A View. from the Desk. June In This Issue:

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1 A View June 2015 from the Desk In This Issue: Trading Trends... 1 Looking Forward... 4 About Us: We offer financial institutions a comprehensive solution that includes balance sheet management, investment banking, and capital markets. Our broad range of services combined with our personal service and professional advice can help you improve your institution s financial performance and achieve your strategic objectives. We have built our process from the ground up to deliver Wall Street Execution with Main Street Customer Service. Each month, Ambassador Financial Group releases a detailed summary of the volume and breakdown of trades executed by our trading desk. This month, we have written a mid-year review of the trading trends we witnessed in the first six months of In the last section titled Looking Forward, we have provided a brief insight into what we expect to see as we move into the third quarter. Trading Trends: The bar chart on the next page shows various fixed income asset classes and the percentage of client purchases falling into each category on a monthly basis. There are some key takeaways from this chart. First, corporates were the most active asset class in four of the first six months of the year, accounting for 39% of all buy-side trades based on par value. Many of these trades fall into two broad categories: structured corporates and high-coupon issues. Clients took advantage of opportunities to add various structured floaters indexed to the long end of the curve as well as fixed to float structures that offer an attractive current coupon with interest rate sensitivity on the back end. In addition, we saw a lot of demand for non-callable corporates with coupons that are significantly above market. These coupons, sometimes as large as 9.00%, help to increase the portfolio s current cash flow which reduces the duration profile. These issues are often offered significantly wider than current coupon comps because many of these issues are non-index-eligible, which reduces demand from some of the larger funds. Furthermore, retail investors have difficulty understanding premiums and thus tend to shy away from these types of issues. This translates into wider spreads and higher yields for other institutional investors looking for these types of securities. continued on page 2 June

2 Figure 1: Client Purchases: Asset Class Breakdown Figure 1 shows various fixed income asset classes and the percent of client purchases falling into each category. 100% 90% 80% 70% 60% 50% 40% 30% 20% 10% 0% JAN FEB MAR APR MAY JUN 2015 YTD Treasuries Taxable Muni Tax Exempt Muni Other MBS Corporate CMO Agency The second most active asset class through the first six months of the year was mortgage-backed securities. MBS accounted for 22% of all client purchases, and this was the most active asset class in May and June. We often witness a positive correlation between MBS purchases and rising Treasury yields. Once Treasury yields began to rise toward the end of April, MBS activity increased as many institutions shifted their focus to securities with a strong cash-flow profile. We continue to see interest in a mix of new production and seasoned pools with 15-year and 20-year amortization schedules. Volume in 10-year MBS has been extremely low this year because the yields have failed to move above 2.00%. More recently, the pay-up on seasoned 15-year pools has become high, so we have seen a shift to new production pools. Demand for 20-year pools continues to be mixed, but seasoned collateral offers a nice balance for clients looking for higher yields and manageable duration profiles. We are always cautious of high premiums because of the potential for prepayment risk should yields fall. That being said, we have recommended that clients roll out the coupon curve during periods when rates move higher, making premiums on some higher coupons more palatable. For instance, after trading well north of $105 in April, new production 15-year 3.00% pools touched the low $103 s in June. This was a good opportunity for clients to layer in some of this coupon. We also saw some activity in seasoned 20-year 3.50% pools. These pools were trading in the low $104 s in June, which offered exposure to the 3.50% coupon at a significantly lower premium than 15-year 3.50% pools, while offering a similar duration profile. continued on page 3 June

3 Figure 2 shows various fixed income asset classes and the percent of client sales falling into each category. CMOs accounted for 6% of all trades through the first six months of the year, failing to account for more than 9% of buy-side trades in any month this year. Some clients are required to buy CMOs due to strict premium and duration constraints in the investment policy. Other clients treat pass-throughs and CMOs as if they are interchangeable because they both pay monthly principal and interest. This is true; however, we prefer to tread cautiously in this space. CMOs have become a tool used by some firms to dump less-than-desirable collateral. These structures can look good to the naked eye, but upon further review some problems might be hiding below the surface. It is also common to see CMOs backed by jumbo loans, loans with high loan to value (LTV), or relocation pools. Pools that are backed by non-tba eligible collateral typically offer slightly more spread; however, this often comes at the expense of erratic prepayment speeds and diminished liquidity. If you have the flexibility to buy a CMO or a pass-through, all else being equal, the pass-through should be more liquid and often serves as a better total return play for clients who take an active approach to the portfolio. Client purchases of munis have been strong through the first six months of year. Tax-exempt munis accounted for 19% of client purchases while taxable munis accounted for 3%. Compared to the first half of 2014, client purchases of tax-exempt munis, as a percentage of total purchases, were 2.5 times higher while taxable muni purchases were 20 times higher. One of the main reasons for this increase in volume is the amount of supply coming to market. Year-to-date (YTD), BQ issuance is 30% higher. The trend is very similar for taxable munis in which issuance is 34% above this time last year. This increased supply has caused deals to price at levels that are attractive compared to other asset classes. Below is a bar chart showing the monthly breakdown of client sales by asset class. The trends in client sales aren t as noticeable as some of the buy-side trends. From the chart, we can see that MBS were the most actively sold asset class, accounting for almost 30% of client sales. For clients who were looking to take gains in the first half of the year, MBS were often the most viable option because spreads were relatively tight and yields were replaceable in other asset classes. Agencies were the next most actively sold at 19%. Although the rise in Treasuries in the second quarter will temporarily make it difficult to execute sales, agencies remain popular sale candidates for clients considering risk mitigation strategies. Figure 2: Client Sales: Asset Class Breakdown 100% 90% 80% 70% 60% 50% 40% 30% 20% 10% 0% JAN FEB MAR APR MAY JUN 2015 YTD Treasuries Taxable Muni Tax Exempt Muni Other MBS Corporate CMO Agency continued on page 4 June

