Welcome to the Spring 2010 issue of On the Edge, the newsletter from Interactive Data Fixed Income Analytics. This issue includes information about some of the new product enhancements and positive changes that are occurring within our business.
With the continued market volatility and general economic uncertainty, I know that many clients are looking to drill down even deeper into their portfolios and truly get behind the numbers. To help you with these efforts, Interactive Data has continued to strengthen our BondEdge® Next Generation platform with more sophisticated analytics, broader datasets and enhanced usability and flexibility.
While we continue to deliver enhancements to BondEdge, many of which are directly based on client feedback, I also want to reaffirm our commitment to the quality of our offerings. To help accomplish this, I have created two new roles within Interactive Data Fixed Income Analytics, one with a laser focus on improving the quality of the BondEdge platform and the other on enhancing the quality of third party data that flows through BondEdge. These roles have been filled with experienced professionals from within the organization with extensive experience with BondEdge, and I fully believe that they will have a tangible impact on our offerings going forward.
As you are likely aware, many clients have completed their conversion to BondEdge Next Generation. I am very pleased to report that we have been receiving rave reviews from clients using this state-of-the-art platform. For those clients who have yet to convert, I encourage you to contact us to discuss this process. We have developed a comprehensive set of informational tools to help you with the transition, and are committed to working closely with you through the entire conversion.
Lastly, Interactive Data Corporation recently announced that it has entered into a definitive agreement to be acquired by investment funds managed by Silver Lake and Warburg Pincus. We anticipate the transition to the new ownership will be smooth and I believe that our clients will benefit from the transaction as our prospective owners have expressed to us that they are committed to supporting investment in Interactive Data's products and services, technical infrastructure and people.
I wish you continued success during the remainder of 2010, and encourage you to contact us if we can be of additional assistance to you in any way.
Best regards,
Keith Webster
Managing Director
Interactive Data Fixed Income Analytics
Interactive Data is pleased to be exhibiting at this year’s SIFMA® Financial Services Technology Expo, June 22-24, 2010 in New York. Representatives will be there to provide details on the comprehensive offerings for Risk Management and Regulation, Electronic Trading and Wealth Management provided by the various Interactive Data businesses.
See a live demonstration of recently released, BondEdge Next Generation Version 3.2.
Highlights of new features in Version 3.2 include:
Come visit us at Booth #1101
Summer 2010
Effective duration and convexity are widely used in fixed income portfolio management to quantify the price sensitivity of securities to interest rate changes. An intuitive understanding of these concepts is necessary to better understand the multi-faceted risks of fixed income. This session will provide a review of the various definitions of duration and convexity and explore the concepts from first principle. Applications for these risk measures will be demonstrated using analysis on a variety of different security types, including bonds with embedded options and interest-sensitive prepayments. A review of the BondEdge Multi-Factor Term Structure Model and its effects on RMBS effective duration and convexity measures will also be discussed.
To be included in emails about this and other future webcasts, please click here, or send an email to subscribe.fia@interactivedata.com. Be sure to include names and email addresses in the message body.
On May 4, 2010, Interactive Data Corporation announced that it has entered into a definitive agreement to be acquired by investment funds managed by Silver Lake and Warburg Pincus. Interactive Data expects the transaction to close by the end of the third quarter of 2010, contingent upon various closing conditions.
Silver Lake and Warburg Pincus are two of the world’s largest and most successful private investment firms, collectively managing more than $44 billion. Both firms have invested behind a broad range of market-leading organizations across an array of industries. Current Silver Lake investments include Nasdaq, Skype, Sabre/Travelocity and SunGard Data Systems. Current Warburg Pincus investments include Fidelity National Information Systems, Nuance and Wall Street Systems.
Interactive Data’s prospective owners bring a long-term perspective to the Company and are committed to supporting investment in the Company’s products and services, technical infrastructure and people. This will help enable Interactive Data to remain focused on enhancing and expanding its offerings, as well as continuing to provide the outstanding level of service you have come to expect.
Additional information about this transaction is available in the press release.
As clients continue to convert to the BondEdge Next Generation platform, the feedback we have been receiving has been overwhelmingly positive. These clients have benefited from Next Generation’s intuitive user interface, ease of navigation, centralized reporting engine that has enhanced our standard and custom client report capabilities and innovative technology framework that enables faster development of reporting enhancements.
Below are two examples of how the new platform has helped our clients achieve their goals:
Hughes Capital Management, Inc. ("HCM") is a registered investment adviser focusing exclusively on fixed income investment management services for private and public sector investors.
