Rates Up: Fast & Furious

Size: px

Start display at page:

Download "Rates Up: Fast & Furious"

Wilfred Dickerson
6 years ago
Views:

1 Chicago September 24, 2015 Rates Up: Fast & Furious Brian Leibfried, CFA Vice President Tony DePalo, CFA Director

3 Should we be concerned about rates up?

5 Bank Stock Value Changes vs. Interest Rate Changes to Yr UST: +135 bps KRE: +33% to Yr UST: (135) KRE: (7%) to Yr UST: +85 KRE: +21% 2015 Performance Trust. All Rights Reserved. Rates Up: Fast & Furious 5

7 How a Bank Makes Money Sources of Revenue Interest income Non-Interest income (AKA fee income) Sources of Expense Interest expense Non-Interest expense (AKA overhead) 2015 Performance Trust. All Rights Reserved. Rates Up: Fast & Furious 7

8 How a Bank Makes Money Revenue Net interest income interest income - interest expense This Revenue stream is variable when measured as a % of average assets Expense Net non-interest expense non-interest expense - non-interest income This expense is close to fixed when measured as a % of average assets 2015 Performance Trust. All Rights Reserved. Rates Up: Fast & Furious 8

9 2-Yr: Net Interest Income Simulation -200 bps -100 bps 0 bps bps bps +400 bps RATE SHIFT SCENARIO Does your 2 year NII simulation look something like this? 2015 Performance Trust. All Rights Reserved. Rates Up: Fast & Furious 9

10 TOTAL RETURN Why Defend? Balance Sheet 3-Yr Total Return Quantile Grid ESM Users 6.00% 5.00% 4.00% 3.00% 2.00% 1.00% 0.00% -200 bps -100 bps 0 bps bps bps bps +400 bps RATE SHIFT SCENARIO 2015 Performance Trust. All Rights Reserved. Rates Up: Fast & Furious 10

11 Why should a bank be concerned about rates up?

13 What are real world legitimate rates up concerns? Regulatory compliance: EV Protection Net interest income Tangible capital and shareholder wealth 2015 Performance Trust. All Rights Reserved. Rates Up: Fast & Furious 13

14 What works and what doesn t? Regulatory compliance For EV, fixed rate asset must have very short cash flow window or very short maturity. Floating rate asset may have longer maturity, cash flow window, or average life If coupon floats. Net Interest Income (NII) preservation To protect NII, we need floating rate assets whose income moves when rates rise. Protect tangible capital (TC) We need positive NII in current period and we must limit excessive mark-tomarket losses Performance Trust. All Rights Reserved. Rates Up: Fast & Furious 14

15 Why do floaters look so interesting for rates up fast and furious? Higher current yield than short fixed rate assets. Treated just like cash in regulatory EV analysis Positive NII today vs. low cost of funds Protect NII as income floats higher alongside rising COF Should protect future shareholder wealth by adding small positive net income today while avoiding mark-to-market losses REMEMBER: Future shareholder wealth = positive net income today and limiting mark-to-market losses 2015 Performance Trust. All Rights Reserved. Rates Up: Fast & Furious 15

16 How much of that narrative really is true in the real world? After considering all costs, do we earn positive net income in current period on floating income assets? Do uncapped floaters effectively limit mark-to-market losses in a manner that allows functional liquidity? 2015 Performance Trust. All Rights Reserved. Rates Up: Fast & Furious 16

17 A Few Questions In your 6/30/15 EV shock test report: How much cushion exists between your % change and your policy limits in rates up 100, 200, 300, 400? 2015 Performance Trust. All Rights Reserved. Rates Up: Fast & Furious 17

18 A Few Questions What is your institution s Net Non-Interest expense (Net Overhead) as a % of total assets? Median for Attendees is 2.10% of assets. For our analysis we will use half of 2.10%, or 1.05% Performance Trust. All Rights Reserved. Rates Up: Fast & Furious 18

