June 2025 Liquidity & Funding Strategies for the Current Environment

Well, good morning, everyone. Thank you for joining us today for our webinar. I am Andrew.

This is Tyler. Happy to have you with us here as we go through our agenda. So if you haven’t joined us for these webinars we have two series that we tend to use one a little more structured with the peer analytics and balance sheet strategies. This one is a little more open-ended We put them on the calendar, and we don’t know exactly what we’re going to talk about until about a month out or so, and that’s a function of what’s happening in the market and in our industry.

So the plan for today is we’ll kick things off with a little 30,000-foot overview of the yield curve and some economic data that is relevant for all of us.

Tyler is going to talk about some things on the collateral and how to optimize liquidity and make sure that, on an off-balance sheet, we’re doing everything we need to be doing to really be maximized and efficient as we can.

I’ll talk a little bit about some more targeted asset and liability strategies and not just for what is staring us in the face right now in terms of what we can do, but in terms of preparing and having discussion for if and when we see some sharper moving rates or some pickups in volatility, just to have that plan before stuff starts happening.

And then lastly, Tyler will come back to answer the existential question of whether to go fixed rate or floating rate within the context of borrowings and the broader balance sheet.

So let’s kick things off from a macro perspective.

So here’s a look at the yield curve.

And I cherry-picked and I pulled the yield curve from the middle of January, as well as more recently.

And the reason we picked January 15th is because that was the point in time when we actually had a positively sloped normal yield curve.

You were with us for the February webinar.

You know, we were beaming with excitement, and for all of you, because we actually had some positive slopes into the yield curve, but unfortunately, it appeared to be short-lived.

From January through April and May, it’s not visualized here, but we saw a pretty aggressive rally in the yield curve that brought down intermediate-term rates.

And as we know, the front end doesn’t move until it does move.

So those changing expectations for where short-term rates are going to be are most expressed in that intermediate part of the yield curve.

So you can see here we have the change in rates from January to June.

If we were to show January to April or May, those moves in the 3-, 5-, and 7-year part of the curve, we’re closer to 90, almost 100 basis points of a drop.

And now, since that time, the intermediate part of the yield curve has come up, and what’s driving that?

And that’s a couple of things there.

One is the fact that higher for longer just won’t go away.

Every time we think that it’s going to be a relic of the last couple of years, it starts to rear its head again, and part of that is economic data that the Fed is keying on.

We’ll get to that in just a moment.

But the other part at play here is treasury supply.

So as you go further out of the yield curve, the expectations for where short-term rates are going to have less and less impact on the level of interest rates.

Makes sense intuitively.

The six-month rate is going to be reflective of what the Fed and Chairman Powell are going to do.

The 10-year, the 30-year, not so much.

That’s more about inflationary pressures, supply and demand, and general macroeconomic type drivers.

And the prospect of increased treasury supply at the long end of the yield curve has been a consistent pressure point pushing rates up.

And so that’s why you can see the change in the shape of the yield curve there, where the impact has been on the intermediate range, where we’ve seen rates come down there as well.

We’ll get into the balance sheet implications in a second.

But if you joined us in February and May, you know that we had a lot of positive momentum and enthusiasm in terms of what was happening to net interest margins for depository institutions.

And in summary, it was funding costs that were starting to plateau, and asset prices, excuse me, asset yields were starting to roll over and reinvest and reprice.

So when we look at the shape of the yield curve today, the drop in the yield curve, the inversion, well, that’s going to put some pressure, right?

And the improvements in the funding costs are really on the margins.

We have the good fortune of having a lot of conversations with a lot of banking credit union executives across New England.

And despite rates nominally at the front-end being lower today than they were a year ago.

I haven’t really heard anybody say it’s gotten less competitive.

And, you know, in fact, just yesterday, I had a call with a banker who said, everybody who walks in the door still wants four and a half percent.

So we’re still fighting those fights in terms of rates.

But at least in the belly of the curve, less so today than a month or two ago, those legacy fixed-rate assets, the market values are looking a little bit better.

But in terms of the income statement and the margin on the margin, the incremental margin, that’s a little more challenged today with this U-shape instead of the slightly positively sloped yield curve.

So let’s consider some economic data.

So we pulled 75 years’ worth of inflation and unemployment data because it’s interesting to see the different environments that we have been in.

