THE CURRENT CHALLENGES OF MANAGING A CREDIT UNION INVESTMENT PORTFOLIO

Transcription

1 THE CURRENT CHALLENGES OF MANAGING A CREDIT UNION INVESTMENT PORTFOLIO June 11, 2014 Steve Twersky, CPA David Howard, CFA FTN Portfolio Strategies Group

2 Agenda The challenging landscape Impact of new risk-weighted capital proposal How have portfolios fared over the last year? Balancing yield and price risk Portfolio strategy thoughts 1

3 The Landscape Remains Very Challenging Fed is likely 12 to 18 months from initial rate rise 2

4 Cost of Waiting on Fed Still Very High Market Median Funds Forecast Median Funds Forecast Current 5-yr Bullet Yield Quarter 3

5 The Landscape Remains Very Challenging Fed is likely 12 to 18 months from initial rate rise Yields under 3 years remain very low 4

6 Short-Term Yields Remain Very Low May Today 2013 Change 1 year (.02) 2 years years years years years

7 The Landscape Remains Very Challenging Fed is likely 12 to 18 months from initial rate rise Yields under 3 years remain very low Spreads are tight across the board 6

8 Tight Spreads Unlikely to Budge Much Large amount of liquidity remains on sidelines Also, large amount of portfolio roll-off over next 36 months Supply of agency issued securities falling Risk premiums are way down Likely to keep spreads tight for some time 7

9 The Landscape Remains Very Challenging Fed is likely 12 to 18 months from initial rate rise Yields under 3 years remain very low Spreads are tight across the board Portfolio yields have dropped to around 1.00% 8

10 Portfolio Yields Trending Higher Average Yield on Cash and Investment Securities 9

11 The Landscape Remains Very Challenging Fed is likely 12 to 18 months from initial rate rise Yields under 3 years remain very low Spreads are tight across the board Portfolio yields have dropped to around 1.00% Most portfolios moved to a net unrealized loss last year 10

12 Drop in Values a Key Concern 3.0% AFS Gain/Loss as % Of Capital 2.0% 1.0% 0.0% -1.0% -2.0% Under $250 Mill $250 Mill to $1 Bill $1 to $5 Bill -3.0% 11

13 Some Degree of Rate Risk is Unavoidable Treasury Rate Shocks Term Up 100 bp Up 200 bp Up 300 bp 1 year -1.0% -2.0% -2.9% 2 years -1.9% -3.7% -5.5% 3 years -2.8% -5.5% -8.1% 5 years -4.6% -9.0% -10.6% 7 years -6.3% -12.1% -17.6% 10 years -8.3% -15.8% -22.6% 30 years -16.9% -30.0% -40.3% 12

14 The Landscape Remains Very Challenging Fed is likely 12 to 18 months from initial rate rise Yields under 3 years remain very low Spreads are tight across the board Portfolio yields have dropped to around 2.50% Most portfolios moved to a net unrealized loss last year Dodd-Frank, Basel III and more regulation to come 13

15 Agenda The challenging landscape Impact of new risk-weighted capital proposal How have portfolios fared over the last year? Balancing yield and price risk Portfolio strategy thoughts 14

16 Proposed Risk-Based Capital Rule for Credit Unions New risk-based capital ratio added for credit unions with assets > $50MM Unlike current approach which focused on interest rate risk, new rule also focuses on member business loans, junior lien real estate loans as well as new treatment for delinquent consumer loans and off-balance sheet exposures Approximately 33% of credit unions have assets greater than $50MM; these credit unions hold almost 95% of total credit union assets According to the NCUA, over 90% of eligible credit unions would be well capitalized under the new rule Intended Effects of Proposed Rule Higher capital levels and/or reduced risk Less concentration in junior lien real estate loans and MBL s Shorter-term investments Higher liquidity Demonstrated understanding of complex investments 15

17 Risk-Based Capital Ratios Status Net Worth Ratio RBC Ratio Conditions Well Capitalized 7% or greater 10.5% or greater Must pass both ratios Adequately Capitalized 6% % 8% % Must pass both ratios Undercapitalized 4% % Less than 8% Must pass both ratios Significantly Undercapitalized Critically Undercapitalized 2% % N/A Or if less than 5% NWR and fail to submit or implement an approved capital plan Less than 2% N/A None 16

