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Investment Options in the Current Market

By David Farris

The yield curve is flat and the Fed is on a path of continuing to raise the Fed Funds rate.  
At the same time, the market is focused on a downturn by pricing in lower funds rates next year in anticipation of a potential recession in the next 12 months.  Many metrics point to the market being at the high of the interest rate cycle, while the Fed is stating they will continue to raise rates until inflation is under control.  Depending on investors risk tolerance and interest rate bias, there are good investment opportunities available for both points of view.  I will present some of these here.

Option 1 is an FHLB 4.00% Agency Callable.  It is callable annually with a 4 year final maturity.  For current yield, this bond is attractive with a 4.00% yield, but if rates stay the same or decrease, this bond will most likely be called and only be outstanding for one year.  
If rates increase, it is a 4 year bond.

Option 2 is a seasoned 15 year 3.50% MBS.  This bond is a conservative short duration bank investment.  It has a 3.67 WAL at base and extends to a 3.93 year WAL +300, so this bond has the interest rate risk of a 3.5 to 4.0 year treasury PLUS 30 basis points of spread. The bond will shorten to a 3.17 year WAL -200, so your balance and yield remains outstanding vs. the callable that will be gone after 1 year.  The callable offers 32 bps more in current yield, but in exchange for the extra yield, the bond holder is short the option the FHLB holds to call the bond after 1 year.  By accepting a lower yield on this MBS bond, you receive WAL stability in return.

Option 3 is a SOFR ARM fixed for 5 years and then resets every 6 months at SOFR +2.12%. The current coupon for the first 5 years on this ARM is 3.80%.  SOFR ARMs are a solid defensive investments against higher rates.  This is due to the floating rate feature after 5 years along with the fact that this bond will start to prepay faster in higher rate scenarios as the first reset approaches.  Returning principal can then be reinvested at higher market rates. The coupon being fixed for 5 years protects against lower rates along with the discount price. This option provides a short duration bank investment that offers what we believe is a good current yield with low interest rate risk.

Option 4 is a Freddie Mac K Floater backed by multi-family loans and is guaranteed by FHLMC.  This bond floats at SOFR +42 (SOFR is currently 2.26%) and with the 99-00 dollar price the discount margin is SOFR +68.  Note that the current yield is only 2.94% but SOFR will track Fed Funds so if the Fed hikes 75 bps in September, this will move up to 3.69%.  
If you are worried about Fed Funds and SOFR continuing to move up then considering this type of investment will protect against this risk.  This conservative investment is defensive against higher interest rates.

Options 5, 6 and 7 are 15, 20 and 30 Year 4.5% Fixed Rate MBS.  These offer higher yields than the previous options, but in exchange for the higher yield, these have more interest rate risk.  The base yields and WALs increase as the final maturities increase from 15 to 20 and 30 years. These structures also extend and shorten more as you move out in final maturity (more WAL volatility).  The higher yields make sense for certain portfolios, especially if you are in the camp of the market being close to the high in the rate cycle.  Along with the higher yields, another positive is that these bonds provide cash flow back in the form of regular amortization and prepayments to reinvest.

Option 8 is a AA BQ Municipal bond with a 4% coupon that matures in 2038 and has a 2030 call date.  The yields shown are tax-equivalent yields for a C-Corp (pre-tax YTC = 3.50%). Municipals will be outstanding until the call date, so if rates decrease, this bond will still have a 4.43% yield to the call date and all the principal will remain outstanding until the call.  This is a positive vs. MBS (and other callable structures) which will prepay and return cash to the investor to reinvest at lower interest rates.  Conversely, if rates increase, this bond could be outstanding until maturity but the premium will be written off to the call so the book yield from call date to maturity date increases (“kicks”) to 5.06% (the yield to maturity is 4.57%).  There are also AA/AAA rated taxable municipals available in the market around 4.00% to 4.10% yields in the 9 to 12 year maturity range with spreads to treasury in the 90 to 100 basis point range.  Municipals should be considered if you believe the market is at the top of the interest rate cycle.

Please contact your Country Club Bank Sales Representative for further information on the securities discussed here and to find the best investments that fit your risk tolerance and interest rate bias.


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