When you consider where we are today and what has happened the last two times, rates went down.

The good and bad things about our role are that we get to talk publicly a lot, and the transcripts go up on the website.

So when we’re right, we get to pat ourselves on the back, and when we’re wrong, we get to look around and pretend that it didn’t happen. No, we don’t do that.

But inflation, just because, and I’m like a broken record with this, the way that we look at inflation with interest rate, excuse me, the year-over-year changes, doesn’t tell the whole story.

I think the impact of inflation, and we can, when we think about consumer goods, we think about services, we think about real estate, plenty of examples in our day-to-day lives tell us that inflation is far from dead. But it’s clean to look at the year-over-year data.

So, a couple of things that jump out here as things to look out for on the horizon for what may happen.

When interest rates go down, the last two short-term rates went down, it was pretty aggressive, and things went down to 0%.

And that was because of the great financial crisis and the COVID situation.

It doesn’t always have to be that case.

And I think that higher for longer has proven that.

So, one of the things that concerns me, or is a possibility that is starting to pick up a little steam, you’re starting to see that in the conversation in the public arena, is that stagflation word, right?

Not a fun word, not a fun environment, because when you think about managing a depository balance sheet, high unemployment rate, and high inflation, one is going to challenge the asset side, right?

Because if you think the Fed is cutting short-term rates, well, then any floating rate assets are going to feel the brunt of that.

And then any legacy fixed-rate assets, of which we have a lot because of where rates have been over the last three to five years, those are going to be pressured because of the impact of inflation, as we saw in the last couple of years as rates getting pushed higher up over there. So we saw bouts of stagflation in the 70s.

That’s the light blue dots over there. And even into the 80s, we could see that in green, excuse me, gray.

But the 21st century has been characterized by, when inflation was high, like in 23 and 24, unemployment was pretty low and stable, right?

We never saw the combination of those two not-so-great things happening at the same time.

And, you know, we won’t belabor the point and get into detail there.

The crystal ball is still a little foggy.

But, again, I would just reiterate that point.

It can be more rhyming than repeating in terms of what is going to happen.

So if we’re banking on rates going to zero, we get some strength in the long end until we really see that progress with the inflationary pressures.

We are in this period of great uncertainty, where things can go in any number of directions.

Thank you, Andrew.

Now I’d like to do a little overview of collateral fledgling.

As many of you know, we cannot hard advance without a fledgling equivalent collateral.

So, as I just said, all advances do need to be secured by an equivalent amount of collateral at the Federal Home Loan Bank, and some members post collateral with us.

I’ll cover that process a couple of slides down, and then based on that collateral, the collateral team applies a haircut, it is based on a number of factors, including what type of collateral it is and some factors within that.

And then based on that resulting post-haircut value of the collateral, that is your amount that you’re able to borrow from the federal home loan bank prior to the application of the credit category limits.

And so for category one, that’s 40% of assets. Category two, that’s 30%. Category three, that’s 15%.

And five for category four. And there’s also tenor restrictions as well.

And that calls to the idea that just because you have capacity doesn’t mean you actually borrow against it.

What I mean by that is you may be saying to your regulator, to your board, well, we have 30% capacity at the Federal Home Loan Bank, but you actually have to have collateral equivalent to that, post-haircut, to be able to take advantage of that.

So something to keep in mind as you think about collateral liquidity is, you know, are we actually pledged enough to take full advantage of our capacity with the Federal Home Loan Bank?

And then at the bottom of the slide, I’d like to look at a strategy that a lot of our members use.

It’s really an efficient way to maximize the borrowing capacity and liquidity that you get from your collateral.

And what that involves is pledging everything that’s housing-related, because the collateral that we accept is housing-related collateral, with us, the Federal Home Loan Bank of Austin, and then taking everything else and pledging that with the Fed.

So, for example, maybe you pledge your CRE with us and your CNI with the Fed, if you’re a bank, or maybe a credit union.

Pleasure one to four family residential with us, and then you bring your auto loans over to the Fed.

It’s a great way to maximize collateral and really efficiently take advantage of it.

So what kind of collateral do we accept?

We take residential loans, so that’s one to four family HELOCs in seconds or second lien mortgages.

We also take multifamily and CRE, commercial real estate, government, and agency mortgage securities as well. And cash, cash is king.

