Bank Board Letter July 2015 : Page 2

inhibiting greater deployment of RDC. That study finds that 75 percent of banks offer RDC to commercial accounts, and two-thirds of banks that offer RDC still have less than 5 percent of commercial accounts using the service. Yet depositors said that they would be interested in a service that would allow them to scan and transmit check images to their financial institution. Banks need to raise awareness of the existence and the value of RDC and increase the adoption rate by commercial depositors. To reconcile this disconnect, financial institutions must more ef-fectively market the aspects of RDC that are most important to their commercial depositors. Misconceptions of what businesses need or want can result in a failure to communicate a compelling message. For example, contrary to what banks believe, what commercial de-positors most value is the time savings when preparing deposits. Banks must also focus on education and training, and that in-cludes their own employees. Branch employees have vital, face-to-face interactions with business clients. They can give clients a thor-ough understanding of the service and what it offers. Then, building awareness of RDC and promoting its benefits becomes a normal part of servicing the client in the course of day-to-day operations. more than one contact with the client to provide a more thorough understanding of how their business can benefit from the service. By learning about prospects’ specific situations, one can help them visualize how an RDC solution can save them time and make them more efficient, ultimately saving them money. In the survey, depositors who processed 100 or more checks were more likely to show interest in electronic depositing. Other factors to consider include company size, geographic spread, transaction volumes and the amount of business conducted with the depositor. Banks may also consider re-approaching commercial clients lost due to the absence of RDC services if the bank now offers RDC. It’s All About tHe equIpment At the core of a successful RDC program is the equipment, and if it is not accurate and fast, it can be a deterrent to RDC adop-tion. The majority of depositors surveyed used a scanner provided by their financial institution, and half of them indicated that the service could be better due to limited scanner performance. Providing your customers with the fastest, most accurate scanners will add great value and assist in expanding RDC adoption. Increasing adoption of RDC services requires just a few simple steps. Ask questions and listen to customers to discover their specific needs and their knowledge of the service. Educate customers and employees. Develop messages that resonate with more than one au-dience. Provide equipment that performs satisfactorily, or empower clients to purchase equipment on their own from approved vendors. Finally, and most important of all, request client feedback to fine-tune treasury services and ensure that customers are satisfied. These simple steps are the keys to increased RDC adoption, and they sup-port branch transformation. Reap the benefits. Bob Gibson is vice president, branch operations at Cummins Allison. How to Grow AwAreness Nearly 70 percent of financial institutions responding to the Cummins Allison survey chose active promotion of their RDC offering as the biggest contributor to clients initially adopting the service. But while promotion contributes to adoption num-bers, client awareness often needs reinforcing. A client’s initial exposure may be followed by multiple stages of awareness. For example, clients may be aware that there is a service called RDC, but are unsure of what it is. Or they may be familiar with it, but not understand how it might be useful for them. Or they may be concerned about costs and training. This may require Monitoring Mortgage-Backed SecuritieS By Larry russeLL m any community banks hold mortgage-backed securities of one form or another in their investment portfolios for a variety of reasons. Although some bankers choose not to invest in MBS, they have been an important holding, on a long-term basis, in many high-performing bank portfolios. At this time, the bond market carries a higher level of price volatility due to the uncertainties of the timing of the first hike in rates by the Federal Reserve since June 2006. This is a unique time in history, given the level of interest rates, the span of time spent at these generational Next moNth: Making Self-Service More Profitable What to Do When Rates (Finally) Rise rates, and the historically high valuations of other asset markets that are tethered to the U. S. bond market and Fed policy. With these conditions in play, if you own MBS, now is an important time to examine those holdings and assess what has actually occurred in each security since acquisition. Have prepayments increased more than expected, mortgage borrow-ers refinanced at a lower cost? If the bond was purchased at a premium price and prepayment speeds have increased, to what degree has the current yield been diminished? Another key measure to monitor is extension risk. Normally, as interest rates increase, prepayments decline as refinancing lessens, resulting in extension of average lives/ durations. Your investment advisor should be able to obtain an analysis of extension risk for each MBS issue held. This rate shock data is readily available and should be monitored as an increase in interest rates becomes more imminent. For a given amount of rate increase, loss to principal becomes larger as the maturity lengthens. If the duration of an MBS lengthens, price risk increases.

