Welcome to the Fall 2009 issue of On the Edge, the newsletter from Interactive Data Fixed Income Analytics.
Looking back on 2009, I believe that the remarkable events of the year – from extreme market volatility to seismic shifts in the landscape of the financial services industry – have helped to drive a heightened interest in portfolio analytics among many segments of the market. We have seen increasing numbers of clients utilizing sophisticated analytical solutions to drill deeper into their portfolios to more effectively manage risk, identify factors driving performance, conduct due diligence and respond to expanding regulations.
In light of these trends, I encourage you to reach out and contact us. Feedback from clients and other market participants on business challenges, market observations and other related topics is invaluable to Interactive DataSM. It directly influences the development process for our latest offerings so we can better address your most critical needs.
During the past year, we have seen a significant number of clients migrate to our state-of-the-art analytics platform, BondEdge® Next Generation. Clients have been very positive about its many new features and the ease of migration. I encourage you to consider moving to BondEdge Next Generation as you work through your plans for 2010.
On behalf of everyone at Interactive Data, I wish you success in the coming year. We look forward to continuing to earn our position as your trusted provider of fixed income solutions each and every day.
Best regards,
Keith Webster
In September, Interactive Data hosted more than 50 clients from the asset management, insurance and consulting industries at the BondEdge Fixed Income Summit in Washington, D.C.
The event featured a series of keynote speeches and client panels that provided insight into the current economic environment, as well as risk management and regulatory issues. Keynote speakers at the event included Jack Malvey, Consultant and former Chief Global Strategist, Lehman Brothers; Kim Wallace, Assistant Secretary of the Treasury for Legislative Affairs, U.S. Department of the Treasury; and Brian Bethune, Managing Director, Chief U.S. Financial Economist, North American Macroeconomics Group, IHS Global Insight.
Lou Gehring, Jack Malvey and Keith Webster
The feedback from event participants was overwhelmingly positive. Peter Collins of CIGNA Portfolio Management, who participated on our fixed income portfolio risk and assessment panel, had this to say; “The Summit offered an excellent mix of high-level fixed income strategy and nuts-and-bolts BondEdge techniques. I came away with a clearer view of the future of the fixed income markets and with better knowledge of BondEdge capabilities.”
Through a series of breakout sessions at the Summit, representatives from Interactive Data demonstrated the many ways that financial institutions can utilize BondEdge to help address real world fixed income challenges. If you are interested in accessing event presentations or other information from the event, please contact us by clicking here.
Jim Hannan of MTB Investment Advisors on the Fixed Income Market – Trends and Outlook Panel
In addition to thought-provoking content and discussions, the Summit was also a great opportunity for people across our industry to come together to network and share best practices. Events included a wine tasting event featuring a premier sommelier and a night-time cruise down the Potomac River.
Lou Gehring at the Wine Tasting Event
Interactive Data has already begun to plan our 2010 Summit. Additional details about this event, including date and location, will be distributed to you soon.
Wine Tasting Guests – Radha Lai of Hillswick Asset Management and Helen Donahue of Montag & Caldwell
William Burns, Ph.D., Senior Vice President, Director of Quantitative Research at Interactive Data Fixed Income Analytics participated in a panel discussion about Market-Consistent Pricing on October 27, 2009 at the Society of Actuaries Annual Meeting.
His presentation explored the basic features and motivations required for a term structure to be arbitrage-free and thus risk neutral. In addition, he provided intuition into how model assumptions translate into stochastic path generation. The panel was moderated by Dominique Lebel, FSA, FCIA, MAAA, of Towers Perrin and also included a presentation from Gary A. Hatfield, FSA, from Securian Financial Group.
Click here to view a copy of the presentations on the Society of Actuaries website.
As part of our “Inside BondEdge Next Generation” series, we hosted a web seminar on August 27, 2009 that demonstrated how insurance cash flow analysts can use BondEdge Cash Flow Analyst for Insurance in connection with their asset modeling and risk analysis activities. The web seminar was attended by professionals from over 40 insurance companies.
BondEdge Cash Flow Analyst for Insurance is a new package of product capabilities designed to assist insurance cash flow analysts, including investment actuaries, with generating scenario driven dynamic asset cash flow projections and analytical risk reports for asset-liability management of insurance asset portfolios. The new offering further expands BondEdge for the insurance market, combining customizable portfolio risk and dynamic cash flow projections and presentation style graphics with automated, flexible report generation capabilities.
Topics covered during this session included:
Poll Recap:
During the web seminar, attendees had the opportunity to complete a brief poll.
The vast majority of those polled use GGY Axis, Milliman MG-ALFA®, TAS Tillinghast Actuarial Software™ or Tillinghast MoSes™ as their primary liability modeling system. BondEdge provides export capabilities to these insurance liability modeling systems and others.
Many of the poll respondents expressed an interest in dynamically linking BondEdge asset cash flows via an API with their liability system. To date, BondEdge has interfaced via an API with both Milliman MG-ALFA and GGY Axis and we look forward to exploring the dynamically linking of BondEdge asset cash flows with other liability systems. We also received high interest in running dynamic cash flow analysis based upon swap curve projections – a feature that has been released with our July release of BondEdge Version 3.1.
Web seminar participants also indicated increasing interest in additional credit related assumptions for dynamic cash flow projections, including the application of “haircuts” to security analysis, projecting credit default vectors for structured finance securities and applying credit spread changes through time. The feedback we receive from these poll questions is an important element in our product development process.
Recording:
Please click here to access the web seminar recording and here to access additional product information for BondEdge Cash Flow Analyst for Insurance. To request more information about this offering, please call (310) 479-9715.
Interactive Data recently hosted a web seminar, “BondEdge Prepayment Model Enhancements,” which was attended by representatives from more than 75 firms. During the web seminar, William Burns, Ph.D., Senior Vice President, Director of Quantitative Research and Tristan Egualada, Ph.D., Senior Quantitative Analyst, discussed the methodologies employed in the BondEdge Prepayment Model for Fixed Rate Mortgages (FRMs) and Adjustable Rate Mortgages (ARMs), as well as recent market developments from the 2008 credit crisis.
Topics covered during this session included:
Poll Recap:
During the web seminar, we polled attendees on their need for and use of a prepayment model. Our informal polling reveals:
Recording:
All attendees were given post-event access to the web seminar recording. If you were unable to attend the event and are interested in requesting online access, please click here. To request more information, please call (310) 479-9715.
Wednesday, December 2, 2009
Inside BondEdge Next Generation: BondEdge Asset Manager
Continuing our “Inside BondEdge Next Generation” series of web seminars will be one that is focused on the BondEdge Asset Manager package. During this web seminar, we will explore the BondEdge Asset Manager package of product capabilities that is scheduled to be released at the end of November. We will demonstrate how asset managers can utilize this new package of capabilities to manage risk/return versus a benchmark, proactively project returns, adjust investment strategies and customize reports. We will also explore the enhancements to BondEdge version 3.1, including performance attribution enhancements, liability as a benchmark and exporting to trade order management systems.
To register for this event, please click here.
January 2010
Introducing the BondEdge Multi-Factor Term Structure Model
During this web seminar, the BondEdge research team will present the fundamentals of the Multi-Factor Term Structure Model that will be used within BondEdge in early 2010. In addition, we will discuss the motivation for choosing the G2++ model and the impact on modeling swaption volatility surfaces will be provided. Finally, there will be a review of model results for the securities affected in the initial release of the new model, namely, fixed and adjustable mortgage pools, CMO tranches and floating rate notes. Particular emphasis will be placed on interest rate path generation, Monte Carlo simulation and expected improvements in projected risk measurements.
To be included in emails about this and other future web seminars, please click here, or send an email to subscribe.fia@interactivedata.com. Be sure to include names and email addresses in the message body.
The past year has been marked by a renewed focus at Interactive Data Fixed Income Analytics on delivering timely product enhancements to help you meet your most pressing business needs, optimizing our client support organization and building relationships with you through a series of in-person and virtual events.