There is no haircut on cash, 100% value there. In the government and agency debt, we take it as well.

And then certain securities and private level label, MBS, mortgage-backed securities, as well.

If you have any questions about whether a specific type of collateral is eligible, please give your relationship manager on the collateral team a call. We’d be happy to work with you to walk through that.

But one topic that’s kind of relevant right now is the bank term funding program that the Fed had offered.

And so that became active in March of 2023, and what that was a program to support banks during this really difficult rate inversion, and it allowed them to post the collateral with the Fed at par as long as it was high-quality collateral, which is a great advantage. There’s no haircut.

And so why not take advantage of that? But that program has come to an end.

So, on March 11 of 2024, it closed to new loans.

And the loans that were available through that program were of a one-year term.

And so, one year from March 11. Well, that’s March 11 of 2025, a couple of months ago.

And so I bring this up because some of you may still have collateral pledged with the Fed.

And there’s nothing wrong with that.

But if you did pledge that collateral to take advantage of the BTFP, it might be worth considering moving that back at this point, just because that advantage, as far as the at par or the lack of haircut, is no longer in play.

So just something to keep in mind, if you have some pre-sending over there that you brought over for BTFP, maybe we can move that back.

Just one point, Tyler, I’ll add in and tie together a couple of things that we’ve mentioned here.

With the Fed taking a wider variety of collateral, the discount window borrowings, and the BTFP, it was focused on high-quality securities.

So, as we all know, high-quality securities can be advantageous to on-balance sheet liquidity ratios.

So whether you’re someone who has a very small or a very large reliance on wholesale funding, that’s going to impact your on-balance sheet liquidity and off-balance sheet capacity a little bit differently.

But just in terms of like we keep saying these two magic words, optimization and efficiency.

So you look down your liquidity waterfall and say, well, if my home equity loans are not providing any benefit for me from a liquidity perspective, if they’re on the balance sheet, well, then sure, I should absolutely pledge that.

So, if you have an instance where you can move the collateral in a way that the less liquid stuff can be liquefied with us or with the Federal Reserve, and if you can get to the point where you’re being as efficient as you can on your loans, then you can sell for X and say, you know what, we feel pretty good about how much total capacity we have at these two sources with just our loan portfolio.

We have this bond portfolio over here.

Do we need to top off our capacity with the Home Loan Bank or the Fed?

Maybe, maybe not.

And if we don’t, then we can leave them on balance sheet as many institutions do.

Historically, depositories haven’t pledged, it’s been a minority of institutions, probably 20% who have pledged bonds to us.

Now that has changed as the quarterly conditions have changed, but it’s still not the vast majority who have. So, you know, take a look and it’s easy.

The process is easier for securities than loans, but if you can get through the process of pledging the loans, then it gives you that much more malleability to leave the securities on or off-balance sheet.

Thank you for adding that in, Andrew, and that’s a great segue to how do you pledge more collateral?

So, say you’re in that situation, you’re thinking, that all sounds great, and I’d like to take the next step, what do I do, and how do I pledge it?

So it does depend on your credit category.

So, for a Category 1 member, you just submit a new qualified collateral report, or QCR.

If you’re wondering what that is or how to do it, please reach out to me, your relationship manager, or the collateral team.

We’d be happy to walk you through the whole process.

Your category two is using the QCR, but you also need to update your balances at that time to receive the credit for the additional collateral.

And then for category three, and for that additional stuff, you do need to deliver the collateral to us physically to receive credit for that additional collateral.

And so now that you have all that collateral pledged, take advantage of it.

You know, we’re going to walk through some great strategies today of advances and how to benefit your balance sheet with them, but even if you don’t have a current borrowing need related to advances, it’s great to demonstrate to regulators that this collateral and then the liquidity capacity that you have with us, it’s not just a number on paper, it’s real active liquidity that you can access very quickly.

It’s one of the fastest sources of funding, so please reach out to your relationship manager at the funding desk and set up a test bar, walk through the process, which is very painless, and you can go to your regulators and prove that that’s a real source of funding immediately.

Thank you, Tyler, and that’s a great point about the regulatory process.

We hear it from many of you folks directly about what regulators are emphasizing in the examination process, and even one of the things that we do to a great extent here is regulatory outreach.