18 Risk Weights for Cash and Investments Item Cash on hand 0% NCUA and FDIC guaranteed notes 0% Direct, unconditional US Gov t obligations (GNMA s excluded) 0% Cash on deposit 20% Cash equivalents 20% Total investments with WAL < 1 year 20% Total investments with WAL > 1 year and < 3 years 50% Total investments with WAL > 3 years and < 5 years 75% Corporate credit union non-perpetual capital 100% Total investments with WAL > 5 years and < 10 years 150% Total investments with WAL > 10 years 200% Corporate credit union perpetual capital 200% Asset-backed security for which credit union is unable to demonstrate comprehensive understanding of features Proposed Risk Weight 1250% 17

19 Weighted Average Life for Investments Item Fixed-rate obligations and deposit, non-amortizing Floating rate obligations, amortizing or not Fixed-rate amortizing securities such as MBS and CMO s Mutual funds and other collective investment funds Weighted Average Life Remaining term to maturity regardless of call features Remaining term to next rate reset Based on current expected principal repayments Maximum weighted average life or duration target as disclosed in most recent prospectus or trust document Money market funds Capital stock in certain mixed-ownership government corporations Other equity securities < 1 year > 1 year and < 3 years > 10 years 18

20 Practical Implications of New Rule U.S. Treasuries and similar obligations lowered to 0% risk weight regardless of WAL Marginal required capital levels decrease for investments with WAL s < 5 years 5- to 10-year WAL investments, including 15- and 20- year agency and GNMA MBS, face higher marginal required capital levels for Well Capitalized credit unions through combination of 150% RW and 10.5% RBC ratio 19

21 Agenda The challenging landscape Impact of new risk-weighted capital proposal How have portfolios fared over the last year? Balancing yield and price risk Portfolio strategy thoughts 20

22 FTN Barometer Peer Data Risk profile of over 1,400 portfolios on PASPort Run weekly using actual portfolio holdings Separate Barometer for Banks and Credit Unions Shows peer average and 1 standard deviation on the data distribution 21

23 Credit Union Mix Saw Little Change April 2013 May Source: FTN PASPort Credit Union Peer

24 Yields Continued to Reprice Lower April 2013 May 2014 Yields fell as portfolios continued to reprice lower: Avg yield down 13 bp Upper bound of 1 standard deviation down 40 bp as band narrows Slower prepay speeds cushioning fall 23 Source: FTN PASPort Credit Union Peer

25 Years Shocked Average Term Decreased Slightly April 2013 May 2014 Dn 100 Unch Up 100 Up 200 Up Source: FTN PASPort Credit Union Peer

26 % Change in Value Price Risk Has Not Increased 2.5% 0.0% -2.5% -5.0% -7.5% -10.0% -12.5% April 2013 May 2014 Dn 100 Up 100 Up 200 Up Source: FTN PASPort Credit Union Peer

27 % Change in Value Risk Comparable to 3 to 4 Year Treasury 5.0% 2.5% 0.0% -2.5% -5.0% -7.5% -10.0% -12.5% April 2013 May yr Treasury 4-yr Treasury Dn 100 Up 100 Up 200 Up Source: FTN PASPort Credit Union Peer

28 % of Portfolio 36-Month Rolloff Remains High 80% 70% 60% 50% 40% 30% 20% 10% 0% April 2013 May 2014 Dn 100 Unch Up 100 Up 200 Up 300 Interest Rates 27 Source: FTN PASPort Credit Union Peer

29 Agenda The challenging landscape Impact of new risk-weighted capital proposal How have portfolios fared over the last year? Balancing yield and price risk Portfolio strategy thoughts 28

30 Bond Analytics Are Highly Model Driven Always important to maintain perspective on model driven analytics Merriam-Webster: A model is a computer simulation based on a system of postulates, data, and inferences presented as a mathematical description of an entity or state of affairs. 29

31 Bond Analytics Are Highly Model Driven Always important to maintain perspective on model driven analytics Merriam-Webster: A model is a computer simulation based on a system of postulates, data, and inferences presented as a mathematical description of an entity or state of affairs. It is better to be approximately right than precisely wrong Warren Buffett 30

32 Maintain Context on Rate Shocks Timing: Unrealistic to assume a major upward shift occurs instantaneously, especially in the current environment Slope of curve: Given current curve steepness and dynamics of interest rate moves, its likely curve will flatten as rates shift higher 31

33 Our Approach Examine a wide universe of securities under a bear flattener scenario Focus on yield and price change Review on both an instantaneous and a 24 month ramp Bear Flattener Scenario 1-year up 200 bp 5-year up 156 bp 10-year up 100 bp 30-year up 75 bp 32