19 A Few Questions What is your current COF and what is your COF beta in rates up scenarios? 0.25% today with a beta of 0.5 in rates up Example Rates up 200 bps over next 12 months Your COF is 1.25% moving into month 13 Avg. COF during 12 months is 0.75% {1.25% % 2} = 0.75% 2015 Performance Trust. All Rights Reserved. Rates Up: Fast & Furious 19

20 A Few Questions How much mark-to-market loss will your institution be willing to realize on the income statement in a given quarter or year? No more than 5% of annual net income Example $500MM bank assets 1% ROA $5MM annual income Max realizable losses $250K/Yr or $62,500/Qtr 2015 Performance Trust. All Rights Reserved. Rates Up: Fast & Furious 20

10-Yr Treasury 8/29/86 03/31/89, +250 8/31/93 12/31/94, +250 9/30/98 1/31/00, +224

27 Summary 10/31/86 3/31/89 12/31/93 4/28/95 1/31/99 7/31/00 5/31/04 7/31/06 Fed Funds Yr UST Yr UST Yr UST Fed Funds 2-Yr UST 5-Yr UST 10-Yr UST 10/31/86 3/31/89 Difference /31/04 7/31/06 Difference Performance Trust. All Rights Reserved. Rates Up: Fast & Furious 27

28 Tony s Takeaways Each rate increase would have been labeled differently Most rate rises started out as a steepener or a parallel shift Every rate rise, to some degree, was a flattener when viewed at peak levels It has been some time since the last significant rate rise ( ) 2015 Performance Trust. All Rights Reserved. Rates Up: Fast & Furious 28

29 What does this examination of historical rate rise nuances and subtleties do for us today? Brazen Answer: Nothing Tempered Answer 2015 Performance Trust. All Rights Reserved. Rates Up: Fast & Furious 29

31 What are real world legitimate rates up concerns? Regulatory compliance: EV Protection Net interest income Tangible capital and shareholder wealth 2015 Performance Trust. All Rights Reserved. Rates Up: Fast & Furious 31

32 What works and what doesn t? Regulatory compliance For EV, fixed rate asset must have very short cash flow window or very short maturity. Floating rate asset may have longer maturity, cash flow window, or average life If coupon floats. Net Interest Income (NII) preservation To protect NII we need floating rate assets whose income moves when rates rise. Protect tangible capital (TC) To protect and build future shareholder wealth, we need positive NII in current period and avoid mark-to-market losses Performance Trust. All Rights Reserved. Rates Up: Fast & Furious 32

33 Cash 0.25% current yield Income floats 1 for 1 with movements in Fed Funds Ultimate defensive asset for rates up fast and furious Hard to hold cash with COF at 0.25% and net overhead expenses at 1.05% Real benefit of cash: functional liquidity 2015 Performance Trust. All Rights Reserved. Rates Up: Fast & Furious 33

34 Uncapped Floater 1.2% current yield Has prepay risks but we will assume those do not impact us Income Floats 1 for 1 with movements in Fed Funds Gets treated just like cash for EV model purposes Does it guarantee functional liquidity? 2015 Performance Trust. All Rights Reserved. Rates Up: Fast & Furious 34

52 Tony Vin Diesel DePalo s Definition Vin Special aka Re-Remic Resecuritizations of legacy mortgage assets that were originated during the mortgage boom 2015 Performance Trust. All Rights Reserved. Rates Up: Fast & Furious 52

Summary of Collateral Statistics 2015 Performance

Credit Support (Loan Loss Reserve) at origination 2015

Default and Loss History of Underlying Collateral 2015

61 TOTAL RETURN AAA Shape 3-Yr Horizon Total Return CMLTI A2 Offering: 7.135MM (FACTOR: 1.00) Sector: RE-REMIC ARM Coupon: 2.66% Settle T+3 CUSIP: 17316YAF5 2.50% 2.00% 1.50% 1.00% 0.50% 0.00% -300 bps -150 bps bps bps CMLTI A2 0.38% 0.74% 1.22% 1.83% 2.37% Proxy Typical Portfolio 1.78% 1.77% 1.64% 1.24% 0.46% Agency 3-Yr 1.00% 1.00% 1.01% 1.02% 1.03% 2015 Performance Trust. All Rights Reserved. Rates Up: Fast & Furious 61