We have regular communication with all the prudential banking and credit union regulators.

And in fact, I was visiting with a regional group, was it last month? It all blends together.

It was a couple of weeks ago.

But we asked them what questions and topics they would like to discuss. And it was liquidity, liquidity, liquidity.

And it wasn’t necessarily folks who were leaning on us because the business model called upon them to leave on us.

It was the folks who hadn’t optimized the collateral, right?

They hadn’t borrowed in a while.

They hadn’t tested the process.

And are they able to do that?

They may have collateral that’s eligible, that’s not pledged, and that’s a point that the regulators could poke at.

So, you know, we all have a million and one things on the task list and all the sticky notes about things that we want to get to here.

But I think this qualifies more as a low-hanging fruit as opposed to an arduous task.

So you go through the process, you’ve documented it every step along the way, and you show that you know how the pipes work.

And then again, you can count yourself in the back and say, that’s one less thing that the regulators could potentially poke at.

So let’s talk about a couple of things that we can be thinking about on both sides of the balance sheet.

So, you know, as I mentioned at the onset, this is a situation where we don’t know exactly what we’re going to talk about until we get to a month out, and we want to really be timely and relevant to what we’re going on.

So, when we stare at the ceiling and say, you know, what should we talk about right now, and what is top of mind?

It’s this opportunity to reprice the asset side of the balance sheet because of the, I get teased around here as being the glass half full guy.

So the path of rates to me, when I see what the intermediate range of the curve has done or the impact of higher for longer, it allows us to roll over, even if it’s slowly, the yields that we have on the box.

So here we’re looking at the five-year treasury yield at the end of each quarter going back to 2019, as well as the yield on the investments for both credit unions and banks in the 75th percentile.

So these are the folks who are right at the top quartile, the beginning of the top quartile.

So, it stands to reason that most members are below these levels.

It’s a good proxy for what the upper end sort of looks like.

And as you might expect, as rates went higher through the course of time, many folks were able to bump those units up.

So, the bank’s 75th percentile was at 2% in the fall of 2021, and has now gone to over 3%.

Credit unions were able to reprice a little bit more aggressively.

That’s a function of two things: a little shorter durations on the legacy investment portfolio, which Pricing, but also structurally higher cash levels in more stable deposits, have led to Repricing in the investment portfolio.

So a couple of things to point out here are that, again, this ties into what I had mentioned a couple of slides back about rates don’t always have to go to the floor when they do.

So in 2019, even before the COVID shock that sent rates down into the zero handle, the belly of the curve was, as you can see, just between one and a half and two percent in 2019.

So when we fast forward to today, the five-year treasury right around 4%, if we think about putting a spread on top of that, you don’t have to go very far out the curve, you don’t have to go into esoteric type things to get a yield and rate that is potentially very, very accretive to what is happening in the portfolio at present.

So now this is easy to say for us that Investments are attractive right now and you know, but we speak to people and we hear a lot of oh we haven’t added Investments back in in in a while Whether it was liquidity driven interest rate risk driven or capital So those are the three big things and I get it but There is a counter-intuitive type angle to this where the opportunities sitting in front of us with these high rates and these wide spreads allow the ability to accelerate the repricing and leads us into a couple things about what is on the short, medium, and long-term horizon.

So if we are of the mind that a hard landing is coming, that despite what I said, Rates don’t have to go to short rates, don’t have to go to zero. Well, what if they do?

And you know, I, you know, having been through the 08 crisis and in 2020, it’s never the thing that everybody thinks it’s going to be that that happens to be the driver, right?

So like right now, or maybe not right now, but over the last year, silence class, an office space, so that’s going to take down the banking industry in the world.

Well, everybody knows about it.

So I’d be hard pressed to say that it’s going to be the driver, that we’ve been around enough to know that when something happens, it doesn’t knock on the door and announce who it is.

It just happens.

So, in any event, if we’re inclined to believe that a hard landing is coming, Tyler is going to look at a couple of different scenarios and how things play out.

But some of the things on the asset side of the balance sheet that you’d want to look for are duration, prepayment protection, even lower risk weighting, right?

Because that’s going to help certainly if we go into a lower rate environment, and especially considering how loaned up a lot of institutions are because of how aggressive the loan growth was in 22 and 23.

