Pub. 5 2016 Issue 8

November 2016 31 l e a d i n g a d v o c a t e f o r t h e b a n k i n g i n d u s t r y i n k a n s a s coupon is much more defensive in a rising rate environment compared to the 2.5% option. However, there’s no free lunch in this market and you’ll need to pay a 5+ point premium for the lower price volatility 4% pool. Figure 2 - Price Volatility Comparison Option 1: FNMA 15-year 4% 110K Max Mega Option 2: FNMA 15-year 2.5% New Issue You’ll also notice that the projected prepays using Citi’s Yield Book model are significantly higher as rates fall in the 2.5% 15-year. So despite paying a lower premium for this option, these fast speeds cause the yield to quickly deteriorate as the cash flows are accelerated. If rates fall 100bps from today’s level, the 2.5% 15-year goes from a 5-year bond to a 2-year bond while the 4% 15-year will shorten by just a few months, from 4.1 years to 3.7. So the question comes down to whether or not the 8bps of additional yield and lower premium are worth the associated risks. For a block size of $1mm, that’s only $800 of additional interest income a year. Every basis point counts in this low rate environment, but for my money, the lower premium of the new issue 2.5% 15-year isn’t worth the cash flow uncertainty and price volatility. Drew Simmons has worked in the field of finance since 2003. He holds a bachelor’s degree in business adminis- tration along with a master’s degree in finance from the Meinders School of Business at Oklahoma City University. As a vice president of The Baker Group, he works with community banks specifically covering interest rate risk, asset and liability management, and fixed income portfolio management. Contact: 800-937-2257; drew@GoBaker.com. Good relationships build business. Member FDIC | © 2016 INTRUST Bank | Equal Housing Lender Business. It’s the link that holds your community together. As a family-owned, Midwest-based financial institution, we understand the importance of local business and built our foundation by developing trusted relationships. Our goal is, and always will be, to be a proactive partner by providing the best financial solutions so you, and your community, can thrive. Call us at 800-732-5120 or visit intrustbank.com .