BondEdge helps support HCM’s investment decisions and to ascertain how their investment decisions are paying off. They have been users of the Performance Attribution module for over a decade as well as the portfolio versus benchmark (COMPARE) reporting which provides them with key portfolio management information to help them validate their investment strategies.
HCM has also implemented BondEdge Next Generation into their middle office client reporting process and plans to take advantage of the new, flexible reporting interface allowing them to increase productivity for their client reporting requirements.
A client since 1987, BondEdge is an integral part of HCM’s fixed income management process from both a client reporting perspective and full integration of BondEdge into their daily portfolio workflow and bond management. For more than 20 years, Frankie Hughes, President has been an avid user of the system and one of our best facilitators in creating a generation of BondEdge champion users.
Weaver C. Barksdale & Associates, Inc. ("WCB") provides fixed income and equity management strategies primarily for institutional investors. The company currently manages over $3.4 billion for 52 clients (or 38 institutions) headquartered in 14 states. The hallmark of the firm’s investment management capabilities calls for each client to have its own customized portfolio(s), as opposed to being part of a predetermined master portfolio, commingled account, or mutual fund.
BondEdge has been an important resource for WCB as it has distinguished itself in the management of customized portfolios. BondEdge’s “What-If” simulations provide them with the tools to help measure the effects of trading for single or multiple portfolios to support decisions on internal portfolio strategic analysis. WCB has also implemented the BondEdge Next Generation Compliance module. This assists with internal portfolio monitoring based upon guidelines WCB inputs to support the creation of specialized strategies that conform to specific guidelines, directives or regulation.
A client since 1991, BondEdge has consistently served to support the needs of WCB for over 18 years. They were one of the first clients to convert to the BondEdge for Windows platform from DOS back in 1996. And now with their conversion to BondEdge Next Generation, we are pleased to continue our history of providing them with the tools to help them meet their business goals.
We are confident the BondEdge Next Generation platform provides a state-of-the-art fixed income portfolio analytical capability that can help our clients meet today’s evolving business needs. We look forward to the opportunity to work closely with more of our clients as they convert to BondEdge Next Generation and to further explore the many ways that financial institutions can utilize BondEdge to help address real world fixed income challenges.
At the end of April Interactive Data released the latest version of our BondEdge Next Generation platform. The new Version 3.2 release contains enhancements to help institutional investors assess risk related to prime and sub-prime residential mortgage-backed securities (RMBS), including fixed and adjustable mortgage pools, collateralized mortgage obligations (CMOs) and asset-backed securities (ABS). Also included within this release are enhancements to the BondEdge “What-If” analysis, as well as additional report and graphics capabilities.
Effective with this release, a multi-factor term structure model is available within BondEdge to compute analytic risk measures and provide interest rate and credit spread simulation analysis on prime and non-prime RMBS. This new model, referred to as “G2++” is an arbitrage free model of interest rates that includes a volatility surface which is calibrated on a daily basis to the swaptions market. The existing single factor term structure model will continue to be supported the within BondEdge. Clients may indicate their term structure model choice within BondEdge and choose the number of interest rate paths that will be used for CMO scheduled and unscheduled tranches, as well as for fixed and adjustable rate mortgage-backed pools and floating rate notes.
We are also pleased to announce the availability of enhanced collateral detail on non-prime RMBS, including historical delinquency, loss and default data as well as current credit trigger status and subordination levels.
We have added a capability to alter the BondEdge prepayment model at an issue level from within the BondEdge Security Calculator for agency/GSE RMBS, including mortgage-backed pools and agency/Government Sponsored Enterprise (“GSE”) CMOs. This allows clients to selectively tune the BondEdge prepayment model at the security level. Clients can scale the BondEdge prepayment model on an overall basis, or can selectively elect to scale the refinancing or relocation aspects of the prepayment model.
The BondEdge Portfolio Import now includes the capability for clients to automate the uploading of prepayment speeds for all RMBS and CMBS. Clients can provide base-case prepayment CPR assumptions for all CMOs (agency/GSE and non-agency), adjustable-rate mortgage pools and CMBS. Clients can continue to provide PSA prepayment assumptions for fixed rate mortgage pools. In addition, we have activated the import of prepayment speeds for sub-prime RMBS that are modeled within the BondEdge Asset-Backed Database.
BondEdge now provides the ability to start multiple “What-If” sessions simultaneously. As each portfolio is selected, a separate session tab labeled with the portfolio name is created. Each session tab includes all of the holdings for the selected portfolio. After more than one portfolio is selected, an additional “All Trades” tab is created which contains a report including all the trades proposed by the client for the multiple “What-If” sessions. The proposed trades can be sorted and sub-totaled at either the portfolio or identifier level.