I think there was a period of time where, between the median loan growth for our members and the median deposit growth, there was a differential of over 10 percent, right?

Loan growth was 14 percent, and deposit growth was 2 percent.

That’s a pretty exceptional gap, and that leads to big jumps in loan-to-deposit ratios.

And on the funding side, Tyler is going to talk a little bit more there about ways that you can get that rapid repricing in that magical 100% beta, which sounds like a bad word when we talk about deposit modeling, but he’s going to show us how on the wholesale side, in a declining rate environment, that’s actually what we want to be seeking out.

And there’s also an ability to prepay or pay down that wholesale funding, which is certainly a component.

And this falls in the camp of what did we learn from the last cycle and what do we wish we had done a little bit differently.

In the middle section, how do we support earnings right now?

If we have the capital and if we feel comfortable with the liquidity that we have.

So we’ve been big fans of that mismatch duration, where you go out to say five years on the asset side and that 12 to 24-month range on the liability.

And then the appeal there is that it can be, it locks in margin or a certain amount of spread right now, and oftentimes, because of the shape of the curve, which is inverted now, but like we said, it was less inverted or flat not too recently.

And with spreads wide, we can get to whatever that magic number hurdle rate that we need in order to do wholesale leverage.

We can get there without taking too, too much interest rate risk.

And as things roll down the curve, you’re in a good place to potentially replace that funding in a lower rate environment.

The last thing I’ll point out here is, and this firmly falls in the camp of preparing now for opportunities later.

We all do tabletop exercises related to external threats or cyber technology, things like that, but I’ve always been an advocate of what we should do, even if it’s more informal, on the ALM and the Treasury side of things.

What if we came in today and spreads were 100 basis points wider?

Would we run for cover?

Would we look to add assets?

What types of things would we do?

Would we look to leverage the advantage that depository balance sheets have in terms of being liability-driven and not being total return-driven, like institutional money managers?

Do we have appetite? And what pools would we be looking at?

And I would think about two different scenarios right now.

I would think about if spreads widen out, and that could be independent of the rate movement. That could be up, down, or sideways.

Do we have an appetite to take advantage of those wider spreads?

And I think that can be appealing because when, and we all know this from the lending side, when you capture more spread, not reliant on lending long and funding short, right?

So it’s just the yield curve is driving that margin.

If you don’t have to rely on the yield curve to drive margin, then you’re indifferent about where rates go.

You know that you’re going to be locked in.

And honestly, as we were preparing for this and we were talking about stagflation and I don’t like talking about bad scenarios like that, What the heck do we do ALM-wise with stagflation is you hope to match and hedge everything down to the studs and hope that there’s enough spread left over with what you’re doing and so that you’re not living and dying with moves in the yield curve.

The other thing that I would think of is that’s in a spread widening scenario.

Let’s just say spreads behave, but rates start to go down aggressively.

I would assess what types of strategic sales we might want to consider making.

So if you have an investment portfolio that’s grown a little bit over the last years beyond where you want it to be, if you have a wholesale funding portfolio that has grown beyond where you want it to be, I would say, I would really map out those scenarios and say, okay, I don’t want to sell it at 86. Still, if it to 92, I would. So I want to be ready to act when we do that.

That can happen on the security side, that can happen on the residential lending side as well.

So many of you who are PFIs in our mortgage partnership finance program, we’ve had many of these conversations with folks about some of those seasoned, well-seasoned three, three and a half loans that are 30-year mortgages still in the books that aren’t going in a way anytime soon that, you know, there may be opportunity to liquidate those up the books. Certainly, you’d want to be doing that into a rallying market where the price is going to be a little more favorable.

Another thing that we’ve been talking about with many members has been if we have funding that was put on at higher levels, the ability to do advance restructure.

So if you have an advance north of four and a half and you’ve met with one of your relationship managers in the last couple of months, chances are that they brought this concept up to you, show you some of these visuals here.

So the moral of the story is we essentially take that implied prepay penalty that you would have to pay if you tried to pay down the advance right now.

And we rip up the old advance and annuitize that fee, put it onto a new advance, as you can see here.

So in this example, if you had a 490 advance that you put on a while back, it’s got 12 months left to go and you want to bump out the curve, but you don’t need any new borrowings because you’re in an okay place liquidity wise, well then you’re able to do that without any impact of the current income statement, negative impact of the current income statement, but you lower the rate immediately.