The new products we introduced during 2009 represent an important step forward for our comprehensive offerings. In February, we rolled out a new BondEdge® API that is designed to provide seamless access to our fixed income security analytics, static cash flows, bond swap and “what-if” capabilities from directly within Microsoft® Excel® and other third party applications. In 2009, we also introduced new packages of capabilities and enhanced functionality for the specific needs of certain types of clients, including BondEdge Cash Flow Analyst for Insurance and BondEdge Fixed Income Strategist. Before the end of the year, Interactive Data expects to announce a new product packaging for our asset management clients. This new offering will include expanded Performance Attribution and Liability Driven Investing capabilities.
However, we believe that Interactive Data can provide greater value to you than product features and functionality. To accomplish this objective and better support your needs, Interactive Data has optimized its global client support organization. We can now provide clients around the world with access to live support professionals 24 hours a day, ensuring that you can receive the help when and how you need it.
In addition to strengthening our client service, we scheduled a series of events throughout the year to provide you with insight into BondEdge and other financial industry topics. Our premier event in 2009 was the BondEdge Fixed Income Summit in Washington, D.C. The Summit featured world class keynote speakers, client panelists and presenters who shared their insights on the global financial markets and on working more effectively with BondEdge.
Complementing this event were customer breakfast meetings in Boston, Chicago, New York and San Francisco and a series of informative client web seminars focused on specific topics, including BondEdge Next Generation, the BondEdge API, BondEdge Fixed Income Strategist and BondEdge Prepayment Model Enhancements, among others. We have received positive feedback from clients that web seminars are an effective and efficient way to communicate and we will continue using them to keep you up to speed on product developments and enhancements. Our next web seminar, Inside BondEdge Next Generation – BondEdge Asset Manager, will be held on Wednesday, December 2nd at 11:00 am PST. Please click here for more information about this event.
As we head into 2010, we aim to continue our focus on delivering product enhancements, high-quality support and insightful communication programs to help you work more effectively with BondEdge.
In late November, Interactive Data is planning to release a new version of BondEdge® that includes enhancements to Performance Attribution, Liability Driven Investing, “What-If” and API capabilities.
Effective with this release, the Factor-Based Performance Attribution (PART) total return report will include additional portfolio versus index comparisons at a detailed sector and quality level in addition to the currency analysis that is already present. You will have the ability to specify sector and quality performance comparisons on either an absolute or contribution-to-return basis. In addition, you will have the flexibility to combine similar return effects together, such as summing sector/quality and selection into a spread effect. Based upon client feedback, the amortization/roll effect will now be split into distinct return elements.
We are also pleased to announce that Factor-Based PART can now accommodate tax-exempt municipal securities, portfolios and benchmarks. BondEdge will utilize the AAA, General Obligation curve for the calculation of term structure effects (e.g. parallel/non-parallel) and credit spread effects. The sector and quality enhancements described above will also apply to municipal performance attribution.
As interest in Liability Driven Investing continues to grow, the benchmark comparison facility within BondEdge Next Generation has now been extended to include liability streams. Current and projected surplus and duration comparison reports can be created based upon shifts to the government and swap curve as well as shifts in credit spreads.
An additional XML based trade order export option has been added for clients utilizing the single and multiple (batch) portfolio “what-if” trade analysis. This capability will provide the framework for BondEdge to become more integrated with trade order management systems.
The BondEdge API has been expanded with the November release to accommodate yield and option-adjusted spread (OAS) as input pricing methods. Base case prepayment rates and credit loss related assumptions may also now be specified for structured finance securities. In addition, you may also alter the base case yield curve employed for purposes of generating risk measures.
Looking ahead to the first quarter of 2010, we anticipate offering modeling and data enhancements related to the generation of risk measures, cash flow projections and simulation analysis for structured finance securities. We are also looking to employ a multi-factor term structure model in the calculation of option-adjusted analytical measures, and to make improved collateral data viewable and used for projecting structured finance cash flows. We also plan to enhance the capability to import in prepayment assumptions from external sources and provide scaling to the BondEdge prepayment model from within the security calculator. Other features expected for the first quarter of 2010 include new chart types for graphics and additional report format controls throughout BondEdge.
