By Jim Reber, President & CEO, ICBA Securities
A best-selling book from the 1990s, “Why Things Are,” took a humorous look at curiosities originating from everyday existence, with the modest goal of answering “every essential question in life.” This column has a more ambitious purpose: to clarify a few of the phenomena surrounding your investment in bonds. So, put on your seat belts as we head out for a ride on the fixed-income highway.
Why do continuously callable bonds have a higher yield than bonds with only one call date?
An investor in a callable bond actually does two things simultaneously when he or she makes the purchase: 1. the buying of the bond from the issuer, and 2. the selling of the right to prepay the debt early to the issuer. For bonds with multiple call dates, the issuer pays something for each right. In aggregate, the value of all the call options as of the issue date is reflected in the higher yield compared to a non-callable bond, or one with one only call date.
Why do mortgage-backed securities priced at 100.00 have different yields than the stated coupon?
For this answer, we have to do a two-step move. First, let’s review what bond-equivalent yield (BEY) means. The yield on a bond has a standard calculation that assumes semi-annual interest payments in arrears (meaning at the end of the period), and principal at maturity date. For example, if you buy a new two-year agency bond, your first interest date will be exactly six months from original settlement date.
Mortgage-backed securities (MBS) differ in two ways. First, some interest payments are received monthly. That’s good from a BEY standpoint. However, MBS also have this nice little convention known as “delay days” before any principal or interest are paid. That’s bad for BEY purposes. Most mortgage securities have delay days ranging from 45 to 85 days. Factoring in the delay of both principal and interest over a period of time probably means the bond-equivalent yield for a mortgage will be less than the coupon, at par.
Why do tax-free bonds have lower price volatility than taxable bonds?
Another popular question. The best way to illustrate this is to take a hypothetical taxable bond, like a 10-year Treasury note, and compare it to a 10-year tax-free bond. At the moment, the 10-year Treasury yields (conveniently) 1.50%, and 10-year high-quality munis yield about 1.65% (for a tax-equivalent yield of 2.05%).
If rates rise 100 basis points (1.0%), the Treasury will then yield 2.50% and its price will decline 8.7%. The muni will only have to drop by 6.9% for its tax-equivalent yield to get to the 3.05% that the market will likely require. It’s worth noting that the two bonds’ volatilities have become more alike since tax reform at the end of 2017. Stated another way, muni price volatilities have increased as tax rates have fallen.
Why is the duration of a bond shorter than its average life?
The most commonly used measurement for price volatility of a fixed-rate security is duration. It is the weighted average period of time to receive all the principal and interest on a bond. Average life, on the other hand, is a tool used in many cases to forecast cash flows on mortgage securities and is the weighted-average time to receive principal only. Since most MBS are back-loaded with principal on their paydown schedules, average lives are almost always longer than duration for a given bond.
Duration is useful for estimating how much a bond’s value will change given a change to market rates. A duration of 3.0 means that the price will decline about 3%, given a 1% increase in the market yield. Concepts like effective duration and convexity also factor into this discussion, but that’s another story for another day.
Why are bankers more inclined to sell at gains than losses?
I’m no shrink, but there is an element to behavior that psychologists refer to as “compartmentalization.” It seems to me that taking a loss is seen by the seller as admission of a bad purchase. In fact, the overwhelming majority of losses realized are market-driven, and I think we agree that bankers aren’t market-timers. So, by being more inclined to take gains, portfolio managers can neatly stack their aggregate sales in the “win” column.
There are just two problems with this practice: selling the winners means your portfolio yield is probably going down, and you’ve triggered immediate tax liability. I would suggest, especially in a robust earning year like the present, that a bank work with its tax accountant and brokers to devise an income-deferral strategy. Higher yields mean more future income. And that falls into the “long-term vision” compartment.
By Rachel Scheuerman, Director - Engagement Solutions, Harland Clarke
Voice search and voice-powered experiences are two of today’s hottest topics — and for good reason. According to a recent Yext webinar, the use of voice-enabled speakers will grow 130 percent over the next year. So, there’s no doubt voice recognition is shaping the emerging customer experience and will have a direct impact on businesses of every kind, including financial services (if it hasn’t already). So, exactly how does voice search impact your financial institution, and most importantly — how can you keep up?
Speak and you shall receive.
For starters, voice search functionality marks a seismic shift in how consumers get results. In fact, over 20 percent of all Google mobile searches are now voice-command interactions. Siri co-founder has even called voice search a “defining characteristic of computing” over the next 10 years. But, unlike a text search you do on your computer, voice search results provide just one answer at a time, meaning there’s only one best answer. This “one result only” model really puts the pressure on financial institutions when it comes to things like:
Now, back to voice.
It’s important to note how younger generations access and consume information through the internet. This might be a no-brainer, but today’s teens and children know of no time in their lives when they didn’t have access to the internet, and most have always had access through a mobile device. It’s critical to understand these behaviors when thinking about how a young person might interact with voice search and the result offerings. While it may seem like a leap for us, for teens this is just more of the same, and soon could be the norm for many industries.
