Common Pitfalls in Investing NASCUS State Summit September 12, 2012 CUNA Mutual Group Proprietary Reproduction, Adaptation or Distribution Prohibited CUNA Mutual Group
A Look in the Rear View Mirror Housing Crisis Tarp Announced Budget for Loan Grow 2009 10 11 &12 Benign Loan Growth 2009 10 11 &12 Sea of Liquidity Fed Announces On Hold Money Flows into Belly of Curve 2
Fed Funds Rate 1989-2012 3
Investment View from Wall Street Analysts Source: Goldman Sachs 4
Probability of a Fed Hike 5
Credit Union Loan Growth Source: NCUA 6
US Treasury Curve 9/2010-2012 7
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
Opportunity Cost or Lost? Review of the Callable Agency Market 9
Historical Callable Agency Matrix 2/2009 & 5/2011 10
Historical Callable Agency Matrix 5/2011 & 9/2012 11
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
Broker s Quote If they want a red polka dot suit with green shoes, give it to them. 1. Conversation with Broker in June 2012 13
Agency New Issue Monitor 14
Misconceptions of Investing I purchase new issue Agencies at/or near par. Therefore, I know I get best execution. 1. Conversation with CFO July 2011 15
New Issue Doesn t Mean Best Execution 16
New Issue Doesn t Mean Best Execution 17
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
Agency New Issue Cost Savings 19
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 2011 20
Agency New Issue Cost Savings 21
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 2011 22
Agency New Issue Cost Savings 23
Agency New Issue Cost Savings Why is this acceptable practice? 24
Mortgage Backed Security Investing Mortgage Backed Securities = Yield + Extension Risk 25
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
New Issuance of Collateralize Mortgage Obligations 27
Large Bank Portfolios % of Total Securities 1997-2011 28
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
Banks Bid Lists 30
Bid Lists and New Issuance When Bid lists hit the market old supply must be sold to clear the way for new supply 31
CMO: Broker Selling a Security 32
Transparency How do I know what the right price is? What monitor on Bloomberg should I ask for? 33
CMO Underwriter Rankings 34
Liquidity & Transparency Passthroughs How they differ from Collateralized Mortgage Obligations? 35
FNCI 4% Passthrough Yield 2007-2012 36
Transparency & Liquidity Source: Trade Web 37
Transparency & Liquidity Source: Trade Web 38
Transparency & Liquidity Source: Trade Web 39
Transparency & Liquidity Source: Trade Web 40
Bond Pricing 1/32 = $312.50 per $1million 16/32=$5000.00 per $1million 32/32=$10,000.00 per $1million 41
Investment Analysis Portfolio Management 42
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
Stressed Investment Portfolio: Quantified By Security Source: Derivative Solutions 44
Investment Portfolio: Quantified Source: Derivative Solutions 45
Prepayments CPR and SMM 46
Mortgage Market vs. 10 Year Treasury Yield 47
Investments Recommended Purchases 48
Recommended Purchase: CMO Pass-Through 49
CMO : Yield Table Bloomberg Median Prepayment 50
CMO : Yield Table CPR Prepayment Analysis 51
CMO : Graph Bloomberg Median Prepayment 52
CMO : Description 53
CMO: Collateral Composition 54
CMO: Collateral Composition 55
CMO: Collateral Composition 56
Investments Not Recommended Purchases 57
CMO Investing Risky Example 58
CMO: Investing PAC Structure 59
CMO: Investing PAC Structure Slow Prepayments 60
CMO: Graph Weighted Average Life In the Bands 61
CMO: Yield Table without Band Protection 62
CMO: Extension Risk 63
CMO: Graph Weighted Average Life No Bands 64
CMO: Yield Table Bloomberg Median 65
CMO: Yield Table Actual Prepayments 66
Mortgage Payment Calculator 67
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
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
Contact Information Edward Meier Sr. Portfolio Manager MEMBERS Capital Advisors 800 356-2644 x7184 edward.meier@cunamutual.com 70