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4Q 2009 Investment Strategy
Sample Bank
Anywhere, US
Market Comments / General Overview
Sep 30, 2009
Portfolio Book
$41,000,000
Portfolio/TA
41.00%
$830,000
Even as it appears the Fed has achieved its goal of restoring a sense of $ Gain/(Loss)
normalcy to credit markets and Chairman Bernanke declaring an end to the % Gain/(Loss)
2.3%
recession in early September, Treasury yields pushed 20 basis points lower
4.62%
across the curve while the S&P 500 jumped almost 19% over 2Q 2009. In the Tax Equiv. Yield
September policy statement, the FOMC did upgrade its economic outlook but Projected Avg. Life
3.30 yrs
reinforced its belief that conditions continue to warrant generous policy
2.17/(.63)
support and exceptionally low levels of the federal funds rate for an extended Eff. Dur/Conv
period of time. It is clear that policymakers will not allow higher borrowing +300bp Risk
(9.33)
rates to derail the recovery in housing or the economy. Despite the clear
signals from the FOMC, the Fed Funds futures market predicts a potential
rate hike in 1Q 2010. However, many economists argue that the Taylor Rule (which evaluates current output to
potential output vs. inflation projections) more accurately points to the Fed staying on hold through 2010 and
even into 2011. Additionally, to provide continued support to mortgage lending and housing markets, the Fed
announced they would purchase the entire approved allotment of $1.45tn of Agency debt and Agency MBS and
extend purchases through the end of 1Q 2010. As the Government grows its balance sheet, the massive supply of
Treasury debt has been easily absorbed by the market, with longer maturity auctions actually the performing very
well. Foreign demand has accounted for almost 50% of the purchases. The simultaneous strength in the stock
and bond markets (gold too) over the 2nd quarter belies historical precedent that one would expect to see one
market start to sell off or soften as the other one rallies. Close attention will be paid to employment and consumer
data over the next several months, with “cash for clunkers” having expired and tax credits for home purchases
ending in November these data points could tell us if we are in the clear or potentially face a “double dip”
recession.
General Strategy
The spread tightening theme of the 2nd Quarter continued through 3rd Quarter. Strong performance across all
sectors pushed the portfolio’s unrealized gain from less than 1% to over 2.3% at the end of September. With rates
remaining historically low, the portfolio yield trended lower another 13 basis points to 4.62%, while the effective
duration fell to 2.17, near the low-end of the Bank target range. The Bank will continue to emphasize core
Government Agency securities that are continuing to be purchased by the government and avoid the temptation of
high yielding, illiquid assets like certain corporate bonds or private-issue MBS. With the yield curve remaining
quite steep over the 3rd quarter and prospects of continued steepness, the Bank will maintain its focus on the
intermediate sector of the curve and strive to sustain a slightly above average portfolio duration. The mix of
the portfolio has continued to shift out of Agency securities and into fixed-rate Agency MBS/CMO and Municipal
bonds to take advantage of relatively wide spreads. As the market normalizes and volatility drops, the Bank will
look for opportunities to replenish the Agency sector. With the fiscal stimulus increasing the supply of “bank
qualified” issues and Build America Bonds, the Bank will attempt to add quality bonds with good underlying
ratings/financials with maturities in the 5-15 year range. With cash earning virtually zero, the Bank will make
efficient deployment of all idle funds and evaluate all options for enhancing income through the portfolio.
Austin, TX | Indianapolis, IN | Oklahoma City, OK | Salt Lake City, UT | Springfield, IL
Member: FINRA & SIPC
Page 1 of 3
The Baker Group
% Portfolio
Agency
Muni
MBS
June, 2017
Eff. Dur/ Conv
09/30
Target
09/30
Target
The Agency sector continued to outperform the Treasury market during
the 3rd Quarter with 5-year bullet Agencies another 5 basis points to just
under 40 basis points currently. Due to relatively low yields offered by this
sector, Agency holdings continued to contract slightly over the quarter and
are at the low end of target. Given the uncertainty of the economic and
interest rate environment, the Bank does not believe it is the right time to
chase yield and take on substantial negative convexity in longer callable
agency products. Sector duration will be maintained by buying securities
with at least one year of call protection, while favoring premium one-time
callable securities with at least 1 year to call and 3 to 10-year maturities.
The Bank will continue to look for opportunities to sell short instruments
and deploy the proceeds on the intermediate portion of the curve.
