| Friday, September 1, 2017 | ||||||||
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MANAGING DIRECTOR: |
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US Treasury Market |
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| Date | 1 mo | 3 mo | 6 mo | 1 yr | 2 yr | 3 yr | 5 yr | 7 yr | 10 yr | 20 yr | 30 yr |
| 8/25/17 | .99 | 1.03 | 1.11 | 1.23 | 1.35 | 1.47 | 1.77 | 2.00 | 2.17 | 2.51 | 2.75 |
| 8/28/17 | .99 | .98 | 1.12 | 1.24 | 1.33 | 1.46 | 1.74 | 1.99 | 2.16 | 2.51 | 2.76 |
| 8/29/17 | .96 | 1.03 | 1.13 | 1.23 | 1.33 | 1.43 | 1.70 | 1.96 | 2.13 | 2.48 | 2.74 |
| 8/30/17 | .96 | 1.03 | 1.11 | 1.23 | 1.33 | 1.44 | 1.72 | 1.97 | 2.15 | 2.49 | 2.75 |
| 8/31/17 | .95 | 1.01 | 1.08 | 1.23 | 1.33 | 1.44 | 1.70 | 1.95 | 2.12 | 2.47 | 2.73 |
Source: U.S. Department of the Treasury, as of 8/31/17
What’s 2+2?
You think the answer would be simple, but depending on who you ask you might get a different answer. “It lies between 3.98 & 4.02” – Engineer. “It’s in the magnitude of 1x101” – Physicist. “What would you like it to be?” – Accountant…. The last answer speaks volumes to both the art and science of the accounting profession.
As investors we are posed with the question of how to amortize our premium (or accrete a discount) when we buy a MBS specified pool or CMO. For this discussion we assume you are utilizing straight line amortization (constant yield is also a popular method). So do you amortize the premium to the average life or maturity?
Philosophically we recommend investors amortize premiums to the average life (or first reset for ARMs) as this typically provides more optionality and a greater level of liquidity (some banks have realized loss restrictions). By amortizing to average life you typically will have a lower yield (vs amortizing to maturity), however as loan demand surfaces you will have more flexibility to fund your loans from your investment portfolio1. As we have always said, the best investment a community bank can make is in a high quality loan. The choice of amortization is one of the few options on a bank’s balance sheet that they can control (similar to a callable CD). While it might be tempting in the short term to amortize to maturity, in the long-term, we find that amortizing to average life is the most prudent1. As a long time bond salesman once said: “1) The consensus forecast is never right (so you can’t amortize too aggressively, but you can definitely amortize too slowly). 2) Give me options (if costs basis is written down to par the bank will have more options vs a premium bond you are still amortizing)”.
1Please note that the total return would be the same if you buy and sell a security with either accounting method. The selection of accounting method will impact the timing of your cash flows (earnings). We find it is typically better to have an upside surprise (vs being stuck in a bond at a loss).
***PLEASE NOTE EACH BANK ACCOUNTING SITUATION WILL BE UNIQUE. PLEASE CONSULT YOUR OWN TAX/ACCOUNTING PROFESSIONAL FOR THEIR GUIDANCE ON YOUR SITUATION. ***
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