Quarterly Investment Strategy

AnyBank, USA

Quarterly Investment Strategy

1st Quarter 2010

Quarterly Investment Strategy

1st Quarter 2010

(Sample)

Table of Contents

I. Overview of Environment

A. National Economic Profile...... 3

Economic Statistics Table...... 4

B. Fed Watch...... 5

C. Current Interest Rates...... 5

D. Quarterly Treasury Note & Bond Performance...... 6

E. Economic Outlook...... 6

F. Local Economic Profile...... 6

G. Asset/Liability Position, Balance Sheet Structure, Liquidity...... 7

II. Investment Portfolio

A. Current Position...... 7

B. General Strategy...... 7

C. Strategies According To Specific Sector...... 8

1. Treasuries...... 8

2. Fixed Rate Agencies...... 8

3. Municipals...... 9

4. Fixed-Rate MBS...... 9

5. Fixed-Rate CMOs...... 9

6. Floating Rate Securities...... 9

Quarterly Investment Strategy

1st Quarter 2010

(Sample)

______

I. OVERVIEW OF ENVIRONMENT

A. National Economic Profile:

The end of 2009 saw improvements in many sectors of the economy due in part to massive government stimulus, though some of these advances are still at suboptimal levels. The looming concern as we embark into 2010 will be how the markets and even the economy as a whole will bear with withdrawal of government support programs and MBS purchases set to wind down over the next quarter. Following four consecutive quarterly declines in GDP starting in September 2008, the U.S. economy finally showed a 2.2% growth rate in Q3 this year as personal spending, exports, private investments, federal spending, and residential investments were on the rise. November’s jobs report indicated a vast one-month improvement in the labor market. A revised report showed November as the first month for employment gains in nearly two years, although it was overshadowed by December’s report revealing asizable loss of 85,000 jobs. In just over two years, the U.S. has lost over 7.2 million jobs since the recession began, highlighting just one element of what the Fed labels as “substantial resource slack” in the economy. The widely watched initial jobless claims for the penultimate week in 2009 fell to the lowest level of first time claims since late July 2008.

The manufacturing sector has regained some steam as factories produced more goods in the latter half of the year helped in part by global demand (thanks to a weak dollar) and rebuilding of depleted inventories. Recent capacity utilization rose to the highest level in nearly a year, helping grow the manufacturing sector as a whole at the quickest pace in more than three years.

Since the recession began at the end of 2007, U.S. consumers have altered their spending habits and prioritized them basis on necessity. Over the last quarter though, consumers have been lured and enticed to spend as deep discounts and stagnant inventory liquidation has spurred spending. Retails sales rose 1.1% and 1.3% in both October and November respectively, along with initial indications of the holiday sales (mainly in December) beating market estimates. For most of 2009, durable goods orders have see-sawed negative to positive to negative as businesses still remain ambivalent about purchases of long-lasting goods. For those individuals that have remained gainfully employed, personal incomes have been on the rise for seven of the last eight months. Personal spending on the other hand has increased lately, possibly due to a combination of higher disposable incomes and fourth quarter spending during the holiday season.

The housing market has rebounded from massive price declines and lackluster sales having likely bottomed out in the first half of 2009. Helped by federal stimulus credits, existing home sales have surged back to levels last seen in early 2007 level. New home sales on the other hand have trended lower of late with a glut inventory remaining and a last minute extension of the federal tax breaks curbing potential sales beforehand. Housing starts have definitely rebounded from record lows set in April, but will likely face some headwinds as tax credits will soon expire and borrowing cost drift up from historic lows. Thewell-recognized S&P/Case-Shiller home price index of the top 20 U.S. metropolitan cities showed a bottoming in April of this year, with prices up over 5% since then. On a year-over-year basis, the rate of decline has substantially contracted from its peak decline rate of -19.0% to the latest rate of -7.3%.

The latest cost of living index in the U.S. showed a 1.8% rise in November on a year-over-year basis. For a majority of 2009, the cost of living fell as price pressures waned with the weak economy and increasing joblessness. Excluding the volatile food and energy items, core consumer prices touched a five and a half year low in August of this year and is well below the 2.1% average since the end of the 2001 recession.
Economic Statistics

* Year-Over-Year % Change

B. Fed Watch

Recent & Upcoming FOMC Meetings

C. Current Interest Rates:

Towards the closing of 2009, as the Fed and Treasury’s simulative programs, initiatives, & security purchases begin to expire or wind down in the coming months, long-term Treasuries began to price in higher inflation expectations. The spread between the 2Yr Treasury Note and the 30Yr Long Bond widened out to historic highs(374bps) on December 10, 2009, as the steepening yield curve suggests more risk associated with longer-term securities. Since Q3’s end, the yield on the 2Yr Note rose just 19bps to 1.14%, whereas the 30Yr Bond’s yield rose nearly 60bps to 4.64%. The Treasury’s benchmark 10Yr Note jump 53bps from Q3 to close the year at 3.84%, marking the highest yield since early August.

