Ask Emily Archives June 2010 Some interest rate risk (IRR) is inherent in the business of banking, but what best practices and management techniques can I follow to ensure sound IRR management and minimize IRR exposure in this current market environment?   May 2010 What are swap spreads?   April 2010 In a recent exam, the NCUA told us that their ALM risk measurement tables are only guidelines and should not be used.   February 2010 I've heard from some sources that buying callables rather than bullets is not a good plan. They say that from a total return perspective, the bullet will yield more. But if I buy a three-year callable and the yield to call (YTC) and yield to maturity (YTM) are both higher than a bullet agency with the same maturity, and I never plan to sell the bond, then who really cares about total return?   January 2010 Our credit union is performing fairly well in this environment, but examiners seem to have a different mindset. The focus seems to be to reduce risk to a point where we can’t make money. Am I missing something?   December 2009 If you fall in the “low” risk category for both the net interest income (NII) simulation and net economic value (NEV) analysis, do you have to worry about interest rate risk? Should you move rates up to double-digit figures in order to really test your inherent interest rate risk?   November 2009 Should you use par values for all non-maturing deposits?   October 2009 When should you perform an ALM validation or back test your models?   September 2009 Should you use the same rates for reinvestments in the net interest income (NII) simulation as the discount rates in the net economic value (NEV) analysis?   August 2009 A.) The Net Interest Income Simulation (NII) shows a gain in net income should rates rise; however the Net Economic Value (NEV) analysis shows a negative value in the “moderate” interest rate risk range. Are the reports erroneous? B.) If you do the NII analysis, is the NEV analysis not important?   July 2009 We have noticed from the increasing number of questions that examiners are paying greater attention to ALM methodologies, practices, and most importantly user knowledge. Questions relating to ALM issues have been appearing on examiner comments and requests. The following is a compilation of statements which will be addressed in the next few Ask Emily articles. Some don’t have easy answers, some are true and some are simply wrong.   June 2009 I read a recent article analyzing one of WesCorp’s securities; CUSIP 751153AC. The bond did not appear that bad and indicated only minimal losses, which wouldn’t be incurred for five years; what are your thoughts?   May 2009 I found your article on the structure of bonds extremely interesting. I was told that the mezzanine bonds were rated AA, which is a very high rating, so how can they potentially lose principal? Also, how can I look at a rating and know how much principal will be lost?   April 2009 I read your article on Other than Temporary Impairment (OTTI). Are you saying that if the accounting rules are changed, that there should be gains in non-conforming securities?   February 2009 Note: This month Emily takes a departure from her usual question and answer format and offers her thoughts on accounting rules SFAS 115 and EITF 99-20.   January 2009 Have you heard about the major banks issuing debt that is guaranteed by the United Stated Government? Where are these securities trading and can credit unions invest in these vehicles?   November 2008 Last year you listed broker projections on interest rates and it really helped us with our budgeting process, will you be doing it again this year?   October 2008 Do you believe that this government bailout is a good thing?   September 2008 I am a board member of a $500 million credit union and I must confess that I don’t really understand all this talk about the credit crisis. Is it real? How can a financial institution say that they have wiped out their equity, but only on a temporary basis? If my investments lose value, even if I have not sold, to me, it is still a loss.   August 2008 What is a commercial mortgage backed security and do credit unions purchase them?   July 2008 How financially secure are FNMA and FHLMC? Are my investments safe?   June 2008 How do you read Fed Funds futures contracts and how do they work?   May 2008 With the current state of the credit markets; are there opportunities in leverage strategies?   April 2008 What should be our balance sheet strategy given what is happening in the markets?   February 2008 I am worried about the corporate credit unions, US Central’s downgrade, and their unrealized losses; should I be concerned?   January 2008 I read your article on FHLMC and their unrealized security losses. On one hand, I am scared to invest in anything; on the other hand, I am seeing yields close to 6 percent on securities backed by non-conforming loans. Are those safe? I don’t want to be hit with losses.   December 2007 What is going on with Freddie Mac and Fannie Mae?   