Entity Setup

Take note of fields below when configuring an entity that will trade IOs.

• Primary Amortization/Accretion Rule (3197): accounting processes IO amortization (calculating amort yield, cost adjustments, etc.) based on the Level Yield 1 method
  • This is done regardless of the entity election
  • Amortization is discussed further in the IO Amortization section of this document
• Gain/Loss on Paydowns (1871): select Amortization
  • Paydowns on IO securities are for zero cash and do not produce any gain/loss
  • Eagle Accounting brings down the proportional amount of cost and amortization
  • This is discussed further in the About MBS Interest Only (IO) Processing section of Manage Fixed Income Processing
  • This field is required for all entities processing MBS trades
• Coupon Spreading Period (637): allows an entity to spread interest income (combination of accrued and amortization) from securities that use a day count basis 30 in the numerator over the Coupon period or a Monthly period
  • None: interest income is posted on a daily basis according to the security’s Day Count Basis (471)
    • The 31st day of the month will have no postings and February 28th will have three days of postings
  • Coupon: interest income is spread evenly across the entire coupon period
    • The same amount is posted each day of a coupon period
  • Monthly: interest income is spread evenly across each month
    • The same amount is posted each day within each month, but the daily amount can vary across months
• IO Security Amort/Income Flag (17387, V17 R2.8): determines how amortization and accretion are recognized on the General Ledger for securities with a processing security type (PST) of Interest Only Factor Based Debt Instrument (DBFBIO)
  • Select Separate Income and Amort on Ledger (INCANDAMORT) to post interest and amortization separately
  • Note: when Coupon Spreading Period is set to Coupon or Monthly, switching the method in this field will result in residual balances in Deferred Interest Income that will need to be cleared with manual ledger entries at the end of each individual DBFBIO security’s coupon period (this is a onetime adjustment after making the change)
• Tax Exempt Processing Flag (4948): determines whether income is posted to taxable or tax exempt general ledger accounts; this field works with the security-level Federal Tax Indicator (545) and impacts the Net Investment Income (NII) process when calculating the mixed expense taxable allocation percentage
  • Yes: the net distributable income is processed against tax exempt income and expenses
    • If the security-level Federal Tax Indicator is set to No, the system posts the income to tax exempt general ledger accounts
    • If the security level Federal Tax Indicator is set to Yes, the system posts income to taxable general ledger accounts
  • No: the system posts the income to taxable general ledger accounts

Reference Data

Storage & Configuration

Eagle models each IO security master file (SMF) as a single row in Data Management.

Market Data

Because IOs tend to be risky investments, we recommend using third party (vendor provided) cash flows in Eagle Accounting to generate the most accurate accruals, coupons, and amortization. Third party cash flows come from the market and are inherently intelligent with respect to current market pricing and other relevant information. Refer to Understand Third Party Cash Flows for more information.

• If using third party flows is not feasible, we recommend posting impairments over the life of the IO based on your evaluation of the investment
• The size of these impairments should be tied to the market where the IO is traded

IOs are a subset of Eagle’s MBS functionality and utilize the same prepayment assumption and factor processing. Refer to the Understand Mortgage-backed (MBS) and Asset-backed (ABS) Securities section of Manage Fixed Income Processing for more information.

• Eagle Accounting incorporates prepayment information into the yield calculation used for amortization
• Changes/updates to prepayment information affects the amortization yield, and therefore the amortization postings
• Use the Prepayment Time Series screens to add or change prepayment information
• Eagle Accounting uses a default CPR of 6% and a PSA of 100 if no time series data is added, unless Prepayment Assumption (4518) = None has been specified in the amortization rule of the entity trading IO securities

Principal Loss Factors

We recommend not adding Principal Loss Factors for IOs. While Eagle Accounting supports doing so, there is no principal returned to the investor for an IO, thus the functionality should not be invoked.

Zero Coupon

While most IOs are traded at a non-zero fixed or variable rate, a rate of zero can occur in the market. In these cases, 0.0001% (entered as 0.0001 in Eagle Accounting) should be used as both the Coupon (70) on the SMF and Current WAC (1227) in the Prepayment Time Series data. The former prevents a yield calculation error and the latter prevents a missing WAC error.

Security Data

IOs can be set up and maintained using Issue Viewer, Security Reference Manager (SRM), or Reference Data Center (RDC). The list below contains all fields required to configure an IO SMF.

• Issue Name (961)
• Primary Asset ID (14) & Primary Asset ID Type (1432)
• Processing Security Type (3931) = DBFBIO (Interest Only Factor Based Debt Instrument)
  
  • This defaults Issue Price (69) and Maturity Price (42) to zero
• Issue Country (1418)
• Asset Currency (85)
• Issue Tax Type (668)
• Primary Exchange (17)
• Coupon (70): if the fixed rate is zero, use 0.0001 instead 
• Coupon Type (97): typically F (Fixed Rate), but all other types are supported
• Day Count Basis (471)
• Payment Frequency (472)
• Delay Days (1799)
• Issue Date (68)
• Dated Date (1183)
• First Coupon Date (473)
• Last Coupon Date (474)
• Maturity Date (38)
• Trading Flat (3949): typically No

Trade Processing

Open (transaction type = BUY or SHORTSELL)

Trades are entered using the Book Trade module once entity and reference data have been configured. Enter the appropriate entity, security identifier, and trade (35)/settle (37) dates and click Submit to query for the security. Right-click it and select Open > Buy or ShortSell. The list below contains all fields required to book an IO trade.

