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The Christmas Edition: The Hope of Christmas

December 20, 2012
Rich Berg and Phil Nussbaum

As many of you know, every year Phil and I send out a Christmas letter that is not from the Performance Trust Companies, but rather personally from the two of us. We use this special time of the year to share with you what Christmas means to us.

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Forward Rates: Not What They Sound Like

December 19, 2012
Adam Buresh

Forward rates are often perceived to be a form of prediction of future interest rates. In fact, in their calculation and application, they are only a statement about current interest rates.

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Skill or Chance

October 26, 2012
By Kurt Fritz

Recently, a federal judge ruled that poker—unlike roulette—is a game largely reliant on skill rather than luck. We find that many securities portfolio managers treat investing—which demands substantial skill—as though it were driven almost purely by luck.

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Hands Off the PMBS Panic Button!

September 12, 2012
By Chirag Shah and Jason Elder

Regulatory Agencies have proposed changes to the capital treatment of securities in recent Notices of Proposed Rulemaking (NPRs). This had led to advice from other precincts suggesting that holders of PMBS securities divest of them now to avoid risk-based capital burdens in two and a half years’ time. We find this strategy to be premature and, when quantified, quite expensive. In our view, the income advantage of these securities over current alternatives provides significant cushion to offset any possible price depreciation over the next thirty months.

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Have We Finally Hit Bottom?

September 4, 2012
Glenn Schultz

The Case-Shiller 20-City Index was released on August 28, 2012 and garnered some fanfare in the retail press. The headlines read: “Housing Prices Record First Increase Since the Third Quarter of 2010.” This has sparked hope in the market of a housing recovery. In fact, this event is perhaps even more long-awaited than it may appear, because the third quarter price increases in 2010 were largely attributed to the effects of a one-time tax credit for home buying, rather than to any secular improvement in the housing market. Case-Shiller’s release requires no such footnote, so we are left asking, have we finally bottomed in housing? 

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Performance Trust Response Letter to Regulatory Capital NPRs

August 27, 2012
Bart Smith

As Bart Smith promised in his recent Disciplined Investor article, “BASEL III Regulatory Notices of Proposed Rulemaking” (July 2,2012, Volume 13), we have formulated our official response to the recent NPRs regarding proposed changes to regulatory capital matters. Please find our letter attached.

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Bond Rates: On a Road to Nowhere?

August 7, 2012
John Behof 

A well-respected economist and money manager has recently made an intriguing case for continued low Treasury yields, based upon the growing dominance of non-investment-based demand for these instruments. While we believe that no one can reliably predict interest rates, his argument may help us resist the widespread assumption that Treasury rates must soon rise.

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What’s the ARM in That?

June 5, 2012
Chirag Shah and Servia Rindfleish

We have traditionally found that ARM securities fail in their purported purpose—to protect the investor in rates up. Now, we find that a certain subset of ARMs with a unique history may finally be able to deliver on this promised protection.

Our Mission, Values and Methodology are committed to the ideal of intellectual honesty. This requires us to check—and frequently recheck—our opinions against facts, math and logic.

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Municipal Guidelines for Depository Institutions

May 24, 2012
Bart Smith

In late 2010, prominent banking analyst Meredith Whitney voiced an ominous outlook for the municipal bond market. In a 60 Minutes interview, Ms. Whitney prognosticated that the market “could see 50 to 100 sizable defaults” amounting to “hundreds of billions of dollars” in potential exposures. In reaction to this and other negative predictions about municipal credit, the market experienced a massive sell-off between December 22, 2010 and February 2, 2011. Over this period, investors sold off some $14 billion in municipal funds, driving down prices and resulting in returns for the fourth quarter of 2010 that were the lowest in 16 years.

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Bonds are Dangerous!

April 25, 2012
John Behof

Extremes in absolute rate-levels—such as today’s proximity to the hard floor of zero—lead to an asymmetry in “bond logic.” In these situations, we must adjust our normal thought processes in order to seek outperformance.