November 2007 Last year you listed broker projections on interest rates and it really helped us with our budgeting process, will you be doing it again this year?   October 2007 Last year you listed broker projections on interest rates and it really helped us with our budgeting process, will you be doing it again this year?   September 2007 We own a Countrywide security that is backed by non conforming loans, are we at risk of principal losses given what is happening to Countrywide? Should we be selling or perhaps buying to take advantage of these markets?   August 2007 We are a California credit union and have been trying to compete with an institution that is offering option ARMs. There seems to be so many different types of adjustable rate mortgages and some of the rates are very low. Can you describe the differences?   July 2007 I am a director of a credit union and have been reading about failures involving CDOs and CLOs, what is the difference between these investments and a CMO?   June 2007 I have recently been requested to place all of my non- maturing deposits at par for purposes of the NEV valuation. What do you think of this practice?   May 2007 What do you think about all the news of subprime loans and how will this affect credit unions?   April 2007 Can you explain the pros and cons of adopting FAS 159?   March 2007 What is the difference between a “putable” advance and a “callable” advance from the Federal Home Loan Bank and which one is better?   February 2007 We have slowed down our indirect loan activity due to higher anticipated losses. We are considering taking less “C” and “D” paper from our dealers and focus solely on premium and “A”, but this is sometimes difficult for our dealers to accommodate. Do you have a suggestion on limits for lower quality loans?   January 2007 We believe that interest rates are falling; therefore I am proposing that we increase the amount of fixed rate mortgages that we have on our books to protect us from loss of income in a falling rate environment. Do you have a standard amount (as a percent of assets) that we should add?   December 2006 I am a CEO at a credit union and am proposing in our strategic plan that we seek out credit unions to merge. It appears that this is prevalent within the industry. Merging entails a good amount of work on my staff but I strongly believe that greater assets will make us more efficient. What are your thoughts?   October 2006 Last year you listed broker projections on interest rates and it really helped us with our budgeting process, do you have that information for 2007?   September 2006 I would like to present my board with a brief explanation on the ALM analyses of Net Economic Value and Net Interest Income Simulation. Can you provide that for me and explain the differences between the two?   August 2006 Do you think that callable securities have a place in our portfolio right now?   July 2006 What is a derivative?   June 2006 How much is too much capital?   May 2006 Our credit union has never designated securities as “Available for Sale” (AFS), instead we have always designated them as “Held to Maturity” (HTM) for we never sell. What do you think of this practice?   April 2006 I have been hearing a lot about how credit unions can’t maximize earnings due to regulatory restrictions and that they are advised by way of ALM modeling to take on way too little interest-rate risk. What do you think?   March 2006 We are heavily involved in indirect loans. Someone suggested that we perform a static pool analysis. What is this?   February 2006 We are having a tough time increasing deposits, what would you suggest we do?   January 2006 What is a mortgage-backed pass-through security? Is there such as a thing as a “non pass-through” mortgage security?   December 2005 What do you think about the use of ROE as a measurement goal versus ROA?   October 2005 We are currently starting our budgeting process. Where do you think that rates will be next year?   September 2005 What effects will the devastation of Katrina have on interest rates?   August 2005 Our credit union needs income and our brokers have been suggesting leverage strategies. These trades look as though we can make some good money. What am I missing and what do you think of these trades?   July 2005 I read your April article on duration and did not realize that there is more than one type of duration. Exactly how many types are there? Also, I always assumed that modified and effective duration were calculated the same way and you can use either one to estimate your price change. Is this correct?   June 2005 I read your April article on duration and did not realize that there is more than one type of duration. Exactly how many types are there? Also, I always assumed that modified and effective duration were calculated the same and you can use either one to estimate your price change. Is this correct?   May 2005 We are seeing our net interest income drop and our CFO claims that it is due to the "flattening of the yield curve" What is this and how will this affect our credit union?   April 2005 I have been reviewing a document that quotes the duration of our investment portfolio at 1.41%? Shouldn't it be 1.41 years?   