August 2024 Peer Analysis and Balance Sheet Strategies Update

Hello, everyone.

Thank you for joining us for our latest installment of our Peer Analysis and Balance Sheet Strategies update.

I am Andrew Paolillo, and happy to have with us here today, Derek Hamilton, who joined us recently as a senior financial strategist here at the bank.

And he’s already hit the ground running and done a number of things for us here internally on the team.

And we’re very excited to have him out there as another face and voice to be working with our members.

And as we were looking for another host here, I have to say full disclosure, Derek, we did have fillers out in the Olympic spirit to Snoop Dogg and Martha Stewart given their involvement with the Olympics and the U.S. Olympic team.

But unfortunately, they did not hear back.

So we’ll make do with what we got, right?

Sounds good.

So, for those of you who’ve been with us for these quarterly webinars, you know the drill in the three areas that we’ll talk about here.

But for those who are new, and then there’s a lot of new folks, I think once again, we had a record number of registrations and attendees, which is fantastic to see.

We’re very appreciative of that.

So, we’ll start things off talking a little bit about drivers and things happening in the markets and the economy.

We’ll then take a deep dive into what’s happening on our member call reports here in New England.

And then lastly, we’ll talk about some actual things that we can put into effect on the balance sheet strategy side. So, we’ll kick things off.

We haven’t done a poll question in a while, but I think given all the discussion and the uncertainty about what is happening with the potential for short-term rate movements.

So you can see the moment here, and bear with us as GoToWebinar recently upgraded their systems here.

So, you may see the layout a little bit differently.

So, bear with us one second as the poll begins to go through, but you can take this time to think about what your answer may be.

So, we have three rate cuts left for the rest of 2024.

Excuse me, three Fed meetings for the rest of 2024, September, November, and December.

So, curious to see what people’s opinions are as to what and how many rate cuts that we have. And we can have different options outlined below.

And for the purpose of the poll, we’ll talk about 25 basis point increments.

So, a 50-basis point cut would really be too.

And right now, what is being priced into the market and it ebbs and flows every single day, it’s about 90 basis points of cuts.

So just a little under four cuts.

So there’s still an expectation that in one of these meetings, there will be a 50-basis point cut.

Personally, I won’t entertain the idea other possibility of a cut occurring in between meetings.

I think that’s a little silly, in my personal opinion.

A weak week for the stock market, in my opinion, doesn’t justify an intermeeting cut in rates. So having a little difficulty getting the poll up, but that’s okay.

We’ll keep it moving forward because, fortunately, I took a stab at guessing what the results of the poll would be.

And keeping with the Olympic spirit here, some visuals as to what we thought
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Maybe not necessarily what people think is going to happen, but I think what banks and credit unions would like to see happen in terms of the rate cuts here.

And so, you can see Steph Curry and the men’s basketball team probably shooting and that shot over some outstretched arms, I think that shot did actually go in.

It was one of the many, the nine three-pointers that he hit.

And that rate cuts would provide some relief for our balance sheets and our income statement.

And then, you know, out of the three, and we’ll get back to this in section three, in terms of the different scenarios here, a soft landing, a hard landing, or higher for longer, I’m going to go on the limb and say most are rooting for some version of the soft landing.

And when it comes to predicting interest rates compared to Katie Ledecky in the 1500-meter race, she doesn’t lose those very often when there’s that type of lead.

Although with interest rates, it’s anybody’s best guess.

We have seen crazier things than comebacks from that type of a margin.

So, let’s jump right into talking about markets and economy.Actually, there’s our poll.

So, feel free to, we’ll give it a minute or two, and we’ll see what everybody’s guesstimate is to what you think is going to happen over the next couple of months.

Okay, I know we can see it here on screen here and it’s coming in kind of sort of what we were handicapping.

Okay, we got a bulk of the answers in.

We’ll just give it another few seconds here.

Okay, Stacey, I think we can wrap it up and see what the results may be.

So nearly two-thirds of folks think that we’re going to see two to three cuts.

And as we talked about before, that the expectation, as of right this moment, is a little under four.

That kind of makes sense in terms of the assessment of what may happen over the next couple months.

Not to say we didn’t even begin to talk about 2025.

That’s a whole other ball of wax.

But no, this is good insight and a good kickoff for what we’re going to talk about here with the yield curve.

So we’ve seen a real sea change over the last few months in terms of what the market expectations are for future short-term rates.

