As rates move higher …?
By Josh Kiefer
As the general consensus continues to suggest higher Treasury rates ahead, portfolio managers should remember the importance of cash flow and price stability. Predictably, unrealized losses expand as interest rates increase. Additionally, cash flow from securities with optionality tend to slow considerably, delaying the re-pricing of principal and aggravating losses.
July 17 — Due to uncertainty regarding trade and tariffs, the markets experienced a sharp decline last quarter, but new research from Sandy, Utah-based Ally Financial and E*TRADE (New York) finds bullish sentiments are returning.
By Nicole Burczyk
Over the past several decades, the fixed income market has been predominately a bull market. Investors have consistently seen the same investment decisions rewarded purely because each meaningful rise in interest rates was followed by an even more significant correction. Over this period of time, as yields lowered, prepayments increased as investors refinanced mortgages at even lower interest rates. Within this framework of lowering interest rates, bank investors have been able to invest in longer fixed rate pass through securities without much concern for the extension risk imbedded in these pools. However, given the current outlook for higher rates, it may be time to consider evaluating the risk within your current portfolio and diversifying into additional mortgage back structures when appropriate.
Respect the shocks but manage to the more likely!
By Dennis Zimmerman
This asset/liability management theme is one that our ALM team has been challenging community bank asset/liability committees to embrace over the last several years.
While regulatory expectations mandate that bank management understand the financial impact to earnings and capital in extreme rate scenarios traditionally defined as shocks, it needs to remember that these instantaneous and significant shifts in rates have a very low probability of happening. Using the typical +/-400bps shock scenario as an example, when was the last time all points on the yield curve instantaneously increased 4 percent? Never. Because it makes sense to establish policy limits to help protect earnings from extreme changes in rates, management should respect the shock outcomes. After all, limits are designed to aid management in 1) identifying IRR exposures, 2) initiating discussions regarding risk and 3) taking action to mitigate extreme risk, when necessary.
By Chris Thompson
The late, great New York Yankee, Yogi Berra, proved to be an accidental humorist. With mangled language and misplaced modifiers, the professional ball player and amateur commentator on the human condition oddly articulated the essence of the matter with quips that inadvertently made sense. No one could argue with the fun fact, “You can observe a lot by watching,” and everybody smiles at the one-liners, “Nobody goes there anymore, it’s too crowded” and “When you come to a fork in the road, take it!” These are simple truths expressed with a strange clarity that resonate with anyone living in the real world and unimpressed by frothy eloquence. You tell ‘em, Yogi!