This release also contains additional report and graphic capabilities. Graph options now include Stacked Bar, Area charts and Pareto Bar charts. We have also implemented additional report print and export formatting controls in order to enhance the appearance of BondEdge report books.
For additional information
Clients can view the Software Release Memo for BondEdge Next Generation Version 3.2 on the Private Client Site.
Introduction to BondEdge Next Generation Version 3.2 Webcast
On April 22, 2010, Louis Gehring, Senior Vice President and BondEdge Product Manager provided a demonstration of BondEdge Next Generation Version 3.2, highlighting the enhancements in this release. This webcast was attended by professionals from over 100 companies.
To request access to the recording of this webcast, please click here.
Introducing the BondEdge Multi-Factor Term Structure Model Webcast
On February 25, 2010, William Burns, Ph.D, Director of Quantitative Research, presented the fundamentals of the Multi-Factor Term Structure Model. In addition, he discussed the motivation for choosing the “G2++” model and the impact on modeling swaption volatility surfaces. There was a review of model results for the securities included in the initial release of the new model, namely, fixed and adjustable mortgage pools, CMO tranches and floating rate notes. Particular emphasis was placed on interest rate path generation, Monte Carlo simulation and expected improvements in projected risk measurements.
To request access to the recording of this webcast, please click here.
William Burns, Ph.D.
Director of Quantitative Research
Introduction
U.S. subprime mortgage debt provided the spark that generated the 2008 financial crisis. Effects from this global crisis included a dramatic increase in spending and borrowing by governments around the world in an attempt to add liquidity to the financial system, protect fragile and interdependent economies and hasten a recovery.
Combined with debt patterns from the past, expected liabilities from pension plans and social programs and shrinking populations, concern began to grow in worldwide financial circles about unsustainable levels of debt owed by several European countries. This has led to turmoil in the currency and government debt markets, particularly in Europe.
Portugal, Ireland, Italy, Greece and Spain are all on credit watch by the major rating agencies. By early May 2010, the possibility of default on Greek government debt has catapulted the Greek government yield curve more than 1000 basis points higher and sent the Euro/U.S. dollar exchange rate into a rapid decent. As the chart below shows, on December 3, 2009 the Euro was trading at approximately $1.51, but as of June 10, 2010 it had fallen to $1.21.
In addition, the concerns are not limited to the countries mentioned above (also referred to as “Club Med” or “the Olive Belt”) or European governments alone. There is speculation that Great Britain is at risk of losing its Aaa credit rating, and the rating agencies have also been examining the United States debt picture more closely. In fact, at the end of 2009 Moody's Investors Service warned in a report that the United States and Great Britain may test the limits of their Aaa sovereign ratings due to deteriorating public finances.1 According to the report, "These are the Aaa countries whose public finances are deteriorating considerably and may therefore test the Aaa boundaries, but which display, in our opinion, an adequate reaction capacity to rise to the challenge and rebound." The report divided the Aaa countries into three categories – resistant, resilient and vulnerable. The United States and Great Britain both fall in the "resilient" category, the report said.
Measuring the Credit Risk of Corporate and Government Debt with all of the uncertainty revolving around government debt, some natural questions arise:
Traditionally, in U.S. markets a yield curve derived from securities issued by the U.S. Treasury2 has been the standard benchmark used to calculate measures of credit risk such as option adjusted spread (OAS) and zero-volatility spread (Z-spread) since debt issued by the U.S. Treasury is Aaa rated and is considered to be essentially riskless in terms of the eventual receipt of principal. This naturally leads to the conclusion that the OAS and Z-spread on U.S. government debt will on average be equal to zero.3
However, as fixed income investors became more sophisticated, and multi-currency portfolio holdings (including both government and corporate debt) became more common, other benchmarks against which to measure credit risk came into high demand. The growth in the interest rate swap (IRS) markets, and availability of LIBOR and IRS rates for different currencies around the world, provided new benchmarks by which credit risk could be measured. In addition, the creation of the European Union has made the Eurozone yield curve a prominent benchmark yield curve.4
Yield curve benchmarks derived from LIBOR and IRS rates, Eurozone rates, as well as U.S. Treasury rates, are now commonplace. These curves are used to calculate common measures of credit risk (e.g. OAS and Z-spreads).