• Original Face (41): original par value of the trade (not including any paydowns)
• Current Factor (91): looked up automatically based on the most recent Final Factor corporate action announcement
• Current Face (40): calculated automatically as Original Face * Current Factor
• Price (45): clean unit price
• Principal (165): cost associated with the trade (calculated automatically as Current Face * Price * Price Multiplier * Quantity Scale
  • Price Multiplier (18) and Quantity Scale (19) are typically 0.01 and 1.00 respectively
• Traded Interest (49): the accrued interest bought (or sold) on the trade
  • Can be automatically calculated based on Current Face and the security's accrual terms
  • To enter this data from a trading system, choose an option without Traded Interest under Select Values to be calculated by STAR (7000)
• Local (50)/Settlement Net Amount (64): the amount of cash that will be moved in local currency terms
• Base Net Amount (478): the amount of cash that will be moved in base currency terms
  • This is calculated using the Local to Base FX Rate (87) that is automatically pulled into the panel
• Broker (88)

Close (transaction type = SELL or BUYCVR)

The Book Trade module should also be used to process both full and partial closes. Enter the same identifiers as the open to query for the security. Right-click it and select Close > Sell or BuytoCover depending on whether the existing position is long or short. All fields on the close are the same as the open, except Lot Selection Method (27). This defaults to the entity-level value, but can be overridden.

• Gain or loss is realized based on the difference between close price and open price

Accounting

Once an IO trade is booked, it will be picked up in Eagle’s global workflow. Daily accruals and periodic coupon payments are generated as part of the earnings process, Eagle Accounting valuation is calculated when posting unrealized gain/loss, and Data Management valuation is calculated in STAR to PACE. These can be scheduled or triggered manually.

• V17 & Above: Accounting Center > Processing and Exceptions > Global Processes

  • Accruals: Earnings > Run Income Accruals

  • Accounting Valuation: Unrealized Gain Loss Entries > Post Daily Fund Unrealized Gain Loss-Position

  • Data Management Valuation: Eagle STAR to Eagle PACE Direct Processing > Transfer Data - Batch

• Prior to V17: Global Process Center

  • Accruals: Earnings > Accrue

  • Accounting Valuation: Unrealized Gain Loss Entries > Post Daily Fund Unrealized Gain Loss-Position

  • Data Management Valuation: STAR to PACE Direct Processing > Transfer Data - Batch

IO Amortization

As mentioned above, Eagle Accounting amortizes IO securities based on Level Yield 1. This method considers the income produced on a debt security (excluding traded interest) to calculate a rate that, when used to compute the present value of all future payments, produces an amount equal to the security’s cost. This rate is the Level Yield and is based on a security’s purchase price, redemption value, time to redemption, coupon yield, and time between interest payments. The Level Yield remains constant through maturity date (unless there are material changes to reference data or amortization rules). Eagle Accounting calculates where the amortization should be, life-to-date, based on the Level Yield and day count of the security. Refer to the Manage Amortization and Yield Calculations section of Manage Fixed Income Processing for more information on amortization in Eagle.

In addition to using the Level Yield 1 method, IO securities have a unique approach to posting amortization compared to other securities in Eagle Accounting. Both accrued interest and amortization are posted as a single, netted stream to Interest Income. Amortization is applied using Cost Adjustments (as Referenced in the About MBS Interest Only (IO) Processing section of Manage Fixed Income Processing), which results in no postings to an amortization account.

These are the daily accrual/amortization postings for a standard bond:

For an IO security, amortization is subtracted from Investment Interest Income, so there is nothing posted to Amortization of Premium. Daily accrual/amortization postings for an IO security are below:

Coupon Spreading

Since most IO securities use the 30/360 day count basis, funds often elect to spread earnings so that an equal amount is posted each day. The unique approach to IO amortization also affects how deferred is posted when coupon spreading is used. While a normal bond simply spreads the interest receivable, IOs spread both interest receivable and amortization since they get lumped together into Interest Income. As a result, deferred interest will come out of interest income.

Valuation

IOs are valued using real clean prices, entered via Add Issue Price or Pricing Center.

• Market Value = Original Face * Current Factor * Price * Price Multiplier * Quantity Scale

Reporting

STAR to PACE (S2P)

Almost all reports in Eagle leverage data from Data Management, which is populated by the S2P process. This will be scheduled as part of the daily workflow, but can also be triggered manually as described in the Accounting section.

The S2P process creates a single row for each IO in the POSITION, POSITION_DETAIL, TRADE, and CASH_ACTIVITY tables. The MARKET_VALUE_INCOME column captures the total market value, inclusive of price fluctuations and period-to-date accruals payable or receivable.

Accounting Reports

Eagle has a core set of accounting reports that can be used to review IO information. These are designed to support the daily operational workflow for business users, allowing Grid Reports to be easily exported to Excel and customized to provide additional details as needed. Advanced Reports are intended to be client-facing and do not provide the same level of customization.

Data Management Reporting

General Reporting (Eagle OLAP)

OLAP reports provide the maximum level of customization, allowing any column in Data Management to be pulled into a report. These go beyond the Eagle Accounting Grid Reports because they are not limited by core queries, can support multiple sources and various types of calculations, and provide drill-down functionality based on user-defined groupings.

Performance

The performance toolkit has full functionality to calculate market value-based performance for IOs using data supplied by the S2P process. Risk and performance attribution features are available to analyze IO performance.

Automation

IO security master files (SMFs) and trades can be loaded through the standard Message Center streams. The SMF must be loaded prior to the trade (trades do not spawn SMFs). Refer to the Supported Generic Interfaces guide for more information.