I recently marked the 16th anniversary of the day I first joined Performance Trust, and it seems like with each passing year of my tenure I’ve become more convinced of the superiority of our Shape Management® methodology over alternative methods that many depository institutions use to select bonds and sectors for investment.

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Bloomberg Median Speeds: Six Analytical Issues

April 12, 2012
Charlie Carpenter

"You want me to buy that???”

I had never gotten that reaction from a client before, and it was especially unusual coming from a veteran who had been harvesting the fruits of Shape Management® for years. However, I cannot say his reaction was a complete surprise—I had noticed the “ugly part” of the Performance Trust Write-Up and had half expected some kind of a reaction.

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Dodd-Frank 939A: Community Bank Impact

March 27, 2012
Bart Smith

As we all know, the country is currently undergoing a massive regulatory overhaul under the Dodd-Frank Wall Street Reform and Consumer Protection Act (“The Act”). The Act was signed into law by President Obama on July 21, 2010 and provides for significant changes to federal financial regulation.

The stated purpose of the Act is to “promote the financial stability of the United States by improving accountability and transparency in the financial system, to end ‘too big to fail,’ to protect the American taxpayer by ending bailouts, to protect consumers from abusive financial services practices and for other purposes.”

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Introducing Bart Smith

March 15, 2012
Bart Smith

We are pleased to announce our newest Performance Trust resource. Bart Smith has just joined us as a Managing Director, coming to us directly from a 25-year career with the Federal Deposit Insurance Corporation (FDIC). We asked him to introduce himself, explain his career change, and describe the types of assistance he can provide to you. We hope you won’t hesitate to take advantage of his expertise.

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Premium Amortization: An Accounting Time Bomb?

March 6, 2012
Doug Wilding

As I have reviewed client portfolios in the course of preparing and presenting their Look-Forwards®, I have noted lately the preponderance of securities held at premium book values. This is hardly surprising considering the Level Playing Field® allocations for Insulators (shorter CMOs with premium coupons that are expected to perform well in a rate rise) in the past few years and given that for some time now, even new issue mortgage-backed pass-throughs have come at premium dollar prices. Recently, in the course of this daily work, I was suddenly struck with a foreboding sense of déjà vu—but in this case, I really had had the experience before, around 2001-2003.

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Miserable Offering Evokes Les Misérables

March 5, 2012
Kurt Fritz

At Performance Trust University®’s, Principles of Performance™, one of my favorite modules is called “Live Callable.” I have been teaching this part of the program for over 10 years now, through yield curves both steep and flat, through volatilities high and low.

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Buffett “Buries the Lead.” Then I Do, Too!

March 1, 2012
Eric C. Brown

“To bury the lead”—In journalism, to obscure (or completely miss!) the main point in a story by focusing on details of secondary importance.

You may be familiar with the comparison between gold and productive assets that Warren Buffett has been dining out on for the past several months. In it, he notes that nearly all of the gold ever extracted from the earth’s crust is still in human hands, and that this gold, if brought together in one place, could form a cube 68 feet on a side, which could easily fit within a baseball infield.

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General Obligation Credit Analysis

February 2, 2012
Les Fraley

The municipal market has garnered unprecedented attention over the past year, largely due to credit fears. To help you seek outperformance and navigate municipal credit risk and opportunity, this article introduces a credit analysis framework used by us and many other credit analysis practitioners (including rating agencies such as Moody’s Investors Service [Moody’s]). The described framework specifically addresses general obligations while offering comparisons to other sectors.

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Insulators with Their “Hair on Fire”

January 11, 2012
Andrew J. Hixson

When I joined Performance Trust in January 2000, my mentor Greg Sheahan pulled me aside and regaled me with tales about the crazy prepayment rates he had seen in the MBS market back in October of 1998. In fact, he required me to memorize 10/5/98 as the date on which rates had hit their lows. In his war story, Greg described how at the time, the market was reeling from the Russian currency crisis and the fall of Long-Term Capital Management. As Treasuries rallied in the resulting “flight to quality,” the market saw a 10-year Treasury at its lowest rate in over 35 years!

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The Christmas Edition: Did it Happen? Why Did it Happen?