A Case Study in Greek Debt
As mentioned earlier, throughout much of 2009 and into 2010 investors and the rating agencies became more concerned about the sustainability of the levels of Greek government debt, as measured against gross domestic product (GDP). As Table 1 illustrates, all of these countries have high debt to GDP ratios.5
There has been a growing concern among investors of a possible default on Greek government debt. Consequently, Greek government yields began to rise sharply as illustrated in Chart 1. The 6-month yield on the Greek government yield curve rose from 2.86% in December 2009, to 6.33% in January 2010, and to 14.90% at the end of April 2010. On April 27, 2010, Greek government debt was downgraded three levels to BB+ (i.e. junk bond status) by S&P®. S&P also issued a negative outlook on Greek government debt, raising the possibility of more downgrades.6
European finance ministers and central bankers agreed on May 9, 2010 on a new loan program that could top €750 billion, designed to keep the Greek debt crisis from spreading to other vulnerable European countries.7 Subsequently, yields on Greek government debt fell roughly 600 basis points from the levels seen at the end of April.
If one were using the Greek government yield curve to determine the credit risk associated with Greek government bonds, it would by definition produce a zero credit risk in terms of OAS and Z-spread for these bonds. This would be true in December 2009, in June 2010, and all points in between. However, fixed income investors and the rating agencies have indicated that there is a substantial risk of default on Greek government bonds.
This provides strong motivation for using Aaa rated government debt, such as that associated with U.S. Treasuries, U.K. Gilts, or Eurozone yields, for measuring government credit risk (e.g. OAS or Z-spread). In other words, when measuring credit risk for both government and corporate debt issued in a given currency, it is vital to use a consistent yield curve benchmark that is not subject to near term credit risk.
Table 2 illustrates the credit spread behavior of Greek government and corporate debt versus the Eurozone yield curve since the end of 2009. The OAS on Greek government debt (i.e. Sovereign) widened by nearly 900 basis points versus the Eurozone yield curve from December 2009 to April 2010.8 At the same time, spreads on finance and industrial Greek corporate issues widened 40 and 156 basis points, respectively.
This is a strong indication that when analyzing Greek debt against a credit stable benchmark, that there is a Greek government bond credit crisis, but at least to this point, not a Greek corporate debt crisis. In other words, Greek corporate debt issues are not impacted in parallel with the Greek government debt.
Performing the same analysis against the IRS and LIBOR rates provides similar results. Table 3 shows the OAS (credit spreads) on Greek debt versus the Euro-Swap curve. As we saw with Eurozone yields above, the analysis suggests that the Greek credit concerns are largely limited to Greek government debt.
It is important to note that although Greek government debt was downgraded during this period, the Euro borrowing markets as seen through the liquidity and transparency of the interest rate swap and LIBOR markets remained a stable benchmark for measuring credit risk.
Finally, one can also use the asset swap market to measure credit spreads. Put simply, an asset swap allows a fixed rate bond holder to swap out of a bond’s contractual fixed rate payments into those of a LIBOR floating rate coupon. This enables the fixed rate borrower to hedge interest rate risk leaving credit risk.9 The spread over LIBOR making the asset swap fair to both the asset swap buyer and seller is referred to as the asset swap spread.
The asset swap spread is a valuable risk measure for several reasons. First, it measures credit risk employing the IRS and LIBOR rates for a given currency, and as discussed earlier, these markets are liquid and well understood. Second, the asset swaps and their associated spreads are real world tools that bondholders employ to hedge interest rate risk. And finally, the asset swap spread is a static risk measure based on observable LIBOR and swap rates, and is therefore not generally subject to proprietary models.
Table 4 provides asset swap spreads10 for Greek debt based on the Euro-Swap curve. It shows the same relationship that was observed for both the government and Euro-Swap OAS.
Summary
The government debt credit crisis that is currently affecting Greek government debt, and is sending chills throughout the world financial markets, may well also negatively affect the government issues from Portugal, Italy, Ireland and Spain. In addition, other European and Asian government debt may also be affected.
In order to understand the effects of the crisis on both government and corporate debt, it is necessary to analyze credit spreads using respected, liquid and transparent benchmarks. BondEdge provides such benchmarks in determining OAS, Z-spreads and asset swap spreads.
1 U.S., Britain may test Aaa boundaries, Moody's warns, by William L. Watts, MarketWatch, December 9, 2009
2 Typical yield curve benchmarks include the On-the-Run U.S. Treasury curve, the Constant Maturity Treasury curve, or a Treasury spline based on the yields and maturities of U.S. Treasury issues.