And really, there seems to be conviction that this time rates will actually be getting cut, not to be confused with the half a dozen head fakes that we have seen over the last year or two.

So what we’re looking at here is three different versions of the steepest in the yield curve.

And you’ll notice that we’re not talking about the two tens, which I don’t think is really all that applicable for depository institutions.

But the combination of tenors that we have here are really indicative of the short, medium, long-term horizon for potential rate cuts.

And I’ll just pause for a second, and if anybody has any questions at any point along the way, you can enter it into the chat module, and we’ll address it as they come or at the end.

So we’ve seen the moves in the short term, at the very front end, the three month to six month, we’ve seen that inversion of the curve.

So that is the market beginning to really believe in the expectations of the cuts.

The biggest change has been in the six-month to two-year range, where the two-year has come down quite, quite a bit, just about 50-basis points further of inversion.

But interestingly, the two- to five-year spread has widened out a little bit.

And I think part of the reason that we can point to there is that, as we kind of alluded to before, I think that the motivation, or excuse me, the catalyst for what really changed this, there wasn’t this one big moment, right?

It wasn’t the failure of a large institution or anything like that.

It just kind of been the slow bleed of some weakening of economic data.

And as I said before, a bad stretch for the stock market, yet still being up on the year, in my mind, doesn’t justify a complete hard pivot in Fed path and direction.

So Derek, why don’t you tell us a little bit about what’s happening in the mortgage base?

Yeah, so we’ve been seeing rates decline a little bit over the last year.

You can see that on the graph as rates are moving down as expected.

But one of the interesting things here is that the yield spreads are also tightening up a little bit.

When prepayment risk is a bit higher, we’re expecting larger spreads demanded by investors.

But now that the prepayments are more bullet-like and the cash flows are more consistent, we’re really seeing those spreads shrink, which is kind of changing the environment there.

Yeah.

So, for those members who are part of our mortgage partnership finance program and sell mortgages to us.

You know, we’ve seen a lot of activity over the last few months, and that continues.

And there’s a lot of drivers for that, you know, liquidity conditions and rates and such.

But when we do see moves in rates, and we’ve talked about this in prior webinars, that aside from current flow business, there may be some potential opportunities that are interesting from, you know, from the CFO treasurer perspective, not necessarily the secondary marketing manager perspective, to look at what loans are inventoried in portfolio, whether they’re some of the loans at the higher coupons that have stuck around, have not yet prepaid, or even some of those low, low coupons that have benefited from, as Derek said, the rise in rates.

So maybe the discount or the underwaterness, I always make up words here, so the underwaterness of the price of those loans has come back a little bit as rates have rallied.

Yep.

So, another thing that we were taking a look at was the spreads for credit.

Typically, good indicator of what’s kind of going on in the economy here.

We’re noticing on the investment-grade credit spread is widening a bit.

So not necessarily something to worry about here, but it’s something we’re going to be keeping an eye on and see how the movement continues throughout the year.

Yeah, no, this is an interesting dynamic in that it’s been happening more in investment-grade credit as opposed to the higher yield, the greater risk segment of the market.

So as Derek said, no panic button just yet, but it’s something that certainly is on the radar.

So, let’s pivot to talking about economic data.

And those of you who have tuned in before know that one of my soapbox issues is the way that inflation is looked at.

And I won’t go on the full rant. I’ll give the quarter rant here and say that when you look at the percentage changes, and we saw the CPI release yesterday, that’s not on the chart here, it’s come down, it’s normalized.

But when you look at percentage changes on the heels of big percentage changes, big moves that we have seen in 22 and 23, there’s almost an asterisk to that number.

And we look at the bottom panel, that shows the actual index level, the price level indexed to 100 going back to 2021.

And just as consumers, as businesses, we know that cost, maybe the rate of change is slowing down, but there’s still the pricing pressure that impacts the goods and services that we have to live our life with.

And I’ll give a shout out, it’s the summertime.

We have our interns here, and our intern Ulman was very instrumental in helping out with this slide and the next one digging into the economic data and looking at some of the industries that were the key drivers.

And in the most recent CPI report from yesterday, energy braces down, but economists, they omit food and energy because it’s too volatile.

It doesn’t count, even though we all rely on food and energy.

But the two biggest drivers that are really pressuring prices in the most recent report was transportation and shelter housing costs.