MONITORING MORTGAGE-BACKED SECURITIES

Larry Russell

Many community banks hold mortgage-backed securities of one form or another in their investment portfolios for a variety of reasons. Although some bankers choose not to invest in MBS, they have been an important holding, on a long-term basis, in many high-performing bank portfolios. At this time, the bond market carries a higher level of price volatility due to the uncertainties of the timing of the first hike in rates by the Federal Reserve since June 2006. This is a unique time in history, given the level of interest rates, the span of time spent at these generational rates, and the historically high valuations of other asset markets that are tethered to the U. S. bond market and Fed policy.

With these conditions in play, if you own MBS, now is an important time to examine those holdings and assess what has actually occurred in each security since acquisition. Have prepayments increased more than expected, mortgage borrowers refinanced at a lower cost? If the bond was purchased at a premium price and prepayment speeds have increased, to what degree has the current yield been diminished? Another key measure to monitor is extension risk.

Normally, as interest rates increase, prepayments decline as refinancing lessens, resulting in extension of average lives/ durations. Your investment advisor should be able to obtain an analysis of extension risk for each MBS issue held. This rate shock data is readily available and should be monitored as an increase in interest rates becomes more imminent. For a given amount of rate increase, loss to principal becomes larger as the maturity lengthens. If the duration of an MBS lengthens, price risk increases.

In considering the above, one may ask “why even own MBS?‚ Well, there is legitimate rationale for owning the “right‚ MBS. “Simpler is better‚ applies here. First, one must be comfortable with the vehicle, knowing there is a degree of variability over time in the duration of MBS. It is a matter of recognizing that some facets of these securities can change, but given a set of certainties, the “wiggle‚ can be managed and accommodated. Once in that posture, the increase in yield and the benefits of monthly cash flow that come with holding MBS can be realized to enhance the position of the bank.

For the sake of brevity, here are three often-employed MBS structures that are simple with fewer “moving parts‚ compared to other MBS alternatives. Historically, these have proven to perform well in community bank portfolios through different interest rate environments.

Adjustable rate mortgages are also a popular structure, particularly the hybrid ARMs. Among the many varieties are Fannie Mae and Freddie Mac 5Yr/1Yr and 7Yr/1Yr amortizing hybrid ARMs with a 5/2/5 format where the numbers indicate both the rate paid by the mortgage borrower and received by the bond holder. With the 5/2/5, the first 5 percent refers to the maximum percentage that the rate can increase at the first reset; the 2 percent refers to the maximum amount that the rate can be adjusted up or down annually; and the final 5 percent refers to the percentage that can be added to the initial coupon rate to determine the lifetime cap.

There are a variety of other formats and structures to consider.

ARMs provide monthly cash flow and the 5/2/5s are among the very few MBS that increase in prepayments (and thus shorten in average lives/durations) as interest rates rise. This occurs as ARM borrowers refinance in increasing numbers as their mortgages move closer to their first reset date where the rate can increase as much as 5 percent. These ARMs normally have 30-year final maturities. Any premium paid should be amortized to the first reset date. The variable-rate coupon is then booked at par, allowing the yield and the coupon to immediately escalate with any increase in the index rate, limited only to the lifetime cap.

ARMs can provide an attractive alternative to the historically low rates available in the current market and provide substantial cash flow for liquidity purposes. Ideally, steady prepayments can be utilized to fund loan growth in a reviving economy. The ARMs are more complex than the simpler 10-year and 15-year pools mentioned earlier, but can be managed and can provide good results.

Given the uncertainties of the timing of any increase in interest rates by the FRB, and the state of the economy, stay close to your MBS holdings. They are like most kids: They can be inherently good, but perform best when you keep your eye on them.

Larry Russell is senior vice president of the Capital Markets Group at Country Club Bank, Kansas City.

Read the full article at http://omagdigital.com/article/MONITORING+MORTGAGE-BACKED+SECURITIES/2057383/265375/article.html.

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