3 Zero OAS and Z-spread are expected on average for nominal government debt when evaluated against its government’s yield curve. However, this is not likely not the case for inflation linked debt.
4 The Eurozone yield curve is based on the German government yield curve.
5 Government to debt to GDP ratios are based on 2009 estimates from the Central Intelligence Agency’s World Factbook.
6 S&P also downgraded Portuguese government debt to A- on April 27, 2010.
7 European leaders set program to defend euro, by Greg Robb, MarketWatch, May 9, 2010.
8 Credit spreads derived through BondEdge and based on end of day prices available within BondEdge for Greek debt.
9 Asset swaps also introduce the notion of counterparty risk.
10 Asset swap spreads based on BondEdge end of day prices for Greek debt.
William Burns, Ph.D.
Director of Quantitative Research
Background
In February, Freddie Mac announced that it would “purchase substantially all 120 days or more delinquent mortgage loans from the company's related fixed-rate and adjustable-rate (ARM) mortgage Participation Certificate (PC) securities.”1 The purchases took place in early March with corresponding principal payments to pass through to investors on March 15 and April 15, 2010.
According to information released by Freddie Mac,2 as of December 31, 2009, the unpaid balance for delinquent fixed rate loans is $49.824 billion. This represents a 120+ day delinquency rate3 of 2.46%. Fixed rate pools issued in 2007 with 6.0% and 5.5% net coupon rates are the most affected. For adjustable rate mortgages, the unpaid balance for delinquent loans is $19.147 billion, representing a 120+ day delinquency rate of 12.54%. Initial interest adjustable rate pools issued in 2007 and 2006 with net coupons of 6.0% and 5.5% are the most affected.
Similarly, Fannie Mae announced their plans to purchase 120 day or more delinquent loans.4 As of December 31, 2009, the unpaid outstanding balance of 120+ days Fannie Mae pools was approximately $127 billion. Of that, approximately $82 billion were 30-year fixed rate pools (with the CL prefix). According to its announcement, Fannie Mae anticipates purchasing approximately 150,000–200,000 loans from MBS trusts in the month of March and expect that they will continue purchasing loans in each of the subsequent few months until they have substantially reduced the current population of loans that are four or more months delinquent.
Furthermore, Fannie Mae will prioritize their purchases based on mandatory purchases (such as modified loans and loans that become 24 months delinquent), loans in MBS having the highest MBS pass-through rates, loans backing CL or CI prefixes, and lastly, loans having the highest unpaid principal balances. CL pools issued in 2007 with 5.5% to 7.0% net coupon rates will be the most affected.
Effects within BondEdge
For investors in Freddie Mac and Fannie Mae pools with 120+ day delinquent loans, the purchase of delinquent loans may result in a short term spike in prepayments. This will automatically be reflected within BondEdge when new factor, balance and weighted loan characteristics are updated by these Government Sponsored Enterprises (GSEs). Consequently, BondEdge risk measures and analytic reporting, including Performance Attribution, will incorporate the actions taken by the GSEs.
However, at this time there will be no modifications to the BondEdge prepayment model as a result of the decision made by Freddie Mac and Fannie Mae to purchase severely delinquent loans. There are two main reasons for this decision. First, the GSEs do not currently publish delinquency rates at a pool level and therefore, the affected pools cannot be identified. Second, the action announced by the GSEs is temporary in nature and is anticipated to last for a short period of time.
As a result of the GSEs’ decision described above, short term prepayment projections within Dynamic Asset Cash Flow could be slower than actual prepayments for affected pools. In addition, the projected prepayment speeds (both lifetime and 12-month) within BondEdge will temporarily be slower than actual prepayments for affected pools based on the purchasing activity of the GSEs. This may also temporarily impact the risk measures, such as option adjusted duration, for affected pools since they may not be based on a short term spike in actual prepayments.
In Summary
As stated above, the purchases by Freddie Mac should be completed by April 2010. The Fannie Mae purchases also began in March and likely persist for several months. At this time, our prepayment model may not reflect the agency purchases of 120+ day delinquent loans, and this may lead to a short term underestimation of actual prepayment for affected pools. However, pools without 120+ day delinquent loans will continue to benefit from the consistency in analytical treatment of projected prepayments.
Please note that clients are free to update the BondEdge prepayment assumptions in a variety of ways – such as through the Prepayment Matrix, User Scaling of the prepayment model, or through the Security Calculator on a single security basis. However, please be aware that such modifications affect the lifetime prepayment assumption, and not only the short term spike in prepayments that may occur as a result of GSEs purchases of severely delinquent loans.