So that aligns with what we’re seeing with market prices for homes here in New England still.

So, talking about unemployment, this has been another economic thing that many have been pointing to, to think about, hey, maybe it’s time for cuts to start happening.

And we’ve seen some tick up in the national unemployment rate.

That’s exhibited by the gray area here.

But closer to home, we want to look what’s happening here in New England because it necessarily doesn’t mean that what’s happening at the top level tells us what we’re seeing in our own communities.

And as is often the case, things here in New England are much more stable and consistent than what’s happening on the broadest level.

So the three Northern New England states, the three lines really have been quite strong and flat to coming down over the last year where the national has been ticking up.

Massachusetts, we’ve seen a little bit of a rise.

Rhode Island has been ticking up as well, and Rhode Island is actually the only state right now that is above what’s happening in at the national level. Connecticut had been higher for a while but has come down a little bit.

So, you know, there’s our look at the Fed’s two main focuses of unemployment and inflation.

But here’s another interesting dynamic that we’ve outlined.

So, this is looking at median hourly wage growth going back a couple decades, almost 30 years here.

And what I’ve annotated with the blue here is the 12 months preceding a technical economic recession and the 12 once at the start of that recession.

And if you squint, you can kind of sort of see a little bit of a trend where leading into the recession, that metric plateaus a little bit.

And then once the recession starts, it starts to come down a little bit.

What’s really odd and fascinating about the environment that we’re in right now is that we’re seeing that recession-like activity in terms of the decrease.

Now, hopefully, you were paying attention to two slides ago where I said you have to put an asterisk when you’re looking at percentage changes when we see the big changes.

So the same way I said inflation is not dead just because it’s normalizing right now. Flipping around, median hourly wage growth is still strong.

People’s incomes are still high. They’re improving. There’s the wealth effect that comes with it.

So, let’s move along to looking at what was actually finding its way onto balance sheet.

So, everybody’s favorite topic, let’s talk about margin.

And you know, it used to be margin pressure, but now there’s a little element of optimism here.

I’m perpetually the optimist around here, so.

But I didn’t have to, you don’t have to squint too hard to see some positive trends.

So, here we’re looking at the percentage of our membership base who are seeing improvements on a quarter-over-quarter basis in terms of a net interest margin.

And we’ve highlighted the sections where banks and credit unions have been able to improve.

And what we see is that for the first time since rates began to, at least since they stopped rising and certainly since a couple of quarters before that, the majority of banks, just, oh, excuse me, not quite, but almost 50% of banks saw quarter over quarter NIM enhancement and nearly 80% of credit unions were able to see improvement.

Now, I’ll temper some of that optimism and say that it’s not all sunshine and rainbows yet, at least on the bank side, because on the bottom left-hand side, you can see that we’re still at pretty, we’re still feeling the effects of the weakness of the last few quarters, that the median NIM across our membership base at 256 has come down a significant amount.

Credit unions have held a little bit better, higher at that 328 level.

So what’s driving some of those changes?

And it’s the slow, slowly but surely, it’s the asset repricing.

So, on the left-hand side for banks, and we’ll get the credit unions in a second, we’re seeing that lift of the asset side of the balance sheet, whether we’re talking about investments or different types of loans.

And I recall we were speaking with the bank a couple weeks ago, and they said in the second quarter, the average loan that they put on the books was comfortably north of 7%, which is historically fantastic, and the spreads were okay as well.

So, whether we’re talking about just a simple turnover, we’re not getting much prepayment, but just the amortization is incrementally picking up, or even if it’s growth that we’re seeing in targeted portfolios.

That those ones and three percent yields are coming off and replacing with fives and sevens.

And then, the funding cost side, we’re seeing a little bit of a maybe call it a plateau or decline that some of the funding cost pressure is starting to abate.

And you know we’ll get to this in the last section, but when we look at the median cost on savings accounts and CDs at $4.18 and $1.61 for savings accounts, now we’re in a position where CDs, you might even have some margin lift depending on where rates go that, you know, we fast forward six months from now and you’re able to go out there with a 4% CD because rates have come down a little bit.

Well, you’re going to get some funding cost relief.

The other, and we’ll get to this in section three, that savings amount, yeah, it’s stabilized a little bit in that mid-ones, and you can argue both directions that hey, it’s going to stay stable, or the pressure and the drift could continue.