And here’s an example that we like because we don’t, it’s not necessary about trying to predict interest rates or go where we need to go or go where we want, where we think is an attractive place on the yield curve, but it’s the strategy of what we call restructure and invest, real complex and mysterious name there, right?

So it’s this idea of creating capacity to take asset duration to take advantage of high rates and widespread right now.

So let’s use this same example. You have one year left to go on an advance at $4.90.

If you were to restructure that out to three years, you’re pumping out the funding, but you’re also lowering the rate by 55 basis points. Great.

Okay, what do we do on the asset side?

Assume you have a little bit of cash, you’re earning IORB, and you go look to the investment market and at a five-year asset at a plus 100.

Okay, well, I like the rate, I like the spread, but you know, moving out, taking duration.

We’ve seen that story before. I don’t know how I feel about that.

So, think of it in the context of the funding extension taps down some of that pure asset duration, right?

Ripping off the band-aid of going from overnight in cash all the way out of the curve.

So when you look at what the net average life and the net spread is, both in the current and post restructure and invest, you’re becoming a slightly more liability sensitive, but that’s something that would benefit you in a declining rate market and you’re putting on higher yielding assets.

But here’s another way to think about this.

So the impact of extending out your funding, effectively takes that asset that you put on the books at a five-year duration at plus 100, which may or may not appeal to you.

Well, what if it was only two years of duration and a spread of like 160?

Well, that’s pretty darn attractive. Well, that is what the net result of the restructuring investment can be.

So if you don’t have an advance that fits that bill, a similar type of strategy is using forward-starting advances.

And so that is very simply where you initiate the advance today based off of today’s yield curve, but it doesn’t disperse until a time down the road.

And during that delay period, you do not have to use up any available collateral, so it’s liquidity friendly, and you don’t have to purchase stock.

Although with where dividend rates are on the stock, maybe you do want to purchase the stock.

So, in any event, you can see here, with the curve being ever so slightly inverted, that shape, the way fixed income mathematics works is that the forward rate is going to be lower than the current rate.

So you can see here in this example, a one-year delay that goes into a two-year advance is at 393, which is below every rate on the currently available curve.

So it creates some capacity to take asset duration.

So you can do a version of restructure and invest, take cash, and go out on the yield curve.

You don’t need funding because you have the cash, but you hedge some of that interest rate risk because you have some fixed-rate funding coming onto the books later.

Another thing you can do with this is pre-replace term funding.

A lot of people have seen growth in CDs and certificates of deposit over the last couple of years.

So, you can look to, as rates get more advantageous, and Tyler is going to talk a little bit more about opportunistic as the curve inverts.

So I would familiarize yourself with this tool in the toolkit, because if we do get in a period where rates fall pretty hard and inversion comes back into the mix, then the math is going to look pretty darn good on forward starting advances.

HOB options are puttable advances, and continue to be very popular, but the way that they get used can vary as well.

So long story short, when volatility is high, like it is right now, and when the yield curve is inverted, less so now than it was in times in the past, there can be opportunities to lower funding, cheaper funding, relative to the classic advanced curve.

So, you know, here’s a look at the one-year treasury rates and the steepness of the curve, and you can see at various points over the last year or so the curve has been inverted, or rates have been low, or more recently we saw a spike in volatility in April and May, which creates opportunity to get some pretty attractive funding.

And here’s a look at where only just in the span of about two months, as we talked about at the beginning of the webinar, where rates have been rising since April and May.

So for those who are opportunistic, we have a number of members who did a great job at this.

When the curve really came down hard and inverted, you can see as visualized on the left-hand side, that you could get into some high to low 3% type of funding, which certainly is more favorable than, as we said, trying to scratch and claw with all those folks who want 4.5% deposits.

So there’s some opportunity there as well.

So I’d like to examine a question that’s probably about as old as fixing income or banking itself, but which has a lot of relevance in today’s volatile interest rate market, and that is to fix or to float.

The real consideration here is how many cuts is the market pricing in, or sorry, predicting, and then pricing in, and then how does that compare to your own expectation of, say, a soft landing or hard landing and future rates?