D. Quarterly Treasury Note & Bond Comparison

Note: Total Return is calculated using the current On-The-Run Treasury as of the beginning of the quarter and a reinvestment rate equal to the yield of the 3-Month T-Bill at the beginning of the quarter

E. Economic Outlook (Bloomberg Economic Survey):

The table above is taken from a survey of economists conducted monthly by Bloomberg Financial Markets. The forecasts shown are from a third party and do not reflect the ideas of The Baker Group.

F. Federal Reserve District ProfileSummary – December 2009:

For additional District profiles, please visit the Fed’s web site:

Reports from the twelve Federal Reserve Districts indicate that economic conditions have generally improved modestly since the last report. Eight Districts indicated some pickup in activity or improvement in conditions, while the remaining four--Philadelphia, Cleveland, Richmond, and Atlanta--reported that conditions were little changed and/or mixed.

Consumer spending was reported to have picked up moderately since the last report, for both general merchandise and vehicles; a number of Districts noted relatively robust sales of used autos. Most Districts indicated that non-auto retailers were holding lean inventories going into the holiday season. Tourism activity varied across Districts. Manufacturing conditions were said to be, on balance, steady to moderately improving across most of the country, while conditions in the nonfinancial service sector generally strengthened somewhat, though with some variation across Districts and across industries. Residential real estate conditions were somewhat improved from very low levels, on balance, led by the lower end of the market. Most Districts reported some pickup in home sales, though prices were generally said to be flat or declining modestly; residential construction was characterized as weak, but some Districts did note some pickup in activity. Commercial real estate markets and construction activity were depicted as very weak and, in many cases, deteriorating.

Financial institutions generally reported steady to weaker loan demand, continued tight credit standards, and steady or deteriorating loan quality. In the agricultural sector, the fall harvest was delayed in the eastern half of the nation due to excessively wet conditions during October and early November. Most energy-producing Districts noted a slight uptick in activity in the sector since the last report. Labor market conditions remained weak since the last report, though there were signs of stabilization and scattered signs of improvement. While some Districts reported upward pressure on commodity prices, they saw little or no indication of upward wage pressures or of any significant increase in prices of finished goods.

G. Asset/Liability Position, Balance Sheet Structure, and Liquidity:

The Loan/Deposit ratio is:

The current Fed Funds position is:

Liability accounts in greatest demand are:

The Overall Bank liquidity position is:

The Bank's Effective GAP ratio (RSA/RSL) in the 1-year time frame is approximately _____%, (compared to our policy limits of 70% to 120%.)

The projected change in net interest income over the next 12 months is:

Rate Environment:Net Interest Change:

+200 BP

Unchanged

-200 BP

II. INVESTMENT PORTFOLIO

A.Current Position: (See Attached Portfolio Analysis):

The Bank portfolio yield is currently %. The Bank’s 4thQuarter strategy to slightly extend the portfolio duration has pushed the Banks Effective Duration to . The portfolio shows a current loss of $______or ______% of book value.

B.Market Comments:

What a difference a year makes. This time a year ago we were trying to get our minds around a new world of quantitative ease, deflation, and deleveraging. Treasury yields were lower across the curve, and the slope of that curve was far less steep than it is today. Indeed, at the beginning of 2009 uncertainty was still pervasive in the financial markets and many were fearful that the worst was yet to come for the economy. Fortunately, due to massive Government stimulus, the economy stopped contracting, the banking system began to heal, and financial markets started to normalize. Now we confront a new phase in the economic cycle as well as likely shifts in Fed policy during 2010. The US economy appears poised to continue the recovery that began in the third quarter of 2009, though at a below-normal pace. Serious obstacles to a meaningful recovery include a persistent drag on growth from high levels of consumer debt and ongoing stress in the labor market. Key economic indicators are improving to be sure, but from extremely depressed levels. The “new normal” thesis remains intact in the New Year. Generally low levels of growth, inflation, and interest rates should continue through much of 2010, though ranges should shift upward as the year progresses. The Federal Reserve is widely expected to begin a gradual exit from its year-long policy of aggressive stimulus. The FOMC policy statements continue to include the “extended period” language with reference to the near-zero fed funds rate, but it is believed that wording could be altered or abandoned by the second half of 2010. The committee has identified resource utilization (i.e. unemployment)inflation trends, and inflation expectations as criteria to watch for indications that the time has come to shift policy. We must keep in mind, however, that we are still in a post-credit bubble collapse unlike any other recession since the Great Depression of the 30’s and the range of outcomes in the financial markets and economy are extremely wide at the current time.