When we talk about credit unions, similar stories in terms of the asset lift, and I think the asset lift has been to a greater magnitude, and a big driver of that has been generally just shorter portfolios, in particular, talking about the heavy reliance on auto portfolios that throw off a ton of cash, and Derek’s going to get into the growth or lack thereof perspective that certainly is a component here as well.

And on the funding cost side, we can see the gradual decline in the rise of interest-bearing deposit cost and share cost.

And they’re still increasing, but again, looking to that rate of change or the magnitude of change certainly can be a valuable exercise.

So, you know, we’ll shift now to looking at what is the correlation or where’s the relationship between interest expense and seeing if there’s any common threads between those who have high interest expense and those who don’t.

And if you look at the top right, you can see an example of the groundbreaking analysis that we bring to you here at the FHL Bank of Boston, that there’s a high correlation between interest expense and the cost of interest-bearing deposits.

So, you know, what would you do without us to tell us that those two things are related?

But we’re not going to go into all of these metrics here.

I’ll just point out two things in particular that jumped out to us.

And the first one is that the cost of savings and money markets has a higher correlation with interest expense than the cost of CDs.

CDs have taken up a lot of bandwidth in the last couple of months.

The other part is that not the cost but the amount of CDs that we have has a greater correlation than the amount of money markets that we have.

So what that tells us it’s not about the rate that you pay on the CDs. It’s about how you have to have them in the first place and how effective you have been at building that durable core deposit, non-maturity deposit franchise, that it’s not just about the rate, that you’re able to provide the service and all the other things that your customers need from you, independent of, hey, we can pay higher than the institution down the street.

The other thing that jumped out to us is that we’re looking to see if there was any kind of connection between the banks who have a certain emphasis on a particular loan type, whether it’s CRE, CNI, or residential mortgages, there really was no relationship in terms of making that connection to say banks who had a focus on this type of loan sector saw more funding cost pressure than others.

And the credit union side, again, I won’t go through everything.

There wasn’t really much of a connection between higher interest income and higher interest expense.

So it wasn’t, you know, there wasn’t the logic of, hey, we’re able to extract a higher yield either because of the types of credit we’re taking or any other driver of that.

And then saying, well, we can justify paying up for expenses because we have that great start in terms of capturing margin.

That there really wasn’t a relationship there
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But where we did see a relationship, at least relative to what banks showed, was that a higher loan to asset ratio did tell us that we would typically see a higher amount of interest expense.

So, I think that speaks to maybe liquidity risk management more so than credit risk management being a driver of how we set deposit prices.

Yeah.

So as Andrew was saying, we’ve been digging through members’ balance sheets to try and take a look.

And one interesting thing I found was the loan mix that’s happening.

So, we’ve seen cost of funds rising.

There’s not much relief there.

So, a lot of the members are trying to remix their portfolios to try to get a better yield.

And we’re seeing that where banks are decreasing their residential portfolios, as well as our credit union members, and trying to remix that with more commercial lending to increase that yield.
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9It’s a bit slower because the churn is a bit slower, there’s no prepayments right now in the industry.

We see a little bit more with credit unions, where the auto portfolios are getting paid down a bit faster.

So it’s slow, but it’s moving.

And this really shows an example of how that’s actually working.

So when you take a look at the banks, you can see that the residential mortgage business or residential loan business is a bit flat, not much growth there over the last several quarters, whereas the commercial side is actually trying to increase a little bit.

Again, there’s forces at play here, there’s liquidity that people have to balance, there’s funding issues that they have to try to balance, especially where it’s tough building deposits.

So that kind of explains why there’s been a slowdown.

There’s not a steep spike in any type of loan movement, but there’s a concerned effort to try to move that loan mix. But when we get to our credit union members, you do see that mix actually working more effectively where they’re not necessarily building out the auto portfolios anymore.

They’re either letting them maintain since the volume needs to be much higher to maintain those or even letting them shrink a little bit and shifting funding over towards commercial loans to try to capture that yield and relieve some of the cost pressure.

Yeah. So, you know, thank you, Derek.

And it’s interesting to reconcile the how and why these growth rates are coming down. And I think we can distill it to one or two sides.

Is it the customer demand waning or is it the institutions themselves trying to pull back a little bit more?

And then, like everything, it’s probably some combination of both of those two things.

Yeah, we’ve heard that directly from our members too. Some have a no growth plan.