Finally, we are considering the activation of additional prepayment model functionality that would allow the specification by clients of default or prepayment vectors.
Please feel free to contact your Analytic Consultant, Client Services or email me directly at william.burns@interactivedata.com if you have any comments, questions or concerns.
1 See Freddie Mac’s announcement as of February 10, 2010 – www.freddiemac.com/news/archives/mbs/2010/20100210_pc_securities.html
2 See www.FreddieMac.com/mbs/docs/delinquencyrates 021010.pdf
3 The delinquency rate is calculated as the number of delinquent loans divided by the total number of loans in the relevant PC category.
4 Refer to Fannie Mae’s announcement on March 1, 2010 – www.fanniemae.com/newsreleases/2010/4960.jhtml?p=Media&s=News+Releases
Louis J. Gehring Senior Vice President, BondEdge Product Manager
In February 2009, with the purpose to stimulate the U.S. economy, President Barack Obama signed into law the American Recovery and Reinvestment Act of 2009 (ARRA). This Act includes $787 billion of federal tax benefits, contracts, grants, loans and entitlements.
The tax benefit component of ARRA provides the ability for state and local governments to issue taxable municipal bonds that can give them access to the conventional corporate debt market. These securities are known as Build America Bonds (BABs) and were first issued in April 2009.
There are two general types of BABs:
Local and state governments may issue BABs as long as the bonds issued are not private activity bonds.
BABs have quickly become popular with both issuers and investors, with issuance during 2009 amounting to over $64 billion.2 This accounted for approximately 16% of overall municipal bond issuance in 2009 and is widely expected to account for an even higher percentage of municipal issuance in 2010. In fact, market estimates for 2010 issuance are as high as $150 billion.3 Driving the high expected issuance in 2010 is the popularity of BABs with issuers and investors, and also as part of the white house’s proposed fiscal year 2011 budget, the Obama administration has proposed a permanent extension of the BABs program, with a reduction in the tax subsidy from 35% to 28% after December 31, 2010.
The BondEdge Approach
Interactive Data’s BondEdge fixed income platform provides robust fixed income analytics that are bundled together with security master data that provides comprehensive security coverage for more than 2.7 million bonds, including a structured finance library of more than 15,000 U.S. structured deals.
There are three benchmark yield curves employed within BondEdge for the computation of analytic risk measures for $US denominated securities. Tax-exempt municipal securities utilize a AAA-rated General Obligation (GO) benchmark curve, while analytics for taxable securities are derived by using either an On-The-Run U.S. Treasury Curve or an All Treasury Curve. In addition, option-adjusted spreads, total return simulations and cash flow projections for taxable securities can be also computed by utilizing the U.S. Swap Curve. BABs employ the U.S. Treasury Curve for analytic measures since they are issued as taxable instruments.
BondEdge provides data coverage on BABs via its affiliate Interactive Data Pricing and Reference Data, Inc.’s municipal database. During 2009, Interactive Data added over 6,000 BAB securities to its municipal database. Terms and conditions provided include coupon, maturity, full call schedules, sinking funds, underlying and actual credit ratings, credit enhancement, sector classifications and tax status. It is the tax status field that provides BondEdge the guidance on whether to utilize a tax-exempt or taxable curve for analytic measures. If the Federal Tax Exempt status flag is turned off, BondEdge will consider the bond a taxable issue. State Tax Exempt status flags do not affect the yield curve selection.
To date, Barclays Capital and Bank of America Merrill Lynch have added BABs to their taxable U.S. fixed income investment grade credit indices. The standard amount outstanding thresholds and composite ratings rules for corporate bonds have been applied to BABs when determining index inclusion status.
Based on published Barclays index data, within the Barclays Capital Credit Index, BABs are included in the non-corporate portion of the Credit Index and are classified within the Local Authority sub-sector. Barclays Capital’s predecessor, Lehman Brothers, added taxable municipals to their credit benchmarks in 2003. Prior to the BABs program, taxable municipal securities were typically associated with private activity bonds. The addition of BABs to the taxable municipal bonds within credit indices have significantly increased this security type on a relative basis, but taxable municipals still represent a modest allocation (about 2%) in investment grade credit benchmarks.
BAB Issuance Characteristics
Following below is a description of the overall BABs universe. For this analysis, we have used Interactive Data’s coverage of the market (over 6,000 securities through year-end 2009). All percentages cited below are computed by using a market-weighted contribution for each issue (i.e. amount outstanding multiplied by year-end 2009 evaluation).
