ALM & Funding Strategies for the Current Environment

ALM & Funding Strategies for the Current Environment webinar
0:04
Well, good morning, everyone, and a big thank you for joining us today.
0:09
Well. It's an understatement to say that it's an interesting time in asset liability management and the funding world.
0:17
And, you know just to bring you behind the curtain a little bit, we sent this e-mail invite out for this webinar on the Friday when it just so happened that a $200 billion bank was taken over by the FDIC and that was not intentional by us, that was, that was a happy coincidence.
0:34
So, you know, last year, as Sean and I talked about what do we want to do for webinars and whatnot. And many of you are familiar with the quarterly Peer Analytics Webinars that we do.
0:44
But we also said, you know, a couple of days before the end of the quarter, let's put placeholders for just a generic ALM funding strategies webinar. And, as we get closer, we'll figure out what, specifically, we want to talk about.
0:59
And it just so happens that March of 2023 happened to be a pretty interesting time, you know, for depositories.
1:05
So you know whether that's a good or bad thing for giving us material to work with, