CMS Case Study

rates. The market sensitivity of each security should be analyzed prior to its purchase and be monitored subsequent to purchase as part of the Bank’s risk management process. The level of analysis required of each security depends upon its complexity. Relatively simple or standardized securities will require little or no pre-purchase analysis as long as they conform to parameters outlined in Sections 8 and 9 and fit current investment strategy as determined by the Bank’s Asset/Liability Committee and Asset/Liability Committee. Securities considered “simple” for this purpose reflect those standardized instruments whose risks are well known to the Bank and include, for example: non-callable, fixed-rate securities; standard mortgage pass-through securities; and non-callable, floating-rate securities whose interest rate is not leveraged (i.e. the rate is not based upon a multiple of the index) and not subject to undue cap risk at the time of purchase. Ongoing analysis of simple securities will be reflected in the Bank’s interest rate risk modeling procedures as carried out under the Asset/Liability and Funds Management Policy (securities carried as Available for Sale will also be analyzed as outlined in Section 3 of this policy). Relatively more “complex” securities will require more extensive and specific pre-purchase and ongoing analyses. Securities considered “complex” for these purposes include the general classifications of collateralized mortgage obligations/mortgage derivative securities (CMO’s) and structured notes. Accordingly, the Bank recognizes that the nature of these securities’ characteristics creates a broader array of risks which must be appropriately analyzed prior to purchase and periodically thereafter. Refer to Appendix C for a summary of these risks. Collateralized Mortgage Obligations: Collateralized mortgage obligations (CMO’s) are bonds collateralized by mortgage-backed securities (MBS). While investments in MBS (single class securities) result in the investor receiving his pro-rata share of all principal and interest payments, CMO’s (multiple class or tranche securities) pass through cashflows depending on the structure of the particular CMO issue. CMO’s can be acquired with fixed or floating interest rate streams and the principal cashflow characteristics can vary widely. Since all CMO issues are different, it is important that the characteristics of a specific instrument/class be fully understood prior to purchase. Structured Notes: Structured notes are generally medium-term agency or corporate instruments with one or more features which differentiate them from the typical medium-term notes traditionally purchased by financial institutions. These securities contain features such as caps, floors, calls, interest rate "step-ups", floating rates derived (directly and inversely) from various market indices and related multiples/fractions thereof, and principal payments/maturities linked to financial variables including interest rate levels and prepayment speeds. While purchase of the more exotic structured notes such as those tied to foreign currencies, commodities or equity markets is expressly forbidden, it may be appropriate at times to consider particular highly sensitive securities which contain specific characteristics which support the Bank’s balance sheet management activities (e.g. interest rate risk management).

Analysis and Documentation: Municipal Bond Analysis:

Appropriate credit evaluation must be performed prior to purchasing municipal bonds with particular focus on non-rated or low rated securities. Municipal bonds shall be reviewed at least annually to determine if there has been any sign of credit deterioration or weakening in the financial condition of an issuer. This includes documenting any monetary or technical default of an issue, adverse financial trends or any public information that would cause concern regarding an issuer’s ability to perform on our debt or any other of its obligations. Credit files (hard copy or electronic version) will be maintained for all municipal bonds and relevant financial information including official statements, offering circulars, prospectuses and financial statements. On an annual basis efforts should be made to obtain the most recent financial statements of the issuer.

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Board Approval 8/19/21