So while it may seem logical to go floating, say when there’s a bunch of rate cuts expected, well it’s actually better to lock in those expected cuts with a fixed rate advance so that you, no matter what happens, whether those cuts materialize or not, you get that full benefit throughout the full duration of the advance.

The market is not pricing in many cuts, but you think that there’s a chance that they do that it does end up cutting.

It makes a lot of sense in that case to go floating because you’re not getting any advantage in that case by going fixed because the market is not expecting nor pricing in any cuts at that point so there’s not as much of a discount likely but if you do go floating say nothing happens well there wasn’t a huge discount anyway so you didn’t lose but if they do end up cutting there’s a tremendous advantage there.

So let’s look at some examples of this and see how it works out in real life.

So like the first looking example, and this is April of 2024, April 30th to be specific.

And at that point, the market was only pricing in one, maybe two cuts for the next 12 months.

So it’s not a huge advantage at that point to borrow fixed versus floating.

You know, day one rate of 555 versus 531.

But we ended up getting a 50-basis point cut in September and then another 25 basis points soon after that in the fall.

And the result was that, through a full 12-month term, you ended up saving seven basis points by borrowing the SOFR floater for one year versus the one-year classic advance.

And so at the end of the SOFR, you’re only paying 462 on that advance on that last day.

So the total cost was 504 versus 531.

In that case, floating was the way to go.

Another example, so let’s say you get a little bit closer to those cuts, it’s September 10th now, And the Fed’s now looking poised to cut, you know, those expectations of making four to five cuts in the next 12 months, and you’re thinking, time to borrow floating, let’s ride it down.

Well, actually, no, you’d be better off in that case to have gone with the fixed one-year classic advance and take advantage of all those priced-in cuts.

You’re getting $4.24 day one through day 365 versus a day one, $5.54 on the one-year so floater and sorry that’s not through days 360 we’re still not all the way there yet this would still be ongoing but to looking good so far yeah looking good so far and put numbers to what would have to happen for you end up behind the ball if you went fixed you need to see probably about 75 basis points of cuts in the next meeting for that silver floater to end up getting ahead of the one-year classic advance so you know that’s not looking so likely and in that last September, you were really better off to go and lock in the one-year Classic Advance.

So far, the total cost is $4.24, the same as day one, versus $4.71 on the sofa. Customs haven’t really made it advantageous yet.

So that’s looking back, which is fun, but you’re saying, what does that mean today?

What’s going to happen going forward?

And so, as of a couple of days ago, the one-year classic advance was $4.23 and the day one sopher was $4.54.

The market’s expecting about three cuts over the next 12 months and should affect expectation materialize.

With one cut in September, December, and March, the one-year sopher floater would cost $4.19 over its life. That beats the one-year classic advance.

Say we get a little bit more of an aggressive cutting cycle, things start to deteriorate in the economy, so we get $50 in July. Then three more cuts after that of 25 basis points, the silver’s going to end up costing $3.66 over its life, just smashing the one-year classic advance in that case.

Let’s say we only get one cut, more of a speculation-type outcome for the next year.

Well, silver costs $4.38, so you lose a factor of 15 basis points, but it’s not terrible.

So I would say, given this, there’s certainly something to be considered there as far as the silver index advances based on the current market expectations.

But another consideration is, you know, on the retail deposit side.

You know, this fix-first-float conversation doesn’t just apply to advances or wholesale funding.

And so you want to think about where the prices are and future expectations of the rate as you decide which products to promote, market, and then how to price them.

So, looking here, we’re seeing average, or medium, CD, jumbo CD rates, and money market and savings rates across the different states of our region.

So we see in Connecticut and Vermont, there’s really actually a pricing advantage with the money markets relative to CDs.

And around Maine, there’s a little bit of CD pricing advantage.

So just something to think about as you, like I said, you’re pricing and promoting your different offerings.

Another consideration, and we’ve been hearing from a lot of members, is that broker deposits are coming in cheaper than advances.

So as you opportunistically shop funding sources, think about where your geography and balance sheet offer you opportunities to price advantageously and create efficient product sets and marketing campaigns.

So now, there are a few other considerations.

You know, obviously, price is very important when we’re talking about fixed versus floating and market rate expectations, but there is no good price on a bad asset.

So, how do we align our borrowings with our balance sheet?

So we want to consider things like interest rate risk, where the net interest margin, non-interest income, and net economic value, or NEV, I’ll stick with NEV going forward.

