Common Pitfalls in Investing

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Phebe Hensley
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1 Common Pitfalls in Investing NASCUS State Summit September 12, 2012 CUNA Mutual Group Proprietary Reproduction, Adaptation or Distribution Prohibited CUNA Mutual Group

Benign Loan Growth 2009 10 11 &12 Sea of Liquidity

2 A Look in the Rear View Mirror Housing Crisis Tarp Announced Budget for Loan Grow &12 Benign Loan Growth &12 Sea of Liquidity Fed Announces On Hold Money Flows into Belly of Curve 2

3 Fed Funds Rate

4 Investment View from Wall Street Analysts Source: Goldman Sachs 4

5 Probability of a Fed Hike 5

6 Credit Union Loan Growth Source: NCUA 6

7 US Treasury Curve 9/

8 Opportunity Cost or Lost? Environment Good News: Fed Funds & LIBOR Historic Lows Bad News: Interest Rates Historic Lows Liquid Concerns Extension Risks Need for Interest Income Benign Loan Demand 8

9 Opportunity Cost or Lost? Review of the Callable Agency Market 9

10 Historical Callable Agency Matrix 2/2009 & 5/

11 Historical Callable Agency Matrix 5/2011 & 9/

12 Investing Today Start by looking at current offerings: What are they telling you? Do I agree and how does it fit into my views? Who benefits? 12

13 Broker s Quote If they want a red polka dot suit with green shoes, give it to them. 1. Conversation with Broker in June

14 Agency New Issue Monitor 14

15 Misconceptions of Investing I purchase new issue Agencies at/or near par. Therefore, I know I get best execution. 1. Conversation with CFO July

16 New Issue Doesn t Mean Best Execution 16

17 New Issue Doesn t Mean Best Execution 17

18 New Issue Doesn t Mean Best Execution Member s shop for CD rates from Financial Institution to Institution. So, why should we assume PAR is the right level? 18

19 Agency New Issue Cost Savings 19

20 New Issue Doesn t Mean Best Execution I am fine with paying my broker a commission he provides a service. 1. Conversation with CFO June

21 Agency New Issue Cost Savings 21

22 New Issue Doesn t Mean Best Execution When did it become acceptable to overpay on our investments? I don t mind if the broker marks the security up, I don t have to show it in my financials. 1. Conversation with CFO June

23 Agency New Issue Cost Savings 23

24 Agency New Issue Cost Savings Why is this acceptable practice? 24

25 Mortgage Backed Security Investing Mortgage Backed Securities = Yield + Extension Risk 25

26 Investing in Mortgage Backed Securities Who is the Natural Investor? Why do Banks like Collateralized Mortgage Obligations? Why do Brokers like Collateralized Mortgage Obligations? Does your Broker only show you secondary offerings? Why? What is Pricing Transparency and should I be concerned? Are all Agency securities liquid? 26

27 New Issuance of Collateralize Mortgage Obligations 27

28 Large Bank Portfolios % of Total Securities

29 Investing in Mortgage Backed Securities Who is the Natural Investor? Why do Banks like CMO s? Why do Brokers like CMO s? Does your Broker only show you secondary offerings? Why? What is Pricing Transparency and should I be concerned? Are all Agency securities liquid? 29

30 Banks Bid Lists 30

31 Bid Lists and New Issuance When Bid lists hit the market old supply must be sold to clear the way for new supply 31

32 CMO: Broker Selling a Security 32

33 Transparency How do I know what the right price is? What monitor on Bloomberg should I ask for? 33

34 CMO Underwriter Rankings 34

35 Liquidity & Transparency Passthroughs How they differ from Collateralized Mortgage Obligations? 35

36 FNCI 4% Passthrough Yield

37 Transparency & Liquidity Source: Trade Web 37

38 Transparency & Liquidity Source: Trade Web 38

39 Transparency & Liquidity Source: Trade Web 39

40 Transparency & Liquidity Source: Trade Web 40

41 Bond Pricing 1/32 = $ per $1million 16/32=$ per $1million 32/32=$10, per $1million 41

42 Investment Analysis Portfolio Management 42

43 Portfolio Management Concerns of Asset Liability mismatch How reaching for Yield maimed the Financial industry in the early 1990 s Housing Crisis wiped out Financial Institutions Capital Effective and Efficient Quantify Risk / Reward 43

44 Stressed Investment Portfolio: Quantified By Security Source: Derivative Solutions 44

45 Investment Portfolio: Quantified Source: Derivative Solutions 45

46 Prepayments CPR and SMM 46

47 Mortgage Market vs. 10 Year Treasury Yield 47

48 Investments Recommended Purchases 48

49 Recommended Purchase: CMO Pass-Through 49

50 CMO : Yield Table Bloomberg Median Prepayment 50

51 CMO : Yield Table CPR Prepayment Analysis 51

52 CMO : Graph Bloomberg Median Prepayment 52

53 CMO : Description 53

54 CMO: Collateral Composition 54

55 CMO: Collateral Composition 55

56 CMO: Collateral Composition 56

57 Investments Not Recommended Purchases 57

58 CMO Investing Risky Example 58

59 CMO: Investing PAC Structure 59

60 CMO: Investing PAC Structure Slow Prepayments 60

61 CMO: Graph Weighted Average Life In the Bands 61

62 CMO: Yield Table without Band Protection 62

63 CMO: Extension Risk 63

64 CMO: Graph Weighted Average Life No Bands 64

65 CMO: Yield Table Bloomberg Median 65

66 CMO: Yield Table Actual Prepayments 66

67 Mortgage Payment Calculator 67

68 CMO: Summary & Pitfalls Sequentials Simple Structure Greater average life volatility vs. PAC, significantly less than Passthrough Lower market price, higher yield PAC Slightly More Complex Structure Stable Cashflows: planned schedule offering initial lowest average life volatility Higher market price, lower yield Pitfalls Slow Prepayment environment Sequentials can extend mismatching liabilities High Prepayment environment Sequential's can trade with wide range of average life month to month. PAC s will turn into structured collateral once the companion supports pay off. Bands are no longer in place, increases average life volatility. Similar to Sequential's or even possibly passthroughs Additional cost for stable cashflows worth nothing. 68

69 Review Quantify your Portfolio Risk by using a Portfolio Management Tool Ask for a Pricing Matrix to justify Pricing Liquidity; put a bond out for the Bid When they show you a security ask them for a bid Ask for Comps Balance Balance Balance Cash holdings Duration Risk should be lower than benefit..always 69

70 Contact Information Edward Meier Sr. Portfolio Manager MEMBERS Capital Advisors x

Balance Sheet Strategies in Today's Economic Environment May 2018

Balance Sheet Strategies in Today's Economic Environment May 2018 Scott Hildenbrand Principal/Chief Balance Sheet Strategist (212) 466-7865 shildenbrand@sandleroneill.com Current Balance Sheet Management