Some kind of want to see how things shake out. And other people say there’s not inventory there.

So, you’re a full mix of everything. Yeah.

And that’s why we have to be cognizant and aware of the broader macroeconomic conditions like we talked about in the section one, because certainly that has the potential to dampen the customer demand side, even if there is the liquidity and the appetite to grow.

So, you know, going back to the positive signs on margin, this is probably my favorite and probably the favorite of the people here in the audience here in seeing some gradual positive shifts in the mix on the deposit side.

Those CDs that we talked about, so here we’re looking at the percentage of banks and credit unions who increased in the particular buckets quarter over quarter.

And so, in light blue up top, we can see the retail time deposits as we got to the tail end of 2022 into 2023.

You know, pretty much everybody was growing the CD book.

But we have seen that start to moderate. And that, as you can imagine, analysis like this, 50% plus or minus a few, that is kind of the cruising altitude.

When you see big jumps into the upper core tiles, that’s when it really starts to tell you something, or the bottom core tiles, rather.

But the biggest number to me here is to look at the non-interest-bearing number.

That has been challenging, certainly, as rates are at four or 5%, and customers are trying to maximize every penny that they have, even in the transactional, operational accounts.

If there’s any loose change floating around, get it into a vehicle where you can earn some incremental income.

But that lift up above 50% is a positive sign, certainly in connection with the decline in CDs.

And that’s a direction that I’d imagine pretty much everybody on this call would like to see.

Credit unions, we have continued to see that decline in CDs, even at its peak in the end of 2023.

A staggering 91% saw growth in that CD book.

And then the non-maturity deposit or the share drafts rather, there’s kind of an asterisk here because there is a pretty clear pattern of seasonality where in the first quarter of the year, you do tend to see a bump in share drafts.

So, looking at the second quarter numbers can be a little misleading, but I think the biggest thing is to see that certificate and CD growth moderating.

Yeah, and there’s good news in the investment portfolios as well.

Seems like a lot of our members are starting to increase their investment yields.

We have noticed some runoff there.

They’re not necessarily reinvesting back into the portfolio, but it seems like a lot of those pandemic-era investments are starting to roll off or hang off, and the yields are increasing higher.

So about 31% of our bank members are over 3% yield, and then about 58% of our credit union members are over 3%.

So, I think in the coming quarters, we’ll have to start introducing some more buckets there as everything starts raising up.

I think we may be running out of shades of green or blue to do that.

But again, for the new folks, if you haven’t noticed, that we’ve tried to keep it consistent with the formatting where banks are in blue and credit unions are in green.

But you know, we touched upon this earlier in terms of the autos producing cash flow and allowing for that faster repricing. Generally speaking to credit unions tend to have shorter investment portfolios and also have held higher levels of cash as well. So part of this dynamic of the credit union yield, acceleration really being you know, pretty extreme in a good way, has not just been the replacement. But it’s also been the growth right taking some of that hey, maybe we were at 12% cash, but gosh, we can get four and five percent with modest durations and little credit risk. Let’s convert that into the bond portfolio.

And then that is going to turbocharge the yield improvement as well.

So, when we take a look at the overall growth, we’ve talked about the individual products.

But as we look at banks and credit unions as a whole, It’s a bit of a different story.

So, when we look at the banks, they’ve increased a bit modestly, about 4% on median.

That could be a significant significance due to them being able to take the wholesale funding more, more willing to take some funding to reinvest into their loan portfolios to keep moving forward, put it in cash, and their investment portfolio.

They’re more willing to do that.

Whereas on the credit union side, the growth has been more, I don’t want to say stagnant, but definitely less dramatic, being under 1% for median growth.

And again, that could be a function of the higher turnover on auto portfolios, just maintaining that level, not necessarily shrinking at all, but they’re definitely maintaining more rather than growing.

Yeah, Derek made a good point about wholesale funding usage.

So, I don’t believe we have it directly here in any slide.

But we certainly have seen, and there’s two parts of that, credit unions have been able to preserve deposit balances better than banks have, so they haven’t had to backfill or increase the wholesale funding side of things.

And also the loan growth has not been to the same level.

So there hasn’t been the incremental need to tap the wholesale funding in order to meet that loan growth.

So, you know, as Derek said, more of a stable holding serve perspective as opposed to the bigger ups and downs.

