Tuesday, January 30, 2018
MANAGING DIRECTOR: Scott Carrithers   PORTFOLIO SALES AND SERVICE: Steve Panknin • George Morris • Jeff Goble • Chris Thompson • Sean Doherty Kevin Doyle • Lonnie Harris •  Mark Tranckino • Robert Schuyler • Tom Toburen • Josh Kiefer  Nicole Burczyk • Kelley Frye • Natalie Regan • Aaron Stoffer • Chuck Honeywell

US Treasury Market
Date	1 mo	3 mo	6 mo	1 yr	2 yr	3 yr	5 yr	7 yr	10 yr	20 yr	30 yr
1/23/18	1.26	1.44	1.63	1.78	2.06	2.18	2.43	2.55	2.63	2.77	2.90
1/24/18	1.25	1.43	1.63	1.79	2.08	2.20	2.43	2.57	2.65	2.80	2.93
1/25/18	1.23	1.42	1.64	1.80	2.08	2.20	2.41	2.55	2.63	2.76	2.89
1/26/18	1.24	1.41	1.64	1.80	2.13	2.24	2.47	2.60	2.66	2.79	2.91
1/29/18	1.28	1.44	1.66	1.80	2.11	2.26	2.49	2.63	2.70	2.82	2.94

                                                                                       Source: U.S. Department of the Treasury, as of 1/29/18  

Extension Risk

In a rising rate environment, investors are less likely to refinance and payoff their home loans.  This slows the pace of prepayments in most mortgage backed pools and increases the average life.  It is important to understand the convexity as the duration of a mortgage backed security changes when interest rates change. 

Typically, mortgage backed pools are negatively convex; meaning as rates rise bond prices decrease, MBS pools tend to decrease in price by a greater amount than similar fixed maturity products, because they can extend in average life. 

Let’s consider the seasoned 3% coupon 15 year Fannie Mae Pool shown below.  Currently, this bond has a base case weighted average life of 3.61 and a yield of 2.57%.  If rates go up 300 basis points, this bond projects extension to an average life of 3.85 and duration of 3.54.   The duration only extends minimally, from 3.33 to 3.54 - a change of only 0.21 years.

Now, let’s compare this to a longer bond; a new issue 3% coupon 15 year Freddie Mac Gold Pool. This bond is much longer and has a 5.40 weighted average life and duration of 4.79.  However, the investor is rewarded with a current yield of 2.80%.  For this higher yield, the investor does take on additional risk above a longer maturity and longer duration.  And that is EXTENSION RISK.   This pool duration extends from 4.79 to 5.52 up 300 basis points.  This is a change of .73 years, much larger than the Fannie Mae pool shown above. 

When you are evaluating pools in a rising rate environment, extension risk is an important consideration.  A duration of 4.79 might be worth the additional yield to some investors; however, if you are concerned about extension risk you may rethink that decision and choose the shorter pool. 

Please feel free to contact your CCB representative with interest in either pool discussed above. 

                                                                                                                                                                                                                                     

This information is intended for institutional investors only. The material provided in this document/presentation is for informational purposes only and is intended solely for private use. Past performance is not indicative of future results. This material is not intended as an offer or solicitation for the purchase or sale of any financial instruments.

•Not FDIC Insured •No Bank Guarantee •May Lose Value