Ben Lemoine Institutional Advisor Darcy Weeks Manager, Investment Operations

Transcription

1 Ben Lemoine Institutional Advisor Darcy Weeks Manager, Investment Operations 1 Permissible Credit Union Investments Investment Cash Flow Characteristics Prepayment Speeds Price/Yield Inverse Relationship and Bond Pricing Bond Classifications: HTM vs. AFS. vs. Trading Catalyst Investment Accounting Accounting Reports Month end Reconciliation 2 1

2 3 U.S Treasury Notes and Bonds The safest and most liquid investment option. Certificates of Deposit Issued by Banks, Credit Unions, and Corporate Credit Unions for a defined period of time and a stated interest rate. Insured up to $250,000 per institution. U.S. Agency Debentures Issued by a U.S. agency or GSE to help fund the purchases of mortgages. Can be in the form of bullets, callables, or step up bonds. U.S. Agency Mortgage backed Securities Pools of real estate loans securitized by the Issuer whereby principal and interest payments are passed on to the Investor ( Pass throughs ). MBSs have amortizing cash flow structures that are defined by the principal and interest payments of the underlying collateralized mortgage loans. U.S. Agency Collateralized Mortgage Obligations Pools of real estate loans securitized by the Issuer whereby principal and interest payments are put in different classes (called tranches ) with varying maturities and cash flow characteristics. 4 2

3 Cash 3% 28% Retail CDs 29% Agy Debentures Agy MBS/CMO Other 14% 26% Source: NCUA 3Q

4 Redemption date is at maturity. Principal payment is received at maturity and interest periodically. Premium or discount should be amortized/accreted to maturity date. Interest calculations are based on Actual/Actual, Actual/360 or 30/360 day count. Includes Agency Notes, Corporate Bonds, Municipals, Treasury Notes. 7 Applicable for: U.S. Treasuries Certificates of Deposit Agency Bullets Principal Semiannual Coupon Payment Fixed maturities enhance spread under declining rates but could be adverse in rising rates. 8 4

5 Call schedule is provided at issuance. Full or partial Discrete or continuous Annual, semi annual, quarterly, daily Principal payment can be received prior to maturity date. Premium is amortized to next call date. Discount is accreted to final maturity. Probability of call is dependent on interest rate environment. Interest calculations are typically based on 30/360 day count. Agency Notes, Corporate Bonds, Municipals. 9 Applicable for: Agency Callables Agency Step ups Callable CDs Principal Principal Returned at Call or Maturity Semiannual Coupon Payment Callables redeem early in declining rates and can be adverse in rising rates. 10 5

6 11 A MBS is a number of mortgages that are similar in amounts, maturity terms, rates, and structure pooled into one security. Principal and interest is periodically received over the life of the security. Issued at a factor of 1.0 and is reduced to 0.0 over the life of the bond. The average life of the bond determines how long it will take to pay back the outstanding principal. Historic prepayment speeds are projected forward to calculate average life. Premium amortization/discount accretions should take into account principal paydowns, lockout dates, pool composition, and current prepayment speeds. 12 6

7 Security backed by a pool of mortgages and structured to fall within an estimated maturity range (tranche) based on the timing of allocated interest and principal payments on the underlying mortgages. Tranches redirect cash flows of underlying securities and can mitigate prepayment risk by reducing cash flow uncertainty. Tranches vary by average life, coupon, stability, prepayment risk, and credit rating. Tranches: PAC, Sequential, Z Tranche 13 Mortgage Backed Securities (MBS) Collateralized Mortgage Obligations (CMOs) Interest and principal and distributed among classes 14 7

8 Applicable for: Agency MBS Agency CMOs Amortizing Structures Principal Monthly Principal and Coupon Back Amortizing structures best in rising rates providing needed cash flow for higher reinvestment but can be unpredictable. Declining rates could result in faster cash flows creating lower investment yields

9 17 Payments borrowers payment of principal and interest on the mortgage collateral Scheduled payments follow terms of loan amortization Prepayments unscheduled principal payments; includes: Voluntary excess principal payments Loans paid off early (re fi s and sales) Foreclosure sales Modifications Non performing loans bought out of the pool 18 9

10 There are a variety of reasons for prepayments: Interest Rates: when interest rates fall prepayments speed up as higher coupon mortgages re finance starts when current coupons are bps lower than the WAC. When interest rates rise prepayment speeds slow as re financing opportunities dry up Age of collateral new collateral is unlikely to re finance after 30 months prepayments slow due to burnout Defaults, historically predictable, but less so for loans originated in the bubble Regional economic conditions GEOs Moves Death Nature of collateral ARMs re fi for traditional reasons and as first re set date nears Balloons re fi for traditional reasons, but as rates start to rise borrowers often opt for longer term financing Shorter mortgages (10, 15, 20yr) are less likely to re fi due to built in burnout 19 Constant Prepayment Rate (CPR) is the annualized equivalent of a single month s prepayments. CPR attempts to predict the percentage of current outstanding principal, in excess of scheduled payments, that will prepay over the next 12 months based on the bonds prepayment history. CPR is measured on 1, 3, 6,12 month, and lifetime basis. Example: 10 CPR predicts that if $1 million of principal is outstanding, 10% or $100,000 in excess of scheduled amortization will prepay over the next 12 months 3 month CPR is the annualized actual prepayment experience on the bond s collateral pool over the prior 3 months. 3 month CPR is often used to project speeds for MBS by brokers and investment accounting systems. Generally accepted by auditors. Most helpful for pools with years of payment history. While past performance is no guarantee of future performance, CPR is helpful because it shows how borrowers have actually prepaid under the preceding interest rate environments

