Do the Math.
By Jeff Goble
Many banks throughout the Midwest have been overweighting mortgage-backed agency securities issues for their portfolios during the period when the Federal Reserve has been conducting historic amounts of quantitative easing. These bonds have nearly replaced the traditional agency and Treasury holdings held in most bank bond portfolios since the Fed has been purposely driving up their prices in order to lower mortgage rates.
One of the twists of owning mortgage-backed securities is that they pay down principal and interest each month as homeowners make their mortgage payments. While excellent for providing monthly cash flows to fund loan growth, their true yields are moving targets as any premium or discount paid is recognized through income at a different pace each month.
So how does one calculate the effective or “true” yield on mortgage-backed securities? The only way to do this is to look backwards since the original purchase date, as illustrated in the chart below.
You can see in this $30mm MBS portfolio that they are ahead of the game by 6 basis points, which is excellent. If you manage any premiums or discounts you pay to be 3 percent or less, your ride will be much smoother. Trust it.
Best wishes for a healthy and prosperous 2019.
“True” Yield Math
Jeff Goble is chief market strategist at Country Club Bank in Kansas City. He can be reached at firstname.lastname@example.org.