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II.
DIF Investments Results -
Third Quarter 2008
DIF
- The amortized cost (book value) of the DIF investment portfolio
decreased dramatically, dropping by $18.757 billion, or by 37.2 percent,
from $50.469 billion on December 31, 2007, to $31.712 billion on September
30, 2008. The DIF portfolio’s market value dropped by $18.967 billion
or by 36.2 percent, from $52.378 billion on December 31, 2007, to $33.411
billion on September 30, 2008.
- The DIF investment portfolio’s total return for the first
nine months of 2008 was 4.39 percent, approximately 21 basis points less
than its benchmark, the Merrill Lynch 1-10 Year U.S. Treasury Index (Index),
which had a total return of 4.61 percent during the same period. The
DIF portfolio’s large cash balances held during the first half
of the year acted as a drag on total return performance. In addition,
the DIF portfolio’s TIPS considerably underperformed the Index’s
conventional Treasury securities during the third quarter.
- During the
third quarter of 2008, to help fund resolution obligations, staff sold
a total of 22 securities on seven occasions. These securities
had a total book value of $8.872 billion, a total market value
of $9.345 billion, a weighted average maturity of 4.88 years, and a
weighted average
effective yield-at-cost of 5.93 percent. These security sales resulted
in realized gains of $473 million. On September 30, 2008, the DIF
portfolio’s
overnight investment balance was $851.2 million, which includes
the receipt of $618.6 million in assessments on September 30, 2008.
The Treasury Market
- During the third quarter of 2008, conventional Treasury market
yields decreased dramatically as the deepening economic crisis and financial
market turmoil prompted a flight to quality with burgeoning investor demand
for Treasury securities. The yield declines also reflected growing consensus
expectations for additional federal funds target rate cuts. The three-month
Treasury bill (T-Bill) and the six-month T-Bill yields decreased by 83 basis
points and 54 basis points, respectively. The two-year Treasury note, which
is also very sensitive to actual and anticipated changes in the federal
funds rate, as well as to flight-to-quality concerns, posted a yield decline
of 66 basis points during the third quarter. Intermediate- to longer-maturity
Treasury security yields also decreased over the course of the third quarter,
although not surprisingly, the yield declines were somewhat less dramatic
then those of shorter-maturity securities. The yield on the five-year Treasury
note declined by 35 basis points, while the yield on the ten-year note dropped
by 15 basis points. The conventional Treasury yield curve steepened during
the third quarter of 2008, reflecting the drop in yields on shorter-maturity
Treasuries. On September 30, 2008, the two-year to ten-year yield curve
had a 186-basis point positive spread (compared to a positive 135-basis
point spread at the beginning of the quarter). Over the past five years,
this spread has averaged 87 basis points.
- During the
third quarter of 2008, in stark contrast to conventional Treasury yields,
TIPS real yields increased sharply over the course of
the third quarter. For example, the real yield on the five-year
TIPS maturing on July 15, 2013, increased by 124 basis points.
The
real yield
on the 10-year TIPS maturing on January 15, 2017, increased by
83 basis points. Some analysts were attributing the rise in real
yields to a sharp
drop in inflation expectations given the recent collapse in oil
and other commodity prices. In fact, current TIPS real yields
indicate market expectations
are that deflation over the near term is a distinct possibility.
As of the end of the third quarter 2008, on a par value basis,
9.2 percent
of the DIF portfolio is invested in TIPS.
Prospective Strategies
- The current DIF investment strategy calls for placing all net proceeds
from deposit insurance assessments, maturing securities, coupon and other
interest payments, and receivership dividends into overnight investments
and short-term T-Bills in anticipation of possible funding needs for resolution
activities. (See attached Approved
Investment Strategy.)
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