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Don founded Kamakura Corporation in April 1990 and currently serves as its chairman and chief executive officer where he focuses on enterprise wide risk management and modern credit risk technology. His primary financial consulting and research interests involve the practical application of leading edge financial theory to solve critical financial risk management problems. Don was elected to the 50 member RISK Magazine Hall of Fame in 2002 for his work at Kamakura. Read More

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Kamakura Corporation
2222 Kalakaua Avenue

Suite 1400
Honolulu HI 96815

Phone: 808.791.9888
Fax: 808.791.9898
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Yesterday we showed that the marginal cost of funding for Bank of America Corporation (BAC) was about 0.30% higher than the marginal cost of funding for Wells Fargo & Co. (WFC) and 0.134% higher than the composite U.S. Dollar Cost of Funds IndexTM. Bank of America Corporation was the 4th most heavily traded bond issuer yesterday and ranked 18th among all reference names in the credit default swap market last week. We last analyzed default risk at Bank of America Corporation on June 11, 2014.

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Forty years ago I spent two summers working with an MIT-educated genius named Wm. Mack Terry, head of the Financial Analysis and Planning Group at Bank of America in San Francisco. One of the many lessons of that experience is that banking is a brutal, efficiency driven business where the competitors with the lowest marginal costs create the most shareholder value. Those costs can be split into operating costs and the marginal costs of funding. In this note we compare the marginal cost of funding for Bank of America Corporation (BAC) with the U.S. Dollar Cost of Funds IndexTM, which uses observable bond pricing for the 4 largest deposit-focused banks in the United States.

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On September 5 in the U.S. bond market, there were 14,691 bond trades in 2,790 non-call fixed rate corporate bond issues representing $4,217,362,432 in notional principal. Which 20 trades were the best trades of the day, and how do we decide the answer to that question? Today, we answer those questions for bonds with maturities of 1 year or more. The answers to these questions are particularly important given the well-known inability of legacy credit ratings to match the accuracy of quantitative methods used in this series of notes. We ignore legacy ratings in this analysis for that reason.

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Forward 1 month T-bill rates twisted again this week, reversing last week’s fall and rising more than 0.13% for all forward rates from 2019 through 2024. The twist in implied forward 1 month Treasury bill rates stems from an increase of 0.06% to 0.10% in current U.S. Treasury yields in the 5 to 30 year maturities. Forward 1 month T-bill rates are now projected to rise steadily until reaching a peak at 3.33% in February, 2021, a peak 2 months earlier and 0.15% higher than last week. The implied forecast shows projected 10 year U.S. Treasury yields rising to 3.64% in 2024, up 0.17% from last week.

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A survey done a few years ago of the interest rate risk managers for the largest U.S. and Canadian banks confirmed some common elements in their approaches to asset and liability management. First, more than 90% of the respondents used just one yield curve as the “base yield curve” for valuation and profitability analysis. Second, this curve almost universally the U.S. dollar interest rate swap curve. Since that survey was taken, interest rate swap spreads have been negative at many maturities and massive fines have been paid by major banks for manipulation of Libor, the short term interest rate at the heart of interest rate swap spread setting. This note show how to improve the accuracy of transfer pricing and valuation in asset and liability management by eliminating the use of the interest rate swap curve, replacing it instead with the U.S. Dollar Cost of Funds IndexTM. We use traded bond price data for KeyBank N.A. and its parent KeyCorp to illustrate the process.

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