So, you know, we talk a lot about the balance sheet max and industry risk and liquidity and margin trends and pressure and all that.

But we know that credit is always front and center.

So, everyone, it feels like since the last four years, everyone’s been bracing for a storm that never really came.

Certainly, with all the uncertainty in 2020, in the fall and 2021, there wasn’t really major impacts in terms of delinquencies or anything like that.

But if we squint, we’re starting to see some isolated idiosyncratic increases in some of the credit metrics.

So here we’re looking at banks past due and non-accruals, specifically in the CRE space, just because that gets a lot of headlines.

I won’t go on a rant about office, Class A office, and the lack of applicability to community finance institutions. That’s for another day.

And then, on the credit union side, looking at delinquent loans to total loans.

So we have seen a little bit of a tick up in the percentage of banks who have past due and non-accruals in the CRE side above three percent, from two to three to five to eight percent.

Not a huge magnitude coming off a very-low level, but for context there you can see the dashed line.

We took a similar eight-quarter experience that we saw within 07-08, and we can see the baseline was much, much higher at that time. 19% getting up to 29%.

So directionally, just because the number is moving up doesn’t necessarily mean that there’s problems on the horizon.

Credit union side, similar type story.

We have seen a little bit of a drift up in terms of the percentage of credit unions above an arbitrary 1% threshold. But again, pales in comparison to what we saw in 07 and 08.

And we’ve mentioned this in the past, talking about angles to come at credit.

What we’re looking at here is purely just the past due and the delinquents.

It says nothing of reserves, which continue to be strong again because that credit storm never came.

We built it up. We did all that.

And even that there’s been some decent amount of reserve releases over the last few quarters.

But still, coverage ratios, excellent.

the ability to absorb potential losses, which may or may not come to the magnitude that the doomsayers are forecasting, but I think most are in a good position to handle any bumps in the road.

So let’s pivot over to the last section here, and we’ll talk about some of the actual levers and things that we can do.

So, if we were in a world where high quality, good credit loans, with sticky rates and sensitive deposits were all falling out of the sky in equal matching amounts, and we felt great about our interest rate exposure and all that, we wouldn’t really have to worry too, too much about the path of rates.

But that’s not the world that we’re in.

So, a lot of people have been talking and debating about where short-term rates are to go, including us, who put out a poll asking for everyone’s opinion.

But I think what gets lost a little bit is what happens in that intermediate end of the curve, because that does have an impact on our balance sheet as well.

And one of the things that I’m most concerned about right now is the possibility that as we start to see short rates go down, that the move in long-term rates or intermediate, however you want to define that, but we’ll here five years, that most of the move has already been done.

So if we think about the environment that we’ve lived in for the last year or so, it’s been really a suboptimal environment.

The curve is inverted, which is not great for depository institutions, but on top of that, the curve is inverted, expecting cuts that never came.

So, the persistence of that inverted curve has lingered on for a long, long time.

Well, what is the opposite of that?

A steep curve where hikes never come.

That, I’d imagine everyone on this call, if we put out a poll, I think we’d have consensus that 100% of people would love that yield curve environment.And that’s what we saw coming out of the great financial crisis, 10, 11, and 12.

The curve was super steep, and hikes didn’t come until the end of 2015.

So, if we see short rates come down, if they come down 200 basis points, let’s say, that will bring rates down into the low threes.

Well, if the belly of the curve, the five-year, does not move, well, there’s not too much terribly slope there, right?

340, you know, 330 or so to 370, 40 basis points of slope, not exactly the optimal conditions.

So, what, so if anything, And I wouldn’t be surprised if the move in the belly of the curve, in fact, moves up a few to 4%, 4.25%.

So the recovery in value of fixed-rate assets, the bond portfolio, the residential mortgages, just because short rates are coming down, I wouldn’t write in pen that possibility for the same things that happen there in terms of the rate moves.

Now, we don’t love to be in the rate prediction game, but we have to be cognizant of the impact on balance sheets in different scenarios.

So when we think about a soft landing, a hard landing, or a higher prolonger, there’s a couple key considerations as we slice and dice the different parts of the balance sheet or the different types of risk that we would look at.

In a soft-landing scenario, we talked a little bit about what could happen with the long rates or the intermediate rates.

you know, look at what we wrote here for credit and deposit growth, not great, not bad, which would honestly be in terms of deposit growth, that would be an improvement in sentiment if we get to that kind of neutral-ish level.