The BondEdge Feed provides powerful analytics that enable you to access dynamic risk measures such as effective duration and convexity, option-adjusted spread (OAS) and key rate durations. You upload a list of securities; and using the BondEdge analytics engine, an end-of-day, security level risk and analytic measures are returned via FTP. The analytics data can be used in a variety of applications including populating data warehouses for use in client statements/reporting, providing inputs to performance attribution and risk models, trading platforms, accounting systems and other third party applications.
The broad range of robust fixed income analytics available in the BondEdge Feed can enable you to streamline data warehousing protocols, improve efficiency while minimizing operational risk. The BondEdge Feed can also assist you to independently monitor the market risk associated with individual securities in their universe of fixed income securities using any of the following analytical measures:
|
|
The BondEdge Feed offers the same comprehensive coverage that is available in the BondEdge analytics platform. The analytics engine retrieves complete terms and conditions for each security from the BondEdge security master database which houses more than 2.8 million global fixed income securities. You can supply your own price as the basis for the analytics calculations. Output is available on a daily, weekly, monthly or quarterly basis and can be delivered via secure FTP.
We are also well underway in our endeavor to deliver BondEdge Feed analytics into additional distribution platforms. This allows us to provide the convenience and efficiency of delivering pricing, reference data, and analytics in a single file.
Many fixed income investors have seen positive returns during 2009 by overweighting market segments that experienced the brunt of the credit crisis in 2008. Lower rated securities, and financial issues in particular, have provided equity-like returns during the first nine months of 2009 and total return dispersions across bond ratings cohorts and adjacent time periods have been extremely high.
The BondEdge representation of the Barclays Capital Credit Index recorded over 1400 basis points (bps) of positive return due to spread tightening in the first three quarters of 2009 after a credit spread loss of nearly 1900 basis points for all of 2008. Industrial spreads for the Barclays Credit Index have narrowed by 321 bps year-to-date while finance bond spreads recorded a 361 bps tightening.
Total returns for high yield benchmarks have been even more substantial as credit spreads have tightened approximately 1000 bps year-to-date for broad high yield benchmarks, translating into published returns of nearly 50% for the first nine months of 2009.
A market price distribution analysis for investment and below investment grade indices illustrates the magnitude of the overall credit rally for 2009. As of the end of 2008, the median market price for the Bank of America Merrill Lynch U.S. High Yield Cash Pay Index was 65.56 and more than 29% of the index was priced below 50. On September 30, the median price had moved to 96, with only 3.3% of the index priced below 50. Nearly 35% of this index population was priced above par as the third quarter closed.
The Bank of America Merrill Lynch U.S. Corporate Index of investment grade bonds also showed dramatic pricing shifts. At year-end 2008, the median market price for bonds in this benchmark was 93.74 with 21% of the index priced below 80. At the end of the 3rd quarter, the median price was 106.03, with only 2.33% priced below 80. Over 83% of this index population was priced over par on September 30, compared with less than 31% on December 31, 2008.
Commercial mortgage-backed securities (CMBS) have also posted very positive credit spread returns for 2009. The BondEdge representation of the Barclays Capital CMBS Index recorded nearly 1800 bps of return due to credit spread tightening for the first three quarters of 2009 as spreads have tightened over 400 bps. However, from year-end 2007 to September 30, 2009 the cumulative credit spread return is still substantially negative as CMBS gave back over 3400 bps of return in 2008 due to spread widening.
In contrast, investors focused on the U.S. Treasury market have recorded negative total returns so far in 2009, particularly for longer maturities as the yield curve has experienced a significant bearish steepening. The slope of the U.S. Treasury curve, as measured by the 2 to 30 year points, has steepened by 119 bps during the first 3 quarters of 2009. 2 year treasuries have risen by 19 bps in yield (from 0.77% to 0.96%), while 30 year treasury yields have risen 138 bps (from 2.67% to 4.05%). An investor in the 30 year treasury security issued in August 2008 (the 4.5’s of May 2038) would have experienced a -21% price return in this bond as the price has moved from 136.48 at 2008 year-end to 107.61 on September 30.