34 Instantaneous Bear Flattener Y i e l d yr yr 4 10-yr bullet 7-yr bullet 20-yr 3 20-yr yr DUS 5-yr bullet FNMA ACE 15-yr yr CMO 5-yr Callable 10-yr yr CMO 3-yr bullet 3-yr Callable 2-yr bullet Fixed MBS Bullet Agencies Fixed Rate CMOs Floating / Adjustable Callable Agency GNMA ARM FNMA ARM CMO Float % -8.0% -7.0% -6.0% -5.0% -4.0% -3.0% -2.0% -1.0% 0.0% % Price Decline 33

35 24-Month Bear Flattener Y i e l d yr yr bullet 30-yr 4 20-yr 3 20-yr yr 3 7-yr bullet 4.5-yr CMO 10-yr yr CMO 5-yr DUS 5-yr bullet Fixed MBS Bullet Agencies Fixed Rate CMOs Floating / Adjustable Callable Agency 5-yr Callable FNMA ACE 3-yr Callable 3-yr bullet GNMA ARM CMO Float FNMA ARM -9.0% -8.0% -7.0% -6.0% -5.0% -4.0% -3.0% -2.0% -1.0% 0.0% % Price Decline 34

36 Instantaneous Bear Flattener ARMs and Floaters Y i e l d yr yr yr bullet yr 3 20-yr yr bullet 15-yr yr CMO yr DUS 5-yr Callable 5-yr bullet 10-yr FNMA ACE 3-yr CMO Very low price risk 1.25 Fixed MBS 1.00 Bullet Agencies 3-yr Callable GNMA ARM 3-yr bullet FNMA ARM 0.75 Fixed Rate CMOs 0.50 Floating / Adjustable 0.25 Callable Agency 2-yr bullet CMO Float % -8.0% -7.0% -6.0% -5.0% -4.0% -3.0% -2.0% -1.0% 0.0% % Price Decline 35

37 Instantaneous Bear Flattener ARMs and Floaters Y i e l d yr yr yr bullet yr 3 20-yr yr bullet 15-yr yr CMO yr DUS 5-yr Callable 5-yr bullet 10-yr FNMA ACE 3-yr CMO 1.25 Fixed MBS 1.00 Bullet Agencies 3-yr Callable GNMA ARM 3-yr bullet FNMA ARM 0.75 Fixed Rate CMOs 0.50 Floating / Adjustable 0.25 Callable Agency 2-yr bullet CMO Float % -8.0% -7.0% -6.0% -5.0% -4.0% -3.0% -2.0% -1.0% 0.0% Quick Move Higher in Yield % Price Decline 36

38 24-Month Bear Flattener ARMs and Floaters Y i e l d yr yr bullet Fixed MBS Bullet Agencies Fixed Rate CMOs Floating / Adjustable Callable Agency 30-yr 4 20-yr 3 20-yr yr 3 7-yr bullet 4.5-yr CMO 10-yr yr CMO 5-yr DUS 5-yr bullet Interim Caps Less of an Issue Slower Move Higher 5-yr Callable FNMA ACE 3-yr Callable 3-yr bullet GNMA ARM CMO Float FNMA ARM -9.0% -8.0% -7.0% -6.0% -5.0% -4.0% -3.0% -2.0% -1.0% 0.0% % Price Decline 37

39 Instantaneous Bear Flattener Straight MBS & Cashflowing CMOs Y i e l d yr yr 4 10-yr bullet 7-yr bullet 20-yr 3 20-yr yr DUS 5-yr bullet FNMA ACE 15-yr yr CMO 5-yr Callable 10-yr yr CMO 3-yr bullet 3-yr Callable 2-yr bullet Fixed MBS Bullet Agencies Fixed Rate CMOs Floating / Adjustable Callable Agency GNMA ARM FNMA ARM CMO Float % -8.0% -7.0% -6.0% -5.0% -4.0% -3.0% -2.0% -1.0% 0.0% % Price Decline 38

40 % Price Change Impact of Rolldown on Straight MBS is Generally Muted 0.0% -1.0% -2.0% -3.0% -4.0% -5.0% -6.0% -7.0% -8.0% -9.0% Immediate Shock 24-mo Ramped Shock Reduction in loss over 24 months 39

41 % Paid Down Straight MBS It s All About the Cashflow 100% 90% 80% 70% 60% 50% 40% 30% 20% 10% 0% Pay Down Profile at 6% CPR 10-Year 15-Year 20-Year 30-Year Years 1-3 Years 4-6 Years 7-9 Years