March 2005 What do you think about indirect loans? I don’t believe that our credit union is making any money on these loans.   February 2005 It appears that financial institutions are being very aggressive in their certificate rates. There is a credit union down the street that is offering 3 percent on a one-year certificate and 5 percent on a five-year certificate. Should I chase these yields? I am concerned about deposit outflow.   January 2005 Our credit union has less to invest these days due to increased loan demand. However, we have been approached by our broker suggesting leverage strategies of borrowing funds and reinvesting in investments. Are these transactions as risk free as they seem or am I missing something?   December 2004 I attended a recent meeting at which you spoke of "ALM risk measurement" tables. What are these and where can I find them?   November 2004 Our credit union performs both NEV and NII analyses. Which analysis does your firm focus on, and what are you typically looking for?   October 2004 Should I be concerned of my Fannie Mae investments given the recent news on its accounting mishaps? Also, can you explain the allegations made against the Agency?   September 2004 Our credit union needs liquidity, but, with interest rates rising, many of our securities are now “underwater” and too costly to liquidate. What consideration should we give to borrowing funds, as well as adjusting our investment policies and practices for future liquidity needs?   August 2004 There has been a lot of negative news lately concerning Fannie Mae and Freddie Mac. Should I be concerned about having securities in our investment portfolio from these agencies?   July 2004 With the NCUA’s recent approval of exchangeable CMOs for credit unions, could you tell me more about them and whether or not they are a good choice?   June 2004 In one of your recent columns, you explained how Fed Funds contracts may be used as a predictor of the market’s expectations for interest rate changes. You indicated that Fed Funds contracts go out 10 months. Aren’t there contracts that go out greater time periods, enabling investors to gauge long-term market sentiment?   May 2004 Economists predict that the FOMC will raise rates as early as August. Is that the market consensus as well?   April 2004 During the last several FOMC meetings, the Fed has decided to leave the federal funds rate at 1%, thereby sparking waves of activity. Why do the markets react so much when the Fed takes no action?   March 2004 The Federal Reserve has been in the news a lot since it dropped using the phrase “considerable period” from its policymaking statement. What exactly does this mean?   February 2004 What is the difference between CPR and PSA in developing prepayment assumptions, and which one should be used to appropriately gauge the prepayment speeds of mortgages?   January 2004 Our loan-to-asset ratio is very low, and we are considering an offer to participate in a pool of automobile loans made previously by another credit union. We’ve studied the terms, but how do we know if we are receiving a good value in this deal?   December 2003 Recently, our credit union has been adversely affected by premium write-offs on our mortgage securities. It has caught us off guard, especially because rates have turned up recently? How can we prevent surprises like this from happening in the future?   November 2003 NEV analysis is considered by many to be the superior tool to net interest income simulation for measuring interest-rate risk. Why is this?   October 2003 NCUA just released Letter No. 03-CU-15, regarding real estate concentrations and interest-rate risk management. We’ve always placed our limit at 25 percent; how much concentration do you think a credit union should have in real estate mortgages?   September 2003 I read in the Wall Street Journal that Fannie Mae's "duration mismatch" is now at six months. What does this mean?   August 2003 What does NCUA’s most recent guidance letter on Non-Maturity Shares and Balance Sheet Risk Management mean for our credit union’s ALM modeling practices?   July 2003 I heard the NCUA has implemented new investment regulations, which specifically address the authorization of investing in commercial mortgage-backed securities (CMRS). What are CMRS products? Is there any value in that sector?   June 2003 What is an exchangeable CMO?   May 2003 I heard a speaker say that you should never invest in anything but bullet securities. Can you comment on this?   April 2003 I recently heard the term “vectored” prepayment speeds. What does this term mean and how is it used?   March 2003 I am a board member of a large credit union with a sizable investment portfolio. Our callable securities are being called, our CMOs and mortgage pass-through are prepaying. What can we invest in that would yield us something?   February 2003 What do you think about callable and step up investments?   January 2003 Our net interest margin is getting squeezed, and our credit union needs more income. An investment broker suggested sequential CMOs. Do you think this is a good strategy?   