Friday, January 31, 2020 |
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| 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 |
| 01/24/20 | 1.54 | 1.54 | 1.55 | 1.55 | 1.49 | 1.48 | 1.51 | 1.61 | 1.70 | 2.00 | 2.14 |
| 01/27/20 | 1.53 | 1.55 | 1.57 | 1.53 | 1.44 | 1.41 | 1.44 | 1.52 | 1.61 | 1.91 | 2.05 |
| 01/28/20 | 1.53 | 1.57 | 1.58 | 1.53 | 1.45 | 1.45 | 1.47 | 1.56 | 1.65 | 1.95 | 2.10 |
| 01/29/20 | 1.52 | 1.56 | 1.57 | 1.51 | 1.42 | 1.39 | 1.41 | 1.51 | 1.60 | 1.89 | 2.05 |
| 01/30/20 | 1.59 | 1.57 | 1.57 | 1.48 | 1.41 | 1.37 | 1.39 | 1.49 | 1.57 | 1.88 | 2.04 |
Source: U.S. Department of the Treasury, as of 01/30/2020
Negative Effects of Premium
This low interest rate environment has many scratching their head wondering what makes the most sense to buy. Yesterday, we discussed being cautious about prepayment speeds picking up. The reason this is a concern is that if a bond is purchased at a significant premium, then the actual yield realized when prepayment speeds pick up is much lower than what the base case would show at the time of purchase.
This 30 year, 4% coupon mortgaged-back security is a great example. The current price on this bond is 105.25 to yield 2.44% in the base case using the consensus Bloomberg prepayment assumption.
This yield looks attractive as you can pick up over 100 bps to a 3.8 year average life. Even when you look at the down 100 and 200 shock, you will see that this is expecting to stay at a positive spread. However, when you look at how this bond has been paying on a historical metric, the real risk starts to show. This bond has been paying much faster than what the assumed speeds are. For the life of this bond to date, it has been yielding 1.59% and only picking up 22 bps. The three month historical speed shows that you have a negative spread to the interpolated curve.
This low interest rate environment has many scratching their head wondering what makes the most sense to buy. Yesterday, we discussed being cautious about prepayment speeds picking up. The reason this is a concern is that if a bond is purchased at a significant premium, then the actual yield realized when prepayment speeds pick up is much lower than what the base case would show at the time of purchase.
This 30 year, 4% coupon mortgaged-back security is a great example. The current price on this bond is 105.25 to yield 2.44% in the base case using the consensus Bloomberg prepayment assumption.
This yield looks attractive as you can pick up over 100 bps to a 3.8 year average life. Even when you look at the down 100 and 200 shock, you will see that this is expecting to stay at a positive spread. However, when you look at how this bond has been paying on a historical metric, the real risk starts to show. This bond has been paying much faster than what the assumed speeds are. For the life of this bond to date, it has been yielding 1.59% and only picking up 22 bps. The three month historical speed shows that you have a negative spread to the interpolated curve.
We are strong advocates of purchasing MBS pools and think that they are important products to have in building a strong performing portfolio. However, understanding the pool characteristics and being mindful of the premium you pay for a pool can drastically impact the overall performance of an individual purchase and ultimately the overall portfolio performance.
If you would like to see MBS options that we think make sense and limit performance variance, then reach out to your CCB Capital Markets representative for further discussion.
If you would like to see MBS options that we think make sense and limit performance variance, then reach out to your CCB Capital Markets representative for further discussion.
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