December 21, 2011
Rich Berg

As many of you know, Phil and I send out a Christmas letter every year that is not from Performance Trust Companies, but rather from the two of us personally. We use this special time of the year to communicate with you in a very personal way, as we will give you our perspective of what Christmas means to us.

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Bite the Bullet: Even If You “Know” Rates Can Only Rise

October 27, 2011
Alex Balc

It is no secret that depository institutions are absolutely flush with cash of late; if this is the case for your institution, then you are probably also familiar with the challenge of finding the means to put that cash to work at acceptable rates of return. Bank of New York recently made news with its announcement that it would begin charging a fee on large deposits (remember when you paid up to attract larger deposits?).

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The Big Guns: The Major Weapons of Strategic Portfolio Design

September 27, 2011
Eric C. Brown

The scope of the Shape Management® disciplines span from Real-Time Execution (choosing between individual securities within a sector already selected for investment), to Tactical Decision-Making (determining which sectors to acquire, hold, or avoid given the current market), to Strategic Portfolio Design (determining the best overall portfolio shape to pursue given the institution’s constraints and objectives). The “Big Guns” of Shape Management are deployed in service of this last discipline—Strategic Portfolio Design.

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September 20, 2011
Alex Balc

On September 23rd, the movie, Moneyball, is set for theatrical release. It is based on the bestseller of the same name, written by Michael Lewis, the famous financial writer who authored Liar’s Poker in 1989 and The Big Short in 2010 (as well as non-financial hit book and movie The Blind Side). If you’ve known Performance Trust a long time, you may recall we sent the book, Moneyball: The Art of Winning an Unfair Game, as a Christmas gift to clients in 2003, because it contained many of the same themes we have been advocating for decades. The release of the film adaptation prompted us to encourage you to read (or reread) the book and—in spite of the risk in recommending a film we have not seen yet—to see the movie later this month.

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Premium MBS and Stimulus Prepayment Risk – Part II

September 8, 2011
Phil Nussbaum

Here we go again. There is once again speculation about a national streamlined refinancing plan that would enable homeowners to take better advantage of historically low mortgage rates. The theory is that such a plan would stimulate consumer spending and jumpstart the struggling economy. We will not debate here whether such a plan would actually lead to the desired stimulus. Rather, we will focus on the impact on us as mortgage-backed security (MBS) investors.

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Wells Fargo Exits HECM Market

June 20, 2011
Adam Buresh

Wells Fargo and Bank of America’s decisions are thought to be because of the headline risk associated with HECM loans. As servicers, they are required by the FHA to foreclose on borrowers who fail to pay their property taxes and home insurance. The negative press associated with foreclosing on senior borrowers is a significant concern to such large banks, for whom HECM origination is a small part of overall revenue. Ultimately they are abandoning a profitable and successful line of business because of the perceived risk it could pose to their overall operations.

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HECM ARMs: The Rates-Up Reverse Mortgage

April 19, 2011
Adam Buresh

GNMA reverse mortgages, or HECMs, have been discussed in a previous Disciplined Investor® (GNMA Reverse Mortgages: An Attractive Investment, Volume 17, Number 10, August 25, 2010), on several Level Playing Fields®, and at The 2010 Advanced Course®. Until now, however, we have focused primarily on fixed-rate HECMs. This article will explore adjustablerate HECM ARMs in more detail.

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Understanding and Quantifying TIPS as an Investment Option

February 28, 2011
Eric C. Brown, Bradley D. Bonga

Treasury Inflation-Protected Securities (TIPS) have been offered by the U.S. Treasury since 1997 and currently populate a market of approximately $550 billion. From time to time, we discover TIPS in the investment portfolios of depository institutions, and we also periodically receive questions about these products from clients. For these reasons, we are offering a description of TIPS and how they work, a discussion of their pros and cons, and a simple method an investor can use to quantify a potential TIPS investment against an appropriate alternative.

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The Humility of Christmas

December 21, 2010
Rich Berg, Phil Nussbaum

As many of you know, every year Rich and I send out a Christmas letter that is from us individually. We use this special time of year to communicate with you in a very personal way, as we will give you our perspective of what Christmas means to us.