General Strategy

Spread products set historic performances over the course of 2009. For the year, while 5Yr Treasury rates rose over 100bp, MBS, Agency and Municipal yields were virtually unchanged. At year-end, the portfolio shows a 2% gain overall, compared to just over 1% at the end of 2008. With greater balance sheet emphasis on the portfolio (now up to 42.5% of Assets) and historically low reinvestment rates throughout the year, the portfolio yield fell 57 basis points to 4.44%, while the effective duration remained between 2.2 and 2.4, right at the Bank’s “just above neutral” target. Given the Treasury’s recent solidification of support for FNMA and FHLMC, the Bank will continue to emphasize core Government agency securities throughout 2010, while continuing to avoid the temptation of high yielding, illiquid assets like certain corporate bonds or private-issue MBS. With the yield curve reaching historically steep proportions (10Yr T-note now 270 basis points above the 2Yr T-Note) and the uncertainty of the economic recovery, the Bank will maintain defensive strategies and use any strength in the market to begin to reduce overall portfolio duration. As the market has begun to normalize and volatility has declined, the Bank has started to take advantage of opportunities to replenish the callable agency sector by reinvesting MBS cash flows in premium 1-time callable instruments. The bank will look to maintain the current mix by also purchasing defensive agency MBS and CMO’s as well as high quality Municipal bonds in the 5-15 year range to take advantage of continued wide spreads. With cash still earning virtually zero, the Bank will continue to make efficient deployment of all idle funds and evaluate all options for enhancing income through the portfolio in a defensive manner.

C.Strategies According To Specific Portfolio Sector:

1. Treasuries:

The Bank anticipates no Treasury holdings at this time.

1. Fixed-Rate Agencies:

The Agency sector significantly outperformed the Treasury market during 2009, with 5-year bullet agency spreads tightening 70 basis points, to just above 30 basis points currently. As the market has normalized and volatility has declined, the Bank has started to take advantage of opportunities to replenish the callable agency sector. Given the uncertainty of the economic and interest rate environment, the Bank does not believe it is the right time to chase yield and take on longer negatively convexed callable agency products. Sector duration will be moderated by buying securities with 3 to 7-year maturities, while favoring premium one-time callable securities with at least one year of call protection. Issuances of step-ups are increasing with a varying range of structures - avoid the callability of multi-steps and favor the one-time steps. The Bank will continue to look for opportunities to sell short instruments and deploy the proceeds on the intermediate portion of the curve.

3. Municipals:

The municipal sector followed a very robust 3rd quarter with a difficult 4th quarter. 10-year tax free Municipal issues widened 35 basis points to currently offer over 150 basis point advantage over Treasuries even though tax-free supply remains muted as large amounts of longer (i.e. >10yrs) taxable Build America Bonds (BABs) continue to be issued as a result of the Obama administrations American Recovery and Reform Act. This reduced shorter maturity supply has kept the Municipal curve quite steep. Given the potential for higher tax rates in 2010, as the Bush tax-cuts are set to expire, along with fiscal stimulus increasing the supply of “bank qualified” issues and Build America Bonds, the Bank will continue to add quality bonds with good underlying ratings/financials in the 10 to 15 year range for tax-free issues as well as adding BABs with 5-10 year maturities. The Bank will purchase BABs with shorter maturities because they do not have the reduced duration benefit as the tax-free issues. The Bank will carefully review the creditworthiness of all underlying municipal issues in addition to assessing the strength of the bond insurer. Preferred insurers of municipal holdings will be the Texas PSF, Berkshire Hathaway, FSA and Assured Guarantee. Given prudent credit analysis, the environment continues to offer excellent opportunities to add to the Municipal sector. Under the current steep Municipal yield curve environment, the Bank will continue to maximize municipal holdings and explore opportunities to swap out of shorter maturities and deploy the proceeds out on the preferred range of the curve.

4. Fixed-Rate MBS:

The agency MBS market had historic performance in 2009, tightening over 100 basis points versus Treasuries, with the Federal Reserve purchasing over $1tn throughout the year. With the purchase program set to expire at the end of 1Q 2010, the Fed has more than $200bn of MBS purchases still to be completed. The Fed/Treasury purchase program had an outsized effect on the agency MBS market in 2009, and the question now is how the market will fill the void when the purchases stop after March. In the absence of a Fed backstop, many analysts believe MBS spreads should widen 20-40 basis points when the Fed purchases stop, but then should be met by strong demand. A host of factors – muted loan demand, low appetite for credit risk, a steep yield curve, large cash holdings, and a shortage of other spread products – point to increased MBS demands from banks. Additionally, given the weak economy, particularly the housing market, MBS supply should stay muted at $350-400bn for the year. In 2009, there was an epic slowdown in prepayments. Adjusted for historically low levels of mortgage rates, prepayment speeds came in far below historic norms, as extremely tight underwriting standards, declining home prices, and increasing refinancing costs more than offset refinancing incentives. As we enter 2010, it is expected that voluntary prepayments will remain very benign given these significant hurdles to refinancing and a continued weak housing market. Alternatively, involuntary prepayments could rise in 2010, as buyouts mount from rising delinquencies and modifications. To manage the balance of prepayment versus extension risks, the Bank will continue to focus on specified agency MBS pools with one or more of the following loan characteristics: 1) seasoned underlying mortgages (e.g. 2005 and earlier origination), 2) higher coupon pools (5.5%+) with particular loan attributes that should provide prepay protection (e.g. low loan balance, investor properties, low FICO, specific geographic concentrations, etc.), and 3) short weighted average maturities (e.g. WAM <100 months).