Credit risk, you know, the strength of your underlying collateral and counterparty strength, you know, as a lot of these loans that are repricing now, you know, at a much higher rate, you’re going to have to see how those borrowers are doing.

In liquidity risk, near-term deposit outflows, investments repricing and rolling off, and there’s an option risk.

Things like, you know, prepays coming in higher or lower than expected or even deposits getting called in early.

And you want to have your funding match your asset and liability growth expectations for the year.

So if you’re expecting to do a lot of loans this year, maybe go fixed so you have that funding locked in because it’s less of an issue.

You’re expecting loans throughout the year, or maybe you’re expecting a lot of liability growth.

Maybe it makes sense to do something with a call option so that, say, you don’t need as much funding down the road, you have the ability to pull that and not have excess funding.

Those of you, you know, speaking of growth considerations, those who are with us for the May webinar may recall the poll question where we asked about the expectations for deposit growth, I think.

And one of the answers, which was the most popular answer, was, I have no clue or conviction.

Your guess is as good as mine.

So I think that speaks to the uncertainty that I think a lot of folks wouldn’t be terribly surprised in this environment if they had 0% growth or 10% growth or anywhere in between.

Absolutely, that’s a great segue to a couple of case studies where we’ll look at examples where you can have that call option and also that 100% deposit data we’re talking about.

So in this example we’re looking at the six-month callable SOFR indexed advance with an option to call after three months and so like I said full deposit data and so if rate expectations or the expectations rate cuts this year materialize we’re going to have an all-in cost just three basis points actually basis points better than going with the classic advance so you’re getting both an advantage on rate and three months in like we’re saying you know you don’t need that funding anymore, hit the eject button.

Get rid of it.

Maybe even at that point, rates are lower, and they are able to backfill with some of those cheap money markets or CDs, regional considerations to apply there.

Plus, you aren’t locked in.

And another consideration is that by going in, loading, and then saying down the line, there’s a real advantage to borrowing fixed and getting some, take advantage of the rate cuts there.

You can actually get a negative deposit or negative beta.

That’s something maybe Andrew can do a little more justice Yeah, so the idea of having floating rate funding, you’re going to have, you’re going to capture the full decline in short-term interest rates, but what if happens if that is accompanied by the intermediate part of the curve, as we had talked about, which gets ahead of potential further cuts.

So let’s just back of the napkin, use some numbers here.

If we see four cuts over a certain period, but then the expectation is that there are six more to come.

Well, you ride the four with the floating rate funding, call the advance, and then switch to a fixed rate funding.

That is, as Tyler pointed out at the very beginning of this section, you’re capturing and locking in the next six cuts.

So it’s almost like beta beyond 100%, which is pretty interesting to think about in terms of managing funding costs.

And then finally, I’d like to look at this, this is a really exciting product that we have, the Discount Note Auction Advance.

And so the way this works, in this case, is the four-week, one-year term.

So it’s a one-year term, and it’s priced based on the Discount Note Auction Floater, the four-week product, plus a premium of 21 basis points.

And what that allows is that every four weeks, when that reprices, you have that option to call the advance.

So throughout the year, especially as we’re saying, you get some really uncertain growth expectations, and you want to have that option every month, you get that advantage.

But the pricing is not really a downside here.

So you’re only paying 1.6 basis points more than rolling a one-month, month after month.

And say we get the expected rate cuts that are being priced in right now, it actually comes in cheaper by about nine basis points than going for a one-year classic advance.

So we get all the advantages of one-year liquidity, pricing advantage, and the option to call throughout the year.

That’s a great point. In times of uncertainty, I think there are two paths you can go.

You can create flexibility and control that you have in your hands, right? And so that’s the idea of having that option to prepay efficiently.

And then the other angle that you could go at is to get compensated for that uncertainty.

And that’s where we’re talking about the widespread on the assets or the value and the puttable advances.

So there’s door A and there’s door B, there are options, and there’s no pun intended on options there, but there’s flexibility to navigate these very tricky and uncertain times. So that brings us to the end.

We appreciate your attendance and taking the time to go through these slides.

As always, if there’s anything that we can assist with quantitatively or qualitatively, please reach out to us.

We’re not that hard to find, and we hope you have a great rest of the day.

Thank you very much.