63 TOTAL RETURN Single A Shape 3-Yr Horizon Total Return CSMC R 8A1 Offering: MM (FACTOR: 0.72) Sector: RE-REMIC ARM Coupon: 3.20% Settle T+3 CUSIP: 12646DBS4 2.50% 2.00% 1.50% 1.00% 0.50% 0.00% -300 bps -150 bps bps bps CSMC R 8A1 0.67% 1.01% 1.42% 1.87% 2.31% Proxy Typical Portfolio 1.49% 1.68% 1.68% 0.95% 0.13% Agency 3-Yr 1.09% 1.09% 1.10% 1.11% 1.12% 2015 Performance Trust. All Rights Reserved. Rates Up: Fast & Furious 63

Single A Collateral Performance 2015 Performance

68 TOTAL RETURN Non-Rated Shape 3-Yr Horizon Total Return BCAP 2013-RR3 6A5 Offering: 3MM (FACTOR: 0.82) Sector: RE-REMIC ARM Non-Rated Coupon: 2.47% Settle T+3 CUSIP: 05542JAX0 3.00% 2.50% 2.00% 1.50% 1.00% 0.50% 0.00% -300 bps -150 bps bps bps BCAP 2013-RR3 6A5 1.50% 1.68% 2.01% 2.47% 2.80% Proxy Typical Portfolio 1.66% 1.67% 1.64% 1.03% 0.23% Agency 3-Yr 0.87% 0.87% 0.88% 0.89% 0.89% 2015 Performance Trust. All Rights Reserved. Rates Up: Fast & Furious 68

12 A Rated Re-Remic 1.80 4/15-7/20 2.74 Non-Rated Re-Remic 2.

72 Summary Bond Static Yield Window WAL Uncapped Floater /17-7/ AAA Rated Re-Remic /15-5/ A Rated Re-Remic /15-7/ Non-Rated Re-Remic /15-5/ AAA A Non-Rated 2015 Performance Trust. All Rights Reserved. Rates Up: Fast & Furious 72

76 Final Takeaways Rates up Fast & Furious: not a concern for most institutions All costs considered, most floating rate assets struggle to win, even in rates up especially without functional liquidity Value of typical bank is higher in rates up If you are considering agency floaters, there may be a more appropriate alternative

77 2015 Performance Trust Capital Partners, LLC (which, along with its affiliates, is referred to as Performance Trust ). All Rights Reserved. This material is for your internal use only and may not be disclosed to third parties. The content is the proprietary and confidential material of Trust and so designated pursuant to a confidentiality agreement between the intended recipient and Performance Trust. The research and other information provided herein has been prepared for informational purposes only and is not an offer or solicitation to purchase or sell securities. Performance Trust may make a market, or have a position in the securities discussed herein and may purchase or sell the same on a principal basis or as an agent. Investing involves risks, including the potential for principal loss. There is no guarantee that the strategies and services will be successful or outperform other strategies and services. Certain assumptions may have been made in connection with the analysis presented herein, and changes to the assumptions may have a material impact on the analysis or results. Past performance is no guarantee of future results. The investments discussed herein may be unsuitable for investors depending on their specific investment objectives and financial position. Investors should independently evaluate each investment discussed in the context of their own objectives, risk profile and circumstances. The information contained herein has been obtained from sources considered to be reliable, and is subject to change without notice. Performance Trust does not guarantee its accuracy, adequacy or completeness and is not responsible for any errors or omissions or for the results obtained from the use of such information. FOR INSTITUTIONAL USE ONLY.

Now What? Navigating Fearlessly Through a Turbulent Environment February 2, 2016

Risk Management Strategy & Solutions Now What? Navigating Fearlessly Through a Turbulent Environment February 2, 2016 Frank L. Farone, Managing Director ffarone@darlingconsulting.com 2015 2016 Darling