21%
20%30%
2.16 /
2-2.5/
(.25)(1.0)
The municipal sector enjoyed a very robust quarter, with bank qualified
issues in the 10- year range tightening another 75 basis points to currently
offer a 120 basis point advantage over Treasuries. A lack of tax-free supply
has been a major factor in the municipal market, large amounts of longer
(i.e. >10yrs) taxable Build America Bonds (BABs) continue to be issued as a
result of the Obama administrations American Recovery and Reform Act.
This reduced shorter maturity supply has kept the Municipal curve quite
steep. The Bank will look to take advantage by ongoing purchases of taxfree municipal bonds in the 10 to 15 year range as well as adding BABs
with 7 – 12 year maturities. The Bank will purchase BABs with slightly
shorter maturities because they do not have the reduced duration benefit
as the tax-free issues. Preferred insurers of municipal holdings will be the
Texas Permanent School Fund, Berkshire Hathaway, FSA and Assured
Guarantee, although the Bank will carefully review the creditworthiness of
all underlying municipal issuers in addition to assessing the strength of the
bond insurer. Given prudent credit analysis, the turmoil continues to offer
excellent opportunities to add to the Municipal sector. Under the current
steep Municipal yield curve environment, the Bank will continue to
maximize municipal holdings. Additionally, as opportunities become
available, the Bank will look for opportunities to swap out of short
maturities and deploy the proceeds out on the preferred range of the curve.
24%
25%30%
3.31/
The FOMC recently announce the Federal Reserve will extend its MBS buy
program through the end of 1Q 2010. They reiterated their intention to
purchase a total of $1.25tn of Agency MBS, with purchases gradually
tapering off. With the Fed having purchased just under $900bn year-todate, just over $350bn remain to be purchased. The Fed/Treasury buy
program has kept MBS market spreads to their tightest levels of the year.
Response to government implementation of various housing stimulus
programs has been muted and has lead to only a slight increase in
prepayments. After peaking in June, prepayments have declined the past
two months. Since the end of June, the MBA Refinance index has gradually
climbed from about 2,000 to 2,870, but is still over 60% below the 7,400
recent peak in Jan 2009. Unless mortgage rates drop to new lows, it
appears too many obstacles will prevent prepayments from getting too fast.
As the Government looks to reduce its role in the MBS market over the next
several months, specific security selection will be more crucial now than
ever. To combat the ultimate temporary nature of the governments
46%
35%50%
1.74/
(.81)
(.26)
(.79)
3–3.5/
0 -(.5)
2.0–3/
(.5)(1.25)
Austin, TX | Indianapolis, IN | Oklahoma City, OK | Salt Lake City, UT | Springfield, IL
Member: FINRA & SIPC
Page 2 of 3
The Baker Group
% Portfolio
June 2017
Eff. Dur/ Conv
09/30
Target
09/30
Target
8%
5%10%
1.65/
2 – 3/
(.5)(1.25)
support through direct MBS purchases and housing stimulus packages, the
Bank will continue to focus on Agency MBS pools with one or more of the
following characteristics; 1) seasoned underlying mortgages (e.g. 2005 and
earlier origination), 2) higher coupon pools (5.5%+) with particular loan
attributes that should provide prepay protection (e.g. low loan balance,
investor properties, low FICO, geographic, etc.), and 3) lower loan balance
GNMA pools.
MBS Float: The Bank’s MBS Floating sector continues to be quite small.
With an increase in origination, the Bank will evaluate new 3x1 and 5x1
Hybrid ARMs as possibilities to build intermediate cash flows and pick up
significant spreads without taking on excessive duration.
CMO
The CMO sector will continue to be comprised of only FNMA, FHLMC, and
GNMA backed securities. The Bank will look for opportunities to buy
Agency CMO structures with quality collateral characteristics that should
provide intermediate cash flows in the 2-7 year range. All CMO’s will be
prudently analyzed for both extension and call risks.
(.76)
Historical U.S. Treasury Yield Curves
5.5%
5.0%
4.5%
4.0%
3.5%
3.0%
2.5%
2.0%
1.5%
1.0%
0.5%
0.0%
9/30/2008
3/31/2009
6/30/2009
9/30/2009
Fed Funds Futures – Current Market Expectations for FUTURE levels (as of 09/30/09):
Austin, TX | Indianapolis, IN | Oklahoma City, OK | Salt Lake City, UT | Springfield, IL
Member: FINRA & SIPC
Page 3 of 3