December 2002 So, are you back in the CMO market?   November 2002 We’re trying to prepare for next year, and it appears that everyone believes low rates will be around for awhile. What do you think is going to happen and how should we plan?   October 2002 A few months ago, I bought a CMO with a premium, and now it’s now prepaying at the down-300 basis point (b.p.) projected prepayment speed. My broker ran the analysis using Bloomberg projected speeds. The yield on my security is now negative. Can these brokers be that far off?   September 2002 I read your July 2002 article, in which you discussed the Eurodollar futures contracts. Isn’t there also a fed funds contract?   August 2002 I read that ALM First Financial Advisors recently received approval from the NCUA to use derivatives to hedge a credit union’s balance sheet. What does this entail and how can I participate?   June 2002 My broker suggested investing in “money market CMOs.” What is the difference between regular CMOs and money market CMOs?   May 2002 I have heard the word “decay” rate used in the context of Asset Liability Management. Would you tell me what this means?   April 2002 I heard that the NCUA recently developed new oversight standards for liquidity management. Would you please describe what this means to our credit union?   March 2002 Our credit union does not presently purchase CMOs. Should we consider them? Are the risks in CMOs greater than pass through mortgage backed securities and what risk limitations should be contained in our policies?   February 2002 I heard that NCUA recently commissioned a study on the valuation of non-maturing liabilities. Why are they studying this and what are the implications?   January 2002 What is an Option Adjusted Spread?   December 2001 Interest rates are rising at last. Should I be extending the maturity horizons on my new investments?   November 2001 What are swap spreads and what is their impact on U.S. Agency securities?   October 2001 Given the tragic events of September 11th and the ensuing impact on financial markets, what should I do with my large overnight investment portfolio?   September 2001 I recently heard a lecture in which the term balance sheet “immunization” was used. What does this mean and how is it practiced?   August 2001 I was present at a recent meeting at which you spoke and described "ALM risk measurement" tables. What are these and where can I find them?   July 2001 This is a difficult rate environment in which to invest. Our credit union has not purchased a CMO for more than 7 years due to policy constraints; however, we are seeing yields in these investments exceeding 6.25% in the 2.5-year range. I believe that the yield is now worth the risk. Am I right?   June 2001 What is an “Investment Advisor” and why should my credit union consider working with one?   May 2001 I have been told that Bank Notes are good investments. Should my credit union invest in them?   April 2001 With regard to market valuing non-contractual share accounts, what is the generally accepted method (if there is such a thing) of discounting cash flows. I’ve heard two discount rates advanced, the local market savings rate and the FHLB advance rate. In your opinion, is one better than the other? Could the OTS decay rate tables be useful?   March 2001 Only recently, I learned that the Treasury will no longer issue one-year Treasury bills. Our credit union and many others have adjustable rate mortgages tied to the constant maturity Treasury (CMT). How will we be able to reset our mortgages?   January 2001 Following a long drought, our credit union has funds to invest and we are discovering that investments in the two to three year range yield less than an overnight rate. What should I do?   December 2000 Our credit union has been advised to monitor net interest income volatility. What is net interest income and why does this get the same attention as bottom-line performance?   November 2000 Recently, our credit union has had tremendous loan growth, necessitating the use of credit with our corporate credit union. If this trend continues, how should we decide between borrowing cash and selling securities to fund additional loan growth, and if we sell, which investments should we choose?   October 2000 I have heard a lot about loan participations between credit unions, recently. How do they work, and do you believe that they are good investment alternatives?   September 2000 Help! We need liquidity, but have classified all of our investments as hold-to-maturity. We recently heard of a FASB ruling permitting a one-time transfer of securities from hold-to-maturity into available-for-sale. Is this true and would you provide details?   August 2000 I have two questions. First, I heard that GNMA was originally part of another government entity. Is that correct? When was it separated and why? Second, do all agencies have the guarantee of the United States Government?   