The interest rate risk profile, I wouldn’t imagine that it would change many for most or it would change rather slowly because we wouldn’t really see the acceleration of asset cash flows and to be determined on deposit side.

In a hard landing, as we might all expect, credit would probably be the concern.

We would see a sea change in the liquidity profile as well as the move from liability sensitive to asset sensitive.

But I think it would be a be careful what you wish for type of scenario because we all remember that in terms of core spread margin business, that those 0% rate environment really, really can be challenging.

It’s the asset repricing effect.

And as we saw in 21, 22, and 23, when rates are down, and then they come all the way back up, the durability of our deposit franchise gets tested to varying degrees.

And then the higher for longer, I purposely put the word pressure in the last five categories here because, as we know from the last year or so, the inverted curve, the higher for longer expectations challenges pretty much every side of the balance sheet and again is a suboptimal set of circumstances.

So a couple of things before we get to the funding side that Derek will kick off.

But as he alluded to before when talking about the lending side, we had the good fortune of talking to a lot of people and getting a lot of qualitative color and insight from you all, as opposed to just the purely quantitative side.

And what’s been interesting, we certainly have seen and heard folks who have purposely tapped the brakes on the lending side being a little bit year. But we haven’t seen too much spread widening in terms of the loan rates.

And it’s interesting because we’re in a tight liquidity environment. We’re in an inverted yield curve environment.

We’re potentially at the end of the credit cycle.

One way to adapt to that would be bumping up spreads a little bit.

So, I think that speaks to the competitive forces that are here in the New England area.

Certainly, as we speak with colleagues and other home loan banks across the country, that tends to be a common theme, that loan demand doesn’t fall off a cliff like it does elsewhere.

On the investment side, I’ll sympathize that it can be challenging that as much as there may be opportunities in terms of the high rates, the high spreads, the ability to customize the cash flows to meet your balance sheet needs, that all sounds great, but investments have had a front row seat to a lot of the interest rate risk and liquidity risk challenges over the last year or two.

So, it is very counterintuitive to say, well, we’re going to lean in to do things in the investment portfolio, given the set of options in front of us right now, when they have, like we said, been at the scene of the crime, for lack of a better way to describe it.

And on the deposit side, differing minds, but is that CD to non-maternity deposit migration over?

Your guess is as good as mine.

I would like to think that it plateaus at a certain point that we’ve seen six to eight quarters of the folks who are going to switch, have switched and that’ll adapt as time goes forward.

But the fact that now potentially the clearing rate for bringing in new deposits doesn’t have to start with a five-handle. It can maybe start with a four.

Maybe that allows some ability to test the elasticity and the sensitivity to the prices from your depositors, which would help provide some funding relief.

Yeah, so as we’re going through all this, we’re always thinking, what do our members need? How can we help them?

And we came up with some ideas of how our members can use some of our advances. We’ll go through three different types really quick.

Floating rate, we have two different types we’d like to talk about, gives you the ability to kind of ride out interest rates for whatever term you want.

The puttable advances, they seem to have a lot of value right now, especially in this declining rate market.

We’ve seen a lot of value and good options there.

And then the classic advances are always a solid choice, pretty clear cut, but I think there’s options for everybody there.

So, what we’ll go over here are the SOFR, sorry, SOFR Callable and the Discount Note Auction Floater, DNA for short, and that’s what I’ll go with for this time forward.

So, with our SOFR Floater, it’s callable, so you have the option to call in this case after three months.

So, if you look at the six-month, three-month callable so far, you have the option at three months, and if you’re willing to, you’re able to call that.

The benefit is that you can ride with the yield curve, just figure out where it’s going.

In this case, if you’re expecting the Fed to cut rates, a three-month callable will get you through the November session.

Possibly, deposits have gone up for you; you have other funding options; you can simply call it with no prepay penalty.

And you have more options at that point, but it gets you through kind of this unknown session through November.

So, DNA floater gives you a similar option to call, but it gives you a very lower upfront payment.

And the rates a little bit better than trying to do the classic advance or trying to roll on a daily basis, really gives you more flexibility and options, especially when it comes to liquidity, because you can stretch out the term as well if you decide to. I think that last point is an excellent one.

If you’re currently rolling short-term advances or thinking about it to plug a gap, take a look at these because they do give you that 100% beta to your funding, which is a great thing in a down-rate environment.