Maturity/Effective Duration
Through year-end 2009, BABs issuance has been highly focused on the long maturity segment of the yield curve. Less than 15% of BABs have stated maturities less than 10 years. Over 60% of the issuance has been in bonds with stated maturities over 20 years.
The overall effective duration for the BAB universe is 10.30, more comparable to long (e.g. 10+ maturity benchmarks).
Credit Ratings
The BAB security universe is, in overall relative terms, a highly rated one from a credit perspective. Over 70% of BAB securities have been rated AA or higher, with only 13% rated at Baa/BBB. In contrast, approximately 25% of the BondEdge representation of the Barclays Capital All Credit Index is rated at AA or above.
Call Options
Approximately 31% of the BAB security universe has embedded call features, while only about 2% of bonds within the Barclays All Credit Index are callable. As of year-end 2009, approximately 33% of the callable bonds are priced to call (i.e. the yield to any of the call dates is lower than the yield to maturity). This relative high exposure to callable bonds produces a lower convexity for the BABs universe (0.75) compared to other long term indices (e.g. the convexity of the BondEdge representation of the Barclays Capital Long Credit Index is 1.09 as of year-end 2009).
Underlying Issuers
States in the U.S.
California has represented nearly 25% of BABs issuance through year-end 2009, followed by Texas (11%) and New York (9%). 90% of the states in the U.S. have participated so far in this program.
Sector
Approximately 45% of BABs amount outstanding is accounted for from General Obligation (GO) issuers – with the breakdown between local and state issuers at about 2:1. For the remaining 55% of issuance, transportation and utility issuers have dominated, representing approximately 30% of overall BABs issuance.
Credit Spreads
The Treasury option adjusted spread (OAS) for the BABs universe, as computed by BondEdge, finished 2009 at a level of 195 basis points. While this is close to the OAS for long corporate benchmarks (the OAS for the BondEdge representation of the Bank of America Merrill Lynch 10+ Corporate Index was 187 bps), BAB spreads are significantly higher than similarly rated corporate bonds (see Exhibit 1).
Conclusion
The Build America Bonds program has been popular with both taxable bond investors and municipal issuers and is expected to bolster taxable bond issuance in 2010 and potentially beyond. The BondEdge platform is well positioned to accommodate these securities within portfolios and fixed income benchmarks from both a reference data and analytical perspective.
1 For Recovery Zone Economic Development Bonds (RZEDBs), issuers receive a subsidy equal to 45% of the interest paid on the bond for the life of the bond.
2 The Bond Buyer
3 Build America Subsidy Cut May Spur $150 Billion Taxable Munis, Bloomberg Business Week, February 2, 2010
4 Bank of America Merrill Lynch U.S. Corporates 10+ Years
During the past 12 months, BondEdge clients have been increasingly migrating to our Next Generation platform. We have been very pleased at the positive feedback that they have provided on our latest, most technologically advanced platform.
In an effort to most effectively continue to deliver leading analytical tools and best serve the evolving analytical needs of our clients, we must focus our product development on our Next Generation platform. Therefore, we are announcing a sunset date of year-end 2010 for the BondEdge legacy platform.
For those clients transitioning to the BondEdge Next Generation platform from legacy, we will be working closely with you to make the transition as clear and efficient as possible. Below are some frequently asked questions regarding the process that you may find helpful…
What is the Conversion Process?
The Conversion Process consists of five steps:
What is the Contract Review?
Your consultant will go over the contract terms and the product offering to make sure the options are aligned with your organization’s needs.
What if our contract is up for renewal in July, but that's not a convenient time for us to implement the conversion?
Your consultant will work with you to coordinate a reasonable conversion plan and timeline.
How much lead time will be given for contract review?
We have experienced differing contract review processes by our clients so we are flexible in working with you as soon as it is convenient for you to move forward.
What is the Conversion Information Packet?
The Conversion Information Packet includes the new BondEdge contract, the 5-Step Conversion Program Document and System Requirements. The Information packet will be sent after the initial consultant call.
You can also view the 5-Step Conversion Program Document and System Requirements on the Private Client Site, just click on ‘Next Generation Conversion Process’ in the left navigation menu.
What is the Pre-Implementation Call?
The Pre-Implementation call introduces the BondEdge Implementation Team to the user(s) and clarifies their role(s) during the process. The call also provides the opportunity to check minimum hardware requirements before proceeding with installation. The pre-implementation call takes about 15-30 minutes.
How long does the remote installation take? How is it done?