July 2000 I heard that the Treasury plans to discontinue issuing one-year Treasury bills. We have adjustable rate mortgages tied to the constant maturity Treasury (CMT). How will we be able to reset our mortgages?   June 2000 My broker recently suggested an investment strategy, which he termed “riding down the yield curve”. Would you validate this strategy and tell me if this is a good time to use it?   May 2000 Our credit union has a CFO. Does it still make sense to out-source select investment activities through an Investment Advisory company?   April 2000 I read your definition of duration and my questions are: (1) Does the duration approximation for market values hold true during large swings in interest rates, and (2) how does pure duration matching handle the cash-flow matched portion of immunization?   March 2000 “I’ve heard the term ‘duration’ applied to investments – what does it mean?”   February 2000 Do NEV shock tests accurately forecast the impact of the Fed systematically raising rates over several months—so called “rate creep”?   January 2000 In your November article, you painted differences between Net Interest Income (NII) simulation and Net Economic Value (NEV). Are NEV results similarly dependent upon the assumptions used?   December 1999 I noticed that Treasury rates have been all over the place this quarter. What are the implications of this for my credit union as an investor?   November 1999 Since Letter to Credit Unions 99-12 was published, a debate has begun over the relative merits of Net Interest Income (NII) simulation vs. Net Economic Value (NEV) as risk measurement tools. Advocates for both sides argue superiority. Who's right?   October 1999 What are swap spreads and what is their impact on U.S. Agency securities?   September 1999 How can I utilize the Option Adjusted Spread methodology in my investment decisions?   August 1999 What is Option Adjusted Spread?   July 1999 I have heard of the term efficiency ratio and am not sure what it means or how it applies to me as a credit union manager.   June 1999 What in the world is going on with interest rates over the last couple of weeks?   May 1999 Right now the market is favoring our investment portfolio with potentially large gains from securities that were purchased one year ago. Should we sell? (PART II)   April 1999 Right now the market is favoring our investment portfolio with potentially large gains from securities that were purchased one year ago. Should we sell? (PART I)   March 1999 Investment strategies for Y2K liquidity planning.   February 1999 Our credit union is in the process of developing a liquidity contingency plan as part of its Y2K efforts. How much liquidity is enough?   January 1999 Does the new Euro currency have any implications for me?   December 1998 Our credit union has been advised to monitor net interest income volatility. What is net interest income and why does this get the same attention as bottom-line performance?   November 1998 Our credit union is concerned about having ample liquidity for the turn of the century. How much is enough?   October 1998 With interest rates falling so fast, can I get better performance by investing all of my credit unions surplus funds in overnight accounts?   September 1998 What is a derivative, and are all derivatives bad?   August 1998 The NCUA recently issued an Interpretative Ruling and Policy Statement saying that the high risk test on CMOs need not be performed after October 1998. Should I continue shocking my CMOs and do I need to change my investment policy?   June 1998 I have been told to stay away from bonds priced at a premium because I will never get the premium amount back when the bond matures. Is this sound advice?   May 1998 Ive heard the term duration applied to investments what does it mean?   April 1998 Our credit union receives investment accounting reports from an outside company. The company claims to perform amortization and accretion calculations on mortgage backed securities in accordance with the constant yield method. What does this actually mean?   March 1998 How do I perform a due diligence for a potential new broker dealer?   February 1998 The new NCUA investment regulation permits federal credit unions to purchase CMOs/REMICs provided they are analyzed using either individual or median prepayment estimates. What are prepayment estimates and how do they affect the analysis of an investment?   January 1998 I have heard the term Net Economic Value several times recently. What does this term mean and how does it relate to my credit union?   December 1997 What is an investment advisor and why should my credit union consider working with one?   November 1997 How does the recent market volatility affect my credit union?   October 1997 How does the recent market volatility affect my credit union?   September 1997 According to Part 703 of the new NCUA Rules and Regulations, what are the reporting requirements and to whom do I need to provide reports?   August 1997 What is the difference between a primary and a regional dealer?   March 1997 What is a mortgage-backed pass-through security?

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