But, as Derek said, you owning the option gives you the flexibility to give it right back to us if, all of a sudden, we can get into a world where you can bring in deposits at 2% or 3%.

So, the puttable advances, we’ve talked about them for a bit, and as long as the yield curve is inverted and long as volatility uncertainty is high, they’re going to continue to present value.

And with the recent rally in intermediate-term rates, we’ve seen the coupons come down pretty sharply and even cross over into different handles that jump off the page a little bit.

So, if you look at some of the longer structures, the seven- and 10-year structures, they’ve moved from being at 3% rates and now having 2% handles on them, which creates an interesting dynamic.

But then even the shorter structures that mitigate some of the tail risk like the two-year structures, have broken inside of 4%.

So there is, again, some continued value there as well.

Where we’ve also seen interest pickup of late is in the SOFR flipper advance, very similar to the HLB option advance, with the key difference being that instead of being fixed rate throughout, it’s floating for the initial period.

So you would get the benefit from an aggressive drop in rates in terms of how dynamic it is in terms of the change in pricing, but again, because rates have gone down, the backend fixed-rate coupons are at more manageable levels than they have been over the coming months.

So always happy to discuss this.
45:1
1We recently put an article on the website about that that shares a little more insight.

As always, reach out to us or your relationship manager.

Always happy to have those types of discussions.

Derek mentioned the classic advances, and this is one big thing that we’ve been talking about a lot with folks.

When you have an inverted curve, the quick executive summary here is that the longer-term rates imply where they think short-term rates will be in the future.

So when we see an example like the one-year rate coming down into the mid-fours, we can extrapolate and say, well, what does that mean?

What is the market pricing?

The classic rate, the short-term classic rate, what would it be in months 10, 11, 12 from right now?

And it recently broke through 4%.

So it’s implying, it’s building in, it’s pricing in those expected rate cuts and the change in the rate term structure.

Whereas the current three-month rate is still in the low to mid five.

So there’s a couple of different ways that you can take advantage in and capture what is already expected in terms of what is priced into the yield curve.

First one would just be a simple modest extension.

So if you’re rolling short-term advances, you’re at one or three months, you nudge out the curve to the six-month or the 12-month mark, you’re going to save on interest expense immediately.

And again, you’re not going to necessarily miss out on the future rate cuts, you’re baking it in and borrowing across the full term.

The second one is something we’ve talked about before: forward-starting advances, being able to take advantage of current market conditions and rates but have the funds disperse at a later period.

And the two primary ways where folks have used this funding has been to pre-replace CDs, the larger CD book that many of us now have, but also funds coming to the end of bank term funding program.

And the last idea, something that’s been off the radar for a while, but those of you may have been familiar with from 2021 and 2019, at least as long as I’ve been around, it’s dependent on the path of rates and the level of rates, but it’s advanced restructures.

So, you’ll see some more stuff from us over the coming weeks and months related to this, because it now has come back into view a little bit.

But it gives you the ability to modify an existing advance, maybe something that you have at a five, five, and a quarter rate with six to 12 months left to go, and you can modify the advance into a new advance, and you get a couple of benefits.

You lower cost of funds immediately, you mitigate interest rate risk by moving out the curve.

The strategy is often referred to as blend and extend, and importantly, there’s no prepayment fee that hits in the current income statement period, that whatever implied prepayment fee there is gets blended into the coupon as you extend out to a further term.

So there may be some margin enhancement benefits, there may be some interest rate risk mitigation benefits, and there’s some liquidity risk management benefits as well.

So again, take a look at your existing advances, we’ll do the same, feel free to reach out for us and we can, we have a report that we can run in a matter of seconds that can tell you what, you know, what the potential may be there.

So that brings us to the end.We were the new record, only three and a half minutes over our allotted time.

So, we’ll give, we’ll give Derek the props for that for keeping me in line and, you know, doing a lot of the heavy lifting.

So, you know, as always, thank you very much for joining in.

We appreciate the partnership and, you know, this is always an enjoyable thing for us to do to be able to take a deep dive into what’s happening across our membership.

So, we’re not hard to find.

So, if there’s anything we can do or be of service and you’ll get these slides in the recording afterwards.

So, if you’ve found any of the slides or content interesting, you can share it amongst your group as you see freely.

But thank you again. This is a pleasure, and hopefully, we’ll speak to you all soon. Bye.