The remote installation session covers 4 or more hours but does not require full user involvement. It is done using the remote support service, GoToAssist.
Is there any alternative other than Remote Installation as this practice might not be allowed by our policy?
For users who do not allow remote server access for system installation, instructions and access to the BondEdge system file libraries will be provided to allow the client to perform the installation themselves, with on call assistance available.
How long does the on-site training take?
The on-site training session will usually range from one to two days and will be scheduled at the convenience of your staff.
Can we run in parallel for a few months in order to avoid any service disruption?
Clients can continue to have both versions of the BondEdge to avoid service disruption. Clients typically cross-over to the new platform after running parallel for a month-end reporting period.
Will there be any more general releases of BondEdge for Windows® after version 5.7?
Version 5.7 is the final BondEdge for Windows general version. We will, however, provide 5.7 Point Releases during 2010.
Do my existing imports (holdings, pvp, scenario, etc) and translation utilities still work in BondEdge Next Generation?
Yes. Existing import files and translation utilities will continue to work in BondEdge Next Generation.
Will my existing export utilities still work in BondEdge Next Generation?
The Legacy-style Cash Flow Testing fixed format flat file (Detail and Summary) and the majority of the BondEdge canned exports have been designed in BondEdge Next Generation to be consistent with BondEdge for Windows. However, we strongly recommend that all exports be tested thoroughly as we cannot guarantee absolute adherence to the legacy BondEdge export formats.
Have Help Screens been developed for BondEdge Next Generation?
Yes, the new platform has help screens developed for the new platform.
Are the cash flow APIs (e.g. MG Alfa, GGY) supported in BondEdge Next Generation?
The Cash Flow APIs used in conjunction with Asset Liability systems are supported in BondEdge Next Generation starting with version 3.12 and above.
Can I backup and restore report templates from BondEdge for Windows to BondEdge Next Generation?
No, the backup utility in BondEdge for Windows will only restore reports in another Windows system so please contact the Client Services Group at 1-800-228-9715 if you are interested in transferring report templates to Next Generation.
When you open an archived BondEdge model will it have a similar look and feel as the current BondEdge Next Generation system?
Any archived version of BondEdge for Windows will have the look and feel of the system when stored along with the corresponding database files. These older versions will not be converted to Next Generation.
Does BondEdge Next Generation have the same module structure as the current version of BondEdge?
The module structure of the Next Generation platform has been reorganized to offer a wider array of functionality in the Base Module. This reduces the number of optional modules required by customers and offers a more fully featured Base Module.
Are the analytics in BondEdge Next Generation the same as legacy? (i.e. mortgage models)
Yes, the analytic models are the same as in legacy BondEdge (through version v5.71), however with BondEdge Next Generation version 3.20 clients benefit from advancements made in various areas of our analytics which may result in analytical differences (e.g. Multi-Factor Term Structure Model).
Will the securities in our local database stay intact or will we have to rebuild that database?
Local bonds can be transferred from the backup and restore function and are not required to be rebuilt.
Will the security dongle in the back of the user box still be used?
The BondEdge security key permissioning has not changed.
What database and version are used?
We are currently using Sybase SQL Anywhere 8.02 for both systems and Next Generation v3.11 corresponds to BondEdge v5.71.
We use a Citrix server to access BondEdge. It runs faster this way. Will we need to use Citrix with Next Generation?
Yes, that would be a preferred configuration for the same reasons.
Can Next Gen run on a VMware server?
Yes, we have a number of clients who are running on VMware servers.
On April 12th, the Interactive Data Fixed Income Analytics New York office moved to another location in downtown Manhattan. Listed below are the new address and fax number for our New York based staff. As always, clients are welcome to stop by and visit.
Interactive Data Fixed Income Analytics
100 Church Street, 11th Floor
New York, NY 10007
Main Fixed Income Analytics New York Office: (212) 771-6771
Please note that the main New York office number is unchanged.
Fax Number: (212) 497-3421
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 either registered service marks or service marks of Interactive Data Corporation in the United States or other countries. BondEdge® is either a registered trademark or a trademark of Interactive Data Corporation in the United States or other countries. The Merrill Lynch Indices are used with permission. Copyright 2010, Merrill Lynch & Co., Inc. All rights reserved. The Merrill Lynch Indices may not be copied, used, or distributed without Merrill Lynch’s prior written approval. Pricing, evaluations and reference data are provided in the U.S. through Interactive Data Pricing and Reference Data, Inc. and internationally through Interactive Data (Europe) Ltd. and Interactive Data (Australia) Pty Ltd. 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).