1The analysis in this article was created using the BondEdge system.
Tristan Egualada, Ph.D.
Senior Quantitative Analyst
Primary and secondary mortgage rates are an integral component to risk measure analysis. They help to establish the incentive that borrowers have to prepay their loans and are therefore a critical daily input to BondEdge. The BondEdge prepay model uses daily mortgage rates to generate cash flows and effective measures, such as option-adjusted duration and spread.
It would be ideal to have a timely, authoritative and readily observable market source for daily mortgage rates, but this is not currently the case. Instead, daily mortgage rates are typically estimated from the secondary mortgage market via the computation of the par TBA coupon rate plus a primary/secondary mortgage spread.
This article first describes primary and secondary market dynamics, defines the primary/secondary spread and provides an analysis of recent trends in the primary, secondary and jumbo mortgage markets.
Primary and Secondary Mortgage Markets
To better comprehend primary and secondary mortgage rates, it is important to understand the dynamics between borrower, lender and investor.
Chart 1: Mortgage Lending Flow Chart
The U.S. residential mortgage market is a huge industry with an estimated value of $12.1 trillion as of September 30, 2008.1 It consists of a primary mortgage market (i.e. actual borrowers and lenders) and a secondary mortgage market (e.g. securitized mortgage pools) that link homeowners to fixed income investors. Starting from the blue box on the right, Chart 1 shows the flow of funds from security investor to homeowner. Borrowers in the primary market receive mortgage funds from lenders such as banks, credit unions or thrifts. Lenders obtain their funds from deposits or by selling their mortgages in the secondary market. Mortgage buyers in the secondary market consist of financial institutions such as Fannie Mae®, Freddie Mac® and others that generate funds by debt issuance or by grouping mortgages into securitized pools, known as Mortgage-Backed Securities (MBS). The liquidity of these secondary market securities provides primary lenders with a low cost, easily accessible source of funding.
The Primary/Secondary Spread
The difference in mortgage rates between the primary and secondary markets, which will be referred to as the primary/secondary spread (PSS), is an important reflection of economic conditions. This section defines and interprets the mortgage rate estimation method used in BondEdge.
Freddie Mac provides an authoritative and comprehensive measurement of primary mortgage rates through a weekly survey. However, this can be estimated on a daily basis as the sum of the daily par TBA coupon rate and the PSS. The par TBA coupon rate is usually linearly interpolated using the two TBA coupons most closely bracketing par (i.e. 100).
The PSS is the servicing fee over the par TBA mortgage rate that delivers the primary lending rate. The buyer sends a monthly payment that is managed by the original lender or servicer for a fee. The rest of the payment is remitted to the loan purchaser, who also charges a fee for payment administration and protection from borrower default. The remaining portion of the payment is finally given to MBS investors.
As an example, on 12/17/08, the secondary market par coupon rate for a 30-year Fannie Mae (with zero points) was 3.95%. According to the Freddie Mac Primary Mortgage Market Survey (PMMS), the rate with zero points can be estimated at 5.37%. Therefore, the PSS for 12/17/2008 is 142 basis points.
Chart 2: Primary/Secondary Mortgage Rate Trends
Recent PSS and Jumbo Mortgage Analysis
From 2003 through 2007, the 30-year Conventional PSS was on average about 71 basis points. During this time, par coupon rates were high (above 5%). However, in the wake of the 2008 credit crisis, par rates dropped below 5% and the PSS rose above 120 basis points as seen in Chart 2.