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When the Facts Change

December 15, 2010
Craig Johnson

There has been a significant move in rates since our last Level Playing Field® (11/05/10)—especially in the belly of the curve, so we wanted to touch base with some thoughts and analytics.

You will remember from the November Level Playing Field that we had some
meaningful additions and subtractions to the Strategic Portfolio.

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Call to Action: Long Opportunities

November 23, 2010
Phil Nussbaum

Uncertainty in the economic and political spheres continues to create new stresses and new opportunities. We highlighted one such new opportunity for bank portfolio managers on last week’s Level Playing Field® calls. Actually, we highlighted two opportunities on the call, one on the asset side and one the liability side. Each one, taken separately, has significant merit. However, it is the combination of these recent opportunities that presents such a unique risk/reward situation. In both cases, the opportunity is in long maturity instruments. Over the years, we have continually monitored opportunities to profitably fund assets with wholesale liabilities. In many market environments, there are few such opportunities. In some past market environments such opportunities have existed to various degrees. This is one of the strongest such opportunities we have seen in some time.

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The Mortgage Collateral Engine: It’s What’s Under the Hood That Counts

November 16, 2010
Tony DePalo

On December 21, 2009, the Wall Street Journal published the Treasury yield forecasts from the 18 primary dealers. The median forecast for the 10-Year Treasury—which was 3.674% at the time—was 4.125%. On November 10, 2010, the 10-Year Treasury was 2.670%. Once again, not only were they wrong on the magnitude of the interest rate move, but they did not even get the direction correct.

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CRA Securities: Customized and Quantified

November 4, 2010
Eric C. Brown, Rob Clare

One of the many “Life Lessons” that Rich Berg has discussed in talks over the past several years has been how important compliance with regulations has become. A desire to remain in compliance may very well cause us to execute a less than optimal strategy – either in our loan portfolio or in our investments. We have recently launched a concerted effort to facilitate your efforts to meet a particular regulatory objective: the creation of customized CRA eligible pools. We are currently working with a variety of Fannie/Freddie/Ginnie issuers to create customized CRA securities for those institutions looking to shore up their CRA profile via the “investment test.” Whether you are interested in acing your next CRA exam, making yourself more attractive as an acquisition, or looking to avoid “headline risk” in your community from vocal affordable housing activists, these securities can help you fulfill your CRA strategy.

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Callable Step-Up: The Return of a Poor Risk/Reward Revisited

September 14, 2010
Kurt Fritz

Callable step-ups. Callable step-ups. Callable step-ups. They just keep on coming. It’s like a bad dream that I can’t forget. In fact, this will be my fourth article dedicated to one of my least favorite sectors—the callable step-up. I wrote the first article on this poor risk/reward in 1998 and revisited it in 2003. Then in May of 2009 I wrote an article entitled, “The Return of a Poor Risk/Reward,” which highlighted the shortcomings of callable step-ups. I’m going to pile on again today.

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Premium MBS and Stimulus Prepayment Risk: Should Investors Now Shun Premiums?

September 1, 2010
Philip Nussbaum

Premium coupon mortgage-backed securities and CMOs (collectively, premium MBS) have performed very well over the past several years as prepayments have been lower to much lower than expected due to the struggling economy and credit impaired homeowners’ inability to refinance to the prevailing lower interest rates. Much of the prepayment that is taking place is actually involuntary, that is, it is due to home foreclosures and liquidations and not voluntary refinancing.

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GNMA Reverse Mortgages: An Attractive Investment

August 25, 2010
Adam Buresh

GNMA reverse mortgage bonds are an attractive opportunity for investors because they provide diversification and offer relatively strong reward compared to their risk. The key to both of these features is the unique and stable character of the actuarial risk that drives prepayments.

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Maybe Technically Right, but Certainly Analytically Wrong

April 14, 2010
Brad Bonga

We are re-releasing this piece on its ten year anniversary. While the stock market has changed a lot over the last ten years, we continue to find market participants incorrectly using single statistic parameters in various markets.

