Investment Value
July 11, 2013
In previous posts we have discussed the increase in long-term rates and the potential impact to loan generation as rates rise. Due to long-term rates continuing to climb this week, we thought it would be beneficial to discuss one of the impacts to investments.
From Bloomberg the morning of 7/9:
One thing that has occurred in this low rate environment is that many institutions are reaching out longer with their investment portfolio to pick up more yield. Note that a 1-year investment yields less than many overnights. The longer investments bring more return, but also more risk. This trade-off is magnified as the upside of such a low-yielding long investment is minimal and it does not take a large increase to wipe out the return.
For example, a month ago an institution could have purchased a
5-year bullet with a yield expectation of 1.09%. A month later, as rates increased 39 basis points, the value of that same bond dropped almost 2%. In fact, a 5-year bullet yielding 1.09% can have a 1.09% loss in value after only a 23 basis point increase in rates.
While the intent of the investment purchases may not be to sell the investments in the future, understanding the potential change in value is beneficial, as the value can impact the flexibility an institution has to alter its structure. The recent increase in rates is a reminder of this, but is a small sample compared to some of the larger changes that history has shown us.