What caused this spread to widen? This phenomenon of high spreads and low par rates is a trend typically attributable to a high volatility environment, such as in late 2008. Referring again to Chart 2, during late 2008 par TBA coupon rates were falling from about 6% to just over 4%. However, primary mortgage rates did not fall as dramatically. The higher volatility environment in late 2008 forced many primary lenders to increase hedging activity resulting in higher transaction fees, thus giving lenders little incentive to drop primary mortgage rates in parallel with secondary market rates.2
There are some signs of market recovery. For example, after May 2009 the PSS tightened as par coupon rates rose. In addition, jumbo mortgage lending is becoming more affordable. To further confirm this notion, Chart 3 below shows the relationship between Jumbo and Conventional mortgage rates from June 2007 to October 2009.
Chart 3: Jumbo and Conventional Mortgage Rates
Under normal economic conditions, the historical Jumbo to Conventional spread3 is 30 to 40 basis points. Notice that the spread peaked at 167 basis points in February 2009.4 Since then, the spread has been on a downward trend, ending at 96 basis points in October 2009. This is still about 60 basis points above the norm, but it reflects improved market stability.
Summary
Daily mortgage rates are estimated in BondEdge to be the par TBA coupon rate plus a primary/secondary mortgage spread (PSS). Analysis of recent PSS movements and jumbo mortgages reveals signs of economic recovery and indicate improved secondary mortgage market stability. As the market rollercoaster ride carries on, we continue to closely monitor the PSS for important timely prepayment model adjustments in BondEdge.
1 According to Fannie Mae 2008 annual report.
2 Analogous results were concluded in a similar market environment in “Forecasting Mortgage Rates in Today’s Environment,” by Kamel Bazizi in the January/February 2002 issue of On the Edge.
3The spread between jumbo and conventional mortgage rates measures the higher risk posed by jumbo mortgage borrowers and additional costs associated with jumbo loans.
4Jumbo and Conventional rates were obtained from Bankrate.com
Will we have problems using BondEdge if our server is in another location?
Yes, because of network delays this may cause an issue in system performance. We recommend a Citrix/Terminal server configuration for optimal performance if the server hardware is in a different location than the users.
Can we install the BondEdge multi-user database engine on Windows 2003?
Yes, Windows 2003 is an approved BondEdge platform version.
Does BondEdge roll up the inflation index to the next coupon date with the assumed rate of inflation?
BondEdge does roll up the inflation index to calculate the Static Cash Flows but not to calculate the yields. The Real Yield calculation assumes that future inflation expectations are contained in the Current Price. The conversion from Real Yield to Nominal Yield uses the current inflation assumption and is adjusted for semi-annual payments.
Does BondEdge use annual cash flows rather than half-yearly cash flows?
The nominal cash flows are adjusted semi-annually by rolling up the semi-annual inflation assumption. However, the Inflation Assumption shown on the Security Calculator is the expectation for annual inflation and must be converted to semi-annual inflation for calculations.
Limitations
This document is provided for informational purposes only. The information contained in this document is subject to change without notice and does not constitute any form of warranty, representation, or undertaking. Nothing herein should in any way be deemed to alter the legal rights and obligations contained in agreements between Interactive Data Fixed Income Analytics and its clients relating to any products or services described herein. Nothing herein is intended to constitute legal, tax or other professional advice and is not an offer of advisory services or investment advice. Market commentary contained within this document represents Interactive Data Fixed Income Analytics' observations of the general market environment. Interactive Data makes no warranties whatsoever, either express or implied, as to merchantability, fitness for a particular purpose, or any other matter. Without limiting the foregoing, Interactive Data makes no representation or warranty that any data or information supplied to or by it are complete or free from errors, omissions, or defects.
Interactive DataSM and the Interactive Data logo are service marks or registered trademarks of Interactive Data Corporation and registered service marks in Austrailia, European Community, Germany, Japan, Korea, New Zealand, Switzerland and Taiwan. BondEdge® is a registered trademark of Interactive Data Corporation in the United States. Microsoft®, and Excel® are either registered trademarks or trademarks of Microsoft Corporation in the United States or other countries. Other products, services, or company names mentioned herein are the property of, and may be the service mark or trademark of, their respective owners.
Interactive Data Fixed Income Analytics is a division of Interactive Data Corporation (NYSE: IDC).