Brad Bonga, the original author of this piece, continues to seek out inefficiencies on behalf of our clients as the Senior Portfolio Manager for Performance Trust Asset Management.

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To Extend or Not To Extend, Part I: Slope, Slope and More Slope

February 23, 2010
Kurt Fritz

This is Part I of a two part Disciplined Investor® that considers the question of whether to extend out the curve in this environment. Long time readers may recall Rich’s three handicaps to consider when deciding which maturities to purchase. Those handicaps are slope, slope to Fed Funds, and the absolute level of interest rates. This article deals with handicap one and to some extent handicap two. The historic slope in the yield curve favors extending in this current environment. Part II will deal with handicap three, where the absolute level of interest rates cautions against extending out the curve in too significant a manner.

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Freddie Mac and Fannie Mae Announcements

February 10, 2010
The Disciplined Investor®

Freddie Mac announced this morning that they would buyout all loans in securitized pools over 120 days delinquent. Later in the day, Fannie Mae also announced a delinquent loan purchase program. Remember that buyouts are a prepayment risk because the delinquent loans in the pools are bought back at par, but they are not credit risk, since principal and interest are guaranteed.

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If I Had Only Known

December 22, 2009
Rich Berg, Phil Nussbaum

As many of you know, every year Phil and I send out a Christmas letter that is from us individually. We use this special time of the year to communicate with you in a very personal way, as we will give you our perspective of what Christmas means to us.

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Cushion Callables: A Soft Landing?

December 16, 2009
Zach Johnson

Do you realize that it has been almost a year since the Federal Open Market Committee (FOMC) lowered the Fed Funds target rate to near zero? Much has changed in that time. The yield curve has steepened, we have seen spreads at historic wides—only to tighten dramatically in the last few months—and now with each passing quarter, there seems to be a growing sense of optimism by some in the market. Though not everyone believes the economy is getting better, most would agree that at some point, short rates must rise. As always, the real question is, “how much and when?” If we only knew the answer to that one question, decision-making in the portfolio would be much less complicated.

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Caveat Emptor: Let the Buyer Beware

November 24, 2009
Nigel Johnson, Andrew Pace

In the past several months we have written articles on the dangers of structured notes and callable step-ups. Both of these products were created by the Street to meet a need felt by investors. In the case of the step-ups, there is a need to put dollars to work in a product that will do well (“step up”) when rates rise. The structured note feeds a much more basic need, a need for yield (as high as possible). In the previous articles, we learned to put emotion and intuition aside, and by crunching the numbers and running the shapes, we illustrated that what appears to be attractive investment alternatives are actually poor risk/rewards.

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The Performance Trust Balance Sheet Look-Forward™

November 10, 2009
Disciplined Investor®

The Rubik’s cube of risk management is particularly challenging in this environment. Management has the task of balancing the capital, asset quality, earnings, liquidity, and rate sensitivity positions of the institution. Because of the interconnected nature of these components, at times it can be difficult to properly identify which component actually presents the most risk. Even when risks are properly identified, it is often not clear what strategy to pursue to alleviate that risk. Management must both accurately identify the risk (nature and magnitude) and develop the appropriate strategies to manage it without significantly negatively impacting other areas of the institution.

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It Does Not Always Depend

October 7, 2009
Disciplined Investor®

Last year, Performance Trust entered the asset management business when it formed a fund to invest in distressed mortgage assets. The following article was written by the asset management team. The analytics highlighted pertain to the kinds of investments we have discussed as part of the Level Playing Field® process. We thought you would benefit from seeing this analysis.

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Understanding Lending as the Sale of Put Options on Collateral

September 28, 2009
Shane B. Hoover, Adam C. Buresh

Managing risk and reward is at the heart of disciplined investing. Over the years Performance Trust UniversityTM and this newsletter have discussed bonds with embedded optionality, such as callable agencies. Rarely, however, have we discussed the optionality embedded in loans. This Disciplined Investor® will show that collateralized lending is similar to selling put options and will use the comparison to make important points about lending.

