduce prepayment/cash flow volatility. 23

14 Prepayment Comparison 15Yr 15Yr FNMA 12Mo CPR by Coupon & Loan Attribute 12 60Mo WALA (March 2013) Prepayments are not created equal. MBS backed by loans with certain attributes such as low loan balances, investor properties, NY loan, GNMA/FHA, etc. tend to prepay slower than generic pools % 3.5% 4.0% 4.5% 5.0% LLB (85K) MLB (110K) HLB (150K) INV (50 100%) GNMA I FNCI Better Performance = More Yield FN 15yr 4% FN 15yr 4% ($110k (YieldBook Projections) (YieldBook Projections) 25

15 What is your Prepay Ratio? 26 GNMA Hybrid ARMs GNMA Hybrid ARMs are adjustable rate mortgage securities that rest annually after an initial fixed period, usually 3 5yrs. GNMA ARMs are Full Faith and Credit of the U.S. Treasury and 100% government guaranteed Monthly/Annual floaters still very expensive, low yield (0.4%) FOMC has acknowledged rates will remain low through at least mid 2015 Hybrids offer a good way to bridge the path from extended low rates to eventually rising rates GNMA Hybrid ARMs offer a great opportunity to buy future rate sensitivity without sacrificing current income 27

16 GNMA 3x1 Example 28 15yr vs. Hybrid Price Volatility GNMA 3x1 Hybrid Fixed Rate GNMA 15yr 3.5% 29

17 MBS Strategy Summary Prepayment Risk To Remain High But Burnout Expected in 1H13 Record low rates, rising capacity, HARP 2.0 and policy risks threaten faster speeds But Refi index down 40% at year end 2012 and potential for burnout rising FHFA and FHA raising G fees in 2013 increased prepay protection of existing pools MBS Prepayments are Bifurcated (May/June 2009) HARP eligible FN/FH and Pre June 2009 GNMA (grandfathered MIPs) continue to have the greatest risk of fast prepayments Post HARP MBS demonstrate much lower prepayment risk and MBS purchases should be focused here for the time being Good loan attributes for Pre HARP MBS may not be good loan attributes in a HARP 2.0 world (e.g. FICO, LTV) our strategy must be flexible and constantly adapted! Buy The Right Prepayment Protection in a HARP 2.0 World Loan Balance remains the gold standard of prepayment protection. It is the attribute least affected by the uncertainty surrounding Fed and government action Investor, NY/TX, Retail Origination.; FHA, LTV 90+, Low FICO Post June 2009 Pure breeds are great when you can find them but Mutt pools are far less scarce and can be just as attractive with less cost, i.e. MBS with smaller amounts of several good attributes may be just as good as pools with 100% of a single attribute 30 Fighting Margin Compression Stay Fully Invested and Don t Stay Too Short Continue to deploy excess liquidity, greatest risk for many is if rates do not rise Optimize Portfolio Allocation with Munis and MBS High performance banks tend to minimize low yielding Agency/Treasury/Cash Consider Longer Munis If Your IRR Profile Allows Munis have historically had lower durations than same maturity taxables Muni yield curve is very steep and the sweet spot for spreads is 7 15yr A robust municipal credit analysis process is critical!! Consider Essential Purpose Revenue Munis Essential purpose revenue bonds often have as good or better credit than G.O. s and you can pickup of TEY depending on maturity Manage Prepay Risk With Loan Attributes To Increase MBS Yield Cutting prepayment risk can add bp of yield to MBS/CMO Low loan balance, NY/TX, Investor, LTV 90+, FHA, Post June 2009 Consider GNMA Hybrid ARMs Opportunity to buy future rate sensitivity without sacrificing current income 31