11 The Public Securities Association (PSA) now the Bond Market Association created a model to estimate the rate (speed) of mortgage prepayments PSA speed is used to refer to those estimated prepayment rates. The PSA model assumes increasing prepayments for the first 30 months and constant prepayments thereafter History shows that in the first few years following origination borrowers: Are less likely to move to a different home, Are less likely to refinance, and Are too strapped financially to allow for additional principal payments. The standard model is referred to as 100 percent PSA. Starts with annualized prepayment rate of 0% in month 0. Increases 0.2% each month, until it peaks at 6% after 30 months. Assumes annual prepayment rate of 6% thereafter. Most useful for bonds that are still close to the collateral s origination dates 21 This is a Bloomberg YT screen for a 15yr, 3.5% pool of fixed rate mortgages. PSA (P) and CPR (C) history PSA Prepayment Speeds 0bp indicates Base Case Price Base Case Yield Base Case Average Life Interest rate scenarios and corresponding estimated PSA speeds and yields 22 11

12 23 Understanding Market Value Interest Rate/Bond Price relationship Market Rates Market Value 1.40% $1,003, % $1,000, % $ 996,

13 At Par price equals 100 The market yield equals the coupon rate Most new issues are sold at PAR At a Discount price is below 100 The market yield is higher than the coupon rate At a Premium price is above 100 The market yield is less than the coupon rate 25 Bonds are quoted on a percentage basis relative to par value (100). Bonds priced at par are equal to $ Bonds purchased at a discount are priced less than $ Bonds purchased at a premium are priced greater than $ Bonds use a 32nds convention is interpreted as /32% or % of par value If the par amount is $1 million, the price of the bond is % of the par amount or $1,027, A tick refers to 1/32 nd and a + refers to 0.5/32 nd If the price is quoted at , then the bond would sell at /32 or % 26 13

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15 Held to Maturity (HTM) Bonds intended to hold to maturity Do not have to take to income Have to move entire portfolio to Available for Sale (AFS) if one bond is sold Available for Sale (AFS) Bonds that could be sold at some point Accumulated Other Comprehensive Income (AOCI) Trading Intent to sell in the short term for a profit Operating income Can decide for each purchase

16 Three ways to sell HTM bonds without having to convert entire portfolio to AFS: Weighted average maturity left on the security must be less than 3 months. Outstanding principal of the bond must be less than 10% of purchased principal. The bond must have had a significant change in its credit rating

17 Accounting Software Generally Accepted Accounting Principles FAS Compliant Bloomberg Data Interactive Data Company Available on TranZact Preliminary Reports Final Reports 33 Methods not using Level Yield Factor Method Straight Line Accelerated Method for CMOs and MBS Constant Premium/Discount Level Yield Complies with FAS 91 Economic Level Yield Bullets, Callables, CDs Level Yield with Prepayment Adjustment CMOs» Bloomberg Median/PSA Level Yield Prospective Accounting with Adjustment for Paydowns MBS» 3 month CPR 34 17

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19 Accrued Interest Book Value HTM vs AFS Asset Type Market Valuation Purchase Redemption Inventory Accounting Summary Regulatory Reports a b 5300 Call Report Excel Data File

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21 Unique identifier for each position. Includes multiple fields. Useful for account reconciliation and board reporting

22 Purchase at Par GL Description Debit Credit Par Value Par Value Purchased X Cash Par Value Purchased X Accrued Interest Accrued Interest Purchased X Cash Accrued Interest Purchased X Purchase at a Discount Purchase at a Premium GL Description Debit Credit Par Value Par Value Purchased X Cash Par Value Purchased X Unamortized Premium Unamortized Premium Purchased X Cash Unamortized Premium Purchased X Accrued Interest Accrued Interest Purchased X Cash Accrued Interest Purchased X GL Description Debit Credit Par Value Par Value Purchased X Cash Par Value Purchased X Cash Unaccreted Discount Purchased X Unaccreted Discount Unaccreted Discount Purchased X Accrued Interest Accrued Interest Purchased X Cash Accrued Interest Purchased X 43 Original Face x Factor = Current Face (Current Face x Purchase Price) / 100 = Principal Value Principal Value + Accrued Interest = Total $1,000,000 x = $620, Current Face ($620, x $103) / 100 = $638, Principal Value $638, $ = $639, Total GL Description Debit Credit Par Value Par Value Purchased 620, Cash Par Value Purchased 620, Unamortized Premium Unamortized Premium Purchased 18, Cash Unamortized Premium Purchased 18, Accrued Interest Accrued Interest Purchased Cash Accrued Interest Purchased

23 Current Face $ 620, Principal Value $ 638, $ (18,604.70) Premium to Amortize Current Face $ 620, Principal Value $ 607, $ 12, Discount to Accrete 45 Assumed Actual Difference Current Face $ 625, $ 617, $ (7,867.57) Principal Value $ 653, $ 645, $ (8,221.61) Amortization $ (28,136.52) $ (27,782.48) $ Accrued Interest $ $ $ (6.89) 46 23

24 Monthly reconciliation. Reconcile cash account to accounting reports. Principal, interest, purchases, redemptions. Export cash entries out of TranZact. Verify general ledger balances to accounting summary report. 47 Permissibility Cash flow characteristics Bond classification (AFS or HTM) Month end entries 48 24

25 Ben Lemoine, MBA Institutional Advisor Darcy Weeks Manager, Investment Operations Catalyst Strategic Solutions 49 25