42 Instantaneous Bear Flattener Bullet Proxy MBS/CMOs Y i e l d yr yr 4 10-yr bullet 7-yr bullet 20-yr 3 20-yr yr DUS 5-yr bullet FNMA ACE 15-yr yr CMO 5-yr Callable 10-yr yr CMO 3-yr bullet 3-yr Callable 2-yr bullet Fixed MBS Bullet Agencies Fixed Rate CMOs Floating / Adjustable Callable Agency GNMA ARM FNMA ARM CMO Float % -8.0% -7.0% -6.0% -5.0% -4.0% -3.0% -2.0% -1.0% 0.0% % Price Decline 41

43 24-Month Bear Flattener Bullet Proxy MBS/CMOs Y i e l d yr yr bullet 30-yr 4 20-yr 3 20-yr yr 3 7-yr bullet 4.5-yr CMO 10-yr yr CMO 5-yr DUS 5-yr bullet Fixed MBS Bullet Agencies Fixed Rate CMOs Floating / Adjustable Callable Agency 3-yr Callable 3-yr bullet 5-yr Callable FNMA ACE GNMA ARM CMO Float FNMA ARM -9.0% -8.0% -7.0% -6.0% -5.0% -4.0% -3.0% -2.0% -1.0% 0.0% % Price Decline 42

44 % Price Change Certain MBS Structures Do Rolldown Well 0.0% -1.0% -2.0% -3.0% -4.0% -5.0% -6.0% -7.0% -8.0% -9.0% Immediate Shock 24-mo Ramped Shock 43

45 Instantaneous Bear Flattener Bullet/Callable Agencies Y i e l d yr yr 4 10-yr bullet 7-yr bullet 20-yr 3 20-yr yr DUS 5-yr bullet FNMA ACE 15-yr yr CMO 5-yr Callable 10-yr yr CMO 3-yr bullet 3-yr Callable 2-yr bullet Fixed MBS Bullet Agencies Fixed Rate CMOs Floating / Adjustable Callable Agency GNMA ARM FNMA ARM CMO Float % -8.0% -7.0% -6.0% -5.0% -4.0% -3.0% -2.0% -1.0% 0.0% % Price Decline 44

46 % Price Change Agencies Also Rolldown Well Especially in 3 to 7-year Maturity Range 0.0% -1.0% -2.0% -3.0% -4.0% -5.0% -6.0% -7.0% -8.0% -9.0% Immediate Shock 24-mo Ramped Shock 45

47 Portfolio Strategy Thoughts Manage in context of full ALM position Keep excess funds invested ARMs and floaters can help manage loss exposure, but be careful not to overweight Use MBS and CMOs to manage core cashflows Focus on curve roll-down to manage future losses Be careful not to chase yield 46

48 Contact Information Steve Twersky, CPA David Howard, CFA

49 Disclaimer This material was produced by an FTN Financial Strategist and is not considered research and is not a product of any research department. Strategists may provide information to investors as well as to FTN Financial's trading desk. The trading desk may trade as principal in the products discussed in this material. Strategists may have consulted with the trading desk while preparing this material and the trading desk may have accumulated positions in the securities or related derivatives products that are the subject of this material. Strategists receive compensation which may be based in part on the quality of their analysis, FTN Financial revenues, trading revenues, and competitive factors. Although this information has been obtained from sources which we believe to be reliable, we do not guarantee its accuracy, and it may be incomplete or condensed. Ratings on all securities are subject to change. Opinions, historical price(s) or value(s) are as of the date and, if applicable, time, indicated. FTN Financial does not accept any responsibility to update any opinions or other information contained in this communication. FTN Financial is not providing investment advice through this material. This is for information purposes only and is not intended as an offer or solicitation of any product. Securities, financial instruments, products or strategies mentioned in this material may not be suitable for all investors. Before acting on any information in this material you should consider whether it is suitable for your particular circumstances. Further information on any of the securities or financial instruments mentioned in this material may be obtained upon request. FTN Financial Group, FTN Financial Capital Markets, and FTN Financial Portfolio Advisors are divisions of First Tennessee Bank National Association (FTB). FTN Financial Securities Corp (FFSC), FTN Financial Main Street Advisors, LLC and FTN Financial Capital Assets Corporation are wholly owned subsidiaries of FTB. FFSC is a member of FINRA and SIPC FTN Financial Group, through FTB or its affiliates, offers investment products and services. FTN Financial is not registered as a Municipal Advisor. 48