Behavior-wise, consumers are being taught how to ask devices the right questions, which is a natural extension of their current behavior. People type questions differently than when they say them out loud. This is because we can speak more words per minute than we can type and also because we are less deliberate with our words when we speak. So, this has resulted in an increase in “conversational search.” Think about the rise of Alexa and Google Home, particularly with older people. These devices make it easier for people with growing, age-related challenges to accomplish simple tasks. Order more dog food, check the weather, understand their calendar for the day, and so on. There’s no reason why banking tools and search for financial-related help topics couldn’t become an everyday voice search all over your community and one day, the globe.
So, how is it powered?
“Intelligent services” triggered by voice rely on your financial institution’s structured data to provide “rich” experiences. This creates an importance to ensure the data about your brand is structured in a way these services understand. A program called Schema Markup helps your website speak the language of intelligent services, so they can understand, categorize, and structure the information about your brand. An enhanced, consistent, and accurate digital knowledge published everywhere can help offer a positive consumer experience.
By complying with these best practices, businesses become a part of that circle of trust around the content showcased to consumers via voice search. Yext puts you in control of all of the public facts about your brand. With Yext, you can be sure consumers find rich, accurate, and consistent information about your brand — wherever they are, in all the ways they search. Every time.
By Chris W. Bell, Associate General Counsel, Compliance Alliance
One of the most common types of questions that we get at Compliance Alliance concerns the deadline of particular regulatory requirements. While some requirements have a definite due date and a knowable trigger, the trigger for other requirements is a bit is more of a judgment call. The suspicious activity report (“SAR”) must be filed “no later than 30 calendar days after the date of initial detection by the bank of facts that may constitute a basis for filing a SAR.” You have to love any rule with a self-referential deadline. What can be clearer than the notion that you have to file a SAR within 30 days of knowing you need to file a SAR? A closer look at the SAR rules can help break this requirement down into a more manageable expectation and tune up your suspicious activity reporting system.
The first thing to keep in mind is what constitutes “suspicious activity.” The Bank Secrecy Act (“BSA”) tells banks, bank holding companies, and their subsidiaries to monitor transactions and file a SAR on any transaction that they deem suspicious. A transaction includes “a deposit; a withdrawal; a transfer between accounts; an exchange of currency; an extension of credit; a purchase or sale of any stock, bond, certificate of deposit, or other monetary instrument or investment security; or any other payment, transfer, or delivery by, through, or to a bank.” You must file a SAR when you have reason to suspect:
You must establish and follow suspicious activity monitoring and reporting systems to fulfill your duties under the BSA. Examiners look for suspicious activity monitoring and reporting systems that include five key components: identification or alert of unusual activity; managing alerts; SAR decision making; SAR completion and filing; and monitoring and SAR filing on continuing activity. This boils down to being able to identify unusual customer behavior, deciding whether that behavior is “suspicious activity” that triggers the reporting requirement, and fulfilling the reporting requirement. During an exam you may be asked to show, through policies, procedures, and processes, how your bank takes the necessary steps to address each component and the person(s) or departments responsible for executing those steps.
Through your transaction monitoring programs, you will identify many cases of unusual behavior on behalf of your customers. That does not mean that you will file a SAR on each case of unusual behavior. You must file a SAR within 30 days of identifying potentially suspicious activity, with the deadline extending to 60 days when you are unable to identify a suspect. “Initial detection” is not when you identify unusual behavior. That is only the first step to identifying suspicious activity. There are many cases where activity can be deemed unusual for a particular customer and generate a red flag, but where the activity, upon further review and investigation, is legitimate and perfectly reasonable. After identifying unusual behavior, you must promptly review the transaction or account to determine whether the unusual behavior suggests that the activity is consistent with one of the types of suspicious activity outlined above. If you determine that the unusual behavior is suspicious activity, the clock starts ticking.
There is no specific timetable for your investigation. While the FFIEC has said the investigation must be completed “within a reasonable period of time,” what is considered reasonable will vary according to the facts and circumstances of the particular activity being reviewed and the effectiveness of your SAR monitoring, reporting, and decision-making process. The examiner will be looking to make sure that you have “adequate procedures for reviewing and assessing facts and circumstances identified as potentially suspicious, and that those procedures are documented and followed.”
One question that comes up often during the review process is the extent to which a bank has to confirm the underlying criminal activity to support a SAR. While the BSA requires you to report suspicious activity that may involve money laundering, BSA violations, terrorist financing, and certain other crimes above prescribed dollar thresholds, you do not have to investigate or confirm the underlying crime itself. Law enforcement will handle the investigation. When evaluating suspicious activity and completing the SAR, you should, to the best of your ability, identify the characteristics of the suspicious activity.
Your bank plays a crucial role in helping the government catch people who are engaged in terrorist financing, money laundering, and other illegal activity. You must have systems in place to monitor for consumer activity that is designed to further such illegal activity and report the suspicious activity to the proper authorities. While your systems should flag all unusual activity, you will not be filing SARs on all of it. Your reporting requirement arises when you have reason to suspect that the identified activity is the kind of suspicious activity under the BSA. You should promptly review all unusual behavior to determine whether you are dealing with suspicious activity and must file a SAR and then file that SAR within 30 days (or 60 days if you cannot identify a suspect). Compliance Alliance members have access to our BSA toolkit, which contains many tools to help you fulfill your SAR filing requirements.