4 Figure 3 shows the duration mix of bonds clients have purchased through our trading desk. Figure 3 below shows the duration mix of bonds that clients have purchased through our trading desk, separated by month. Almost 68% of all buy-side trades executed in the first six months of the year fell in the 3- to 5-year duration bucket. This trend is almost identical to what we witnessed in the first six months of The main difference between this year and last is the increase in activity in the 6- to 8-year duration bucket. Through the first half of this year, activity in this bucket is up twofold, accounting for 22% of client purchases. It is also interesting to compare fluctuations in the longer duration buckets to Treasury yields. For instance, the 6- to 8-year duration bucket was the most active in March, accounting for 54% of client purchases. As yields began to move higher in April, and continued this trend through the rest of the second quarter, the percentage of trades in the 6- to 8-year duration bucket diminished. Clients were able to find the yields they required shorter on the curve, and some clients were hesitant to add longer duration assets in case the Treasury sell-off continued. Figure 3: Duration Mix 100% 90% 80% 70% 60% 50% 40% 30% 20% 10% 0% JAN FEB MAR APR MAY JUN 2015 YTD 12+ Years 9 11 Years 6 8 Years 3 5 Years 0 2 Years Looking Forward: The second quarter was fairly lackluster for investors. U.S. equities were mixed with the Dow Jones Industrial Average (DJIA) down 1.14% YTD and the S&P up 0.20% on the year. The S&P 500 was up over 6% this time last year. Although U.S. equity returns are relatively flat on the year, YTD bond holders haven t really fared any better. The 10-year Treasury officially ended the second quarter at 2.354%. This is an increase of only 18 basis points (bps) from the start of the year but a 71 bps increase from the lows touched at the end January. The 5-year Treasury has risen 49 bps while the 30-year Treasury has risen 92 bps from the 2015 lows. continued on page 5 June

5 As we begin the third quarter, we must reiterate that we believe the markets are entering a period of increased volatility. We have been warning about an uptick in volatility due to a potential FOMC rate hike and issues plaguing the global economy. This volatility was especially apparent toward the end of June when the VIX (Volatility Index) surged 55% and the MOVE (Merrill Lynch Option Volatility Estimate) index increased 12% over the course of one week. Most of this volatility can be blamed on the deteriorating conditions first in Greece and now in Puerto Rico. After Greece failed to miss a debt payment to the International Monetary Fund (IMF) and initiated a referendum allowing Greeks to vote on austerity measures, U.S. Treasuries experienced a flight to quality. Should Greece manage to negotiate another bailout, it will only be a matter of time before Greece is back in the headlines as they continue to kick the can down the road, failing to solve any of the country s financial troubles. As we begin the third quarter, we must reiterate that we believe the markets are entering a period of increased volatility. Unfortunately, we have no control over the level of volatility in the market, but we can control how we react to it. Since the start of the financial crisis, volatility has benefited many of our clients who chose to take a more active role in the portfolio. We believe the increased volatility will create opportunities going forward that our clients will be able to exploit to drive value in the portfolio. Good luck in the third quarter. Joshua A. Albright, CFA Senior Vice President, Fixed Income Trading Ryan G. Epler Senior Vice President, Fixed Income Trading Mark B. Trinkle Senior Vice President, Fixed Income Trading June

6 THE AMBASSADOR TEAM: 1605 North Cedar Crest Blvd. Suite 508 Allentown, PA (toll-free) Executive Blvd. Suite 503 Rockville, MD (toll-free) Chicago Mercantile Exchange 30 South Wacker Drive 22nd Floor Chicago, IL (toll-free) Joshua A. Albright, CFA Senior Vice President, Fixed Income Trading Allen R. Collins Managing Director, Chief Compliance Officer Arnold G. Danielson Chairman Emeritus, Danielson David G. Danielson Managing Director, Head of Investment Banking Ryan G. Epler Senior Vice President, Fixed Income Trading Heidi Geist Administrative and Trade Settlement Coordinator Belle Gutschick Administrative Assistant Mike Harrison Vice President Karl J. Ostby Managing Director, Investment Banking Robert J. Pachence, Jr. Co-Founder & Managing Principal John D. Putman Senior Vice President Michael Rasmussen Managing Director, Investment Banking Matthew T. Resch, CFA Co-Founder & Managing Principal Jay Shah, CFA Vice President, Capital Markets Eric R. Tesche Managing Director Mark B. Trinkle Senior Vice President, Fixed Income Trading John S. Walker, Ph.D., CFA Director of Research & Chief Economist Rick Weiss Managing Director, Head of Investor Relations The information presented is for informational purposes only. This is not an offer or solicitation to purchase or sell any security through Ambassador Financial Group, Inc., a current member of FINRA/SIPC. For more information contact us at Ambassador Financial Group, Inc. June