15 Hoosier Banker November 2016 To the uninitiated, this information alone would suggest you should buy the newer issue 15-year for more yield. So the question is: What is the premium on the higher coupon Mega giving me, considering I’m sacrificing 8bps of yield? Figure 2 shows price shocks in 100bp increments, as well as the swing in the bond’s average lives for these two examples. In the more extreme example of rates up 300bps, the 110K 4 percent Mega has price depreciation of -10.9 percent, compared to -14.5 percent for the new issue pool. The 110K 4 percent Mega also has far less extension risk with a 4.78-year average life, as rates are shocked up 300bps compared to 6.23 years for the 2.5 percent 15-year. Clearly the 4 percent coupon is much more defensive in a rising-rate environment compared to the 2.5 percent option. However, there’s no free lunch in this market, and you’ll need to pay a 5+ point premium for the lower price volatility 4 percent pool. Figure 2 - Price Volatility Comparison Option 1: FNMA 15-year 4% 110K Max Mega Option 2: FNMA 15-year 2.5% New Issue You’ll also notice that the projected prepays using Citi’s Yield Book model are significantly higher as FIGURE 2 - Option 2 FIGURE 2 - Option 1 rates fall in the 2.5 percent 15-year. So despite paying a lower premium for this option, these fast speeds cause the yield to quickly deteriorate as the cash flows are accelerated. If rates fall 100bps from today’s level, the 2.5 percent 15-year goes from a five-year bond to a two-year bond, while the 4 percent 15-year will shorten by just a few months, from 4.1 years to 3.7. The question comes down to whether or not the 8bps of additional yield and lower premium are worth the associated risks. For a block size of $1million, that’s only $800 of additional interest income a year. Every basis point counts in this low-rate environment, but for my money, the lower premium of the new issue 2.5 percent 15-year isn’t worth the cash flow uncertainty and price volatility. t Elizabeth Doebler has been promoted to senior consultant with BKD, LLP, Indianapolis. She is a member of BKD National Financial Services Group and has 17 years of banking experience. BKD, LLP, Indianapolis, has been named to INSIDE Public Accounting’s 2016 Best of the Best Accounting Firms list. The recognition is based on overall superior financial and operational performance, using metrics that measure growth, profitability, income, productivity, accountability, turnover, professional development and governance. Welcome, New Members The Indiana Bankers Association welcomes the following companies to the IBA network as associate members. Blue and Company John Brater, 513-834-6901 blueandco.com Blue & Co. LLC, ranked as the 53rd largest CPA firm in the United States by INSIDE Public Accounting, was started in Indiana in 1970. With 13 offices in four states ‒ Indiana, Kentucky, Ohio and Texas ‒ and more than 400 professionals, Blue is proud to serve clients in the financial services industry. Luse Gorman PC Thomas Hutton, 202-274-2027 luselaw.com Luse Gorman PC is a law firm specializing in securities; corporate, regulatory and transactional law; executive compensation; and employee benefits. It represents clients on securities and regulatory law matters before the Federal Deposit Insurance Corp.; the Board of Governors of the Federal Reserve System; the Office of the Comptroller of the Currency; the Securities and Exchange Commission; and state, securities and banking/savings and loan regulators. Russell Roberts Appraisals Inc. Russell Roberts, 270-872-5510 commercialappraiserky.com Provider of commercial appraisal services on a regional basis in the states of Indiana, Kentucky, Tennessee, Georgia, Alabama and Mississippi. t For more information about the benefits of associate membership, please contact Rod Lasley at 317-387-9380, email: rlasley@indianabankers.org. assOciate MeMBers’ cOrNer News from IBA’s valued associate members
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