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The Portfolio Manager’s Dilemma

July 24, 2009
Tony DePalo

The trough of the economic cycle is upon us, and the portfolio manager’s dilemma is becoming a reality once again. Loan demand has slowed at depository institutions, and again they find themselves flush with cash in another low rate environment. Through monetary policy, the government has fixed the fed funds rate at close to zero. That means this influx of cash earns almost nothing if left in cash. Most community banks understand the cost of sitting in such low yielding fed funds and are looking for investment opportunities. Yet, it is difficult to invest in fixed income assets with all of the inflationary talk. This low interest rate environment is again creating a great dilemma for the portfolio manager. Stay short and be ready for rates up but earn little while waiting, or invest longer to earn more at the potential cost of locking in the lows of interest rates. If we choose the latter, which security should we buy?

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The Return of the Structured Note

June 10, 2009
Brad Gavin

Two weeks ago, Kurt Fritz wrote an article about the increased number of callable step‐ups being offered in the market place. As is often the case when we write articles about specific structures, many of us end up fielding calls that begin something like, “Hey, can I show you a bond that I’m being offered? It seems interesting, but perhaps I’m missing something.” Last week, after Kurt sent out the callable step‐up article, one of our clients sent us the following FHLB structured note:

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The Return of a Poor Risk/Reward

May 21, 2009
Kurt Fritz

Samuel Johnson once said, “Integrity without knowledge is weak and useless, and knowledge without integrity is dangerous and dreadful.”

This quote is very poignant as I see the incredible number of callable step‐ups being pushed out by brokerage firms around this country. I wrote my fist article on these stinkers in 1998, revisited them in 2003, and am going to get on my soap box again today. If you are a student of interest rates and their history, you will immediately recall a common theme from all three of these periods—a low and steep yield curve. I was not around for the first big issuance period in 1993, which also happened to have a very low and steep curve.

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FASB Mark‐to Market Proposals: Positive Developments on OTTI

March 18, 2009
James V. Lorentsen, CPA

On March 16, the FASB met to discuss potential proposals relating to OTTI. Yesterday, March 17, they formally released two proposed staff positions (FSP). These FSPs provide application guidance on determining fair value in inactive markets and on accounting for securities that are other than temporarily impaired (OTTI). Both proposals are very positive steps forward and approaches that we have been advocating for over a year. The FASB is seeking comments through April 1st on both proposals with the goal of evaluating the input at an April 2nd board meeting. We anticipate sending a comment letter within one week.

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The 5th Standard Deviation: It Happened

December 22, 2008
The Disciplined Investor®

As many of you know, every year Phil & I send out a Christmas letter that is not from Performance Trust Companies, but rather from the two of us personally. We use this special time of the year to communicate with you in a very personal way, as we will give you our perspective of what Christmas means to us. We warn you in advance that some of the discussion that follows will be controversial in a business setting. Some may find it out of place, distasteful or even offensive. To you, we ask your forgiveness in advance.

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Troubled Asset Relief Program (TARP)

October 31, 2008
Brian Battle

As most of you know, we had our “Credit Summit” here in Chicago this week. Response was great on fairly short notice with 115 customers and more than 100 financial institutions represented. Lack of capital and liquidity are the fundamental causes of the banking problems we are seeing today. These were the main topics addressed at the summit. Former FDIC Chairman Donald Powell gave a very well‐received presentation and began his comments with the phrase: “Capital is king.” We agree. In fact, Michael Iannaccone and I spoke on day one of the seminar specifically about TARP and how to take advantage of it. Many of you mayhave also seen Rich on CNBC discussing TARP.

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Buy General Market Municipal Bonds II

October 23, 2008
Brian Battle, Rob Livingston

This “Call to Action” is a result of the disorganization in world credit markets. As participants unwind their positions, we now see historically wide spreads on taxexempt municipal bonds and a disconnect of normal pricing between General Markets, Bank Qualifieds, and Treasuries. The current state of these three separate, but related, markets allow us to now buy general market munis at unprecedented levels. We saw this opportunity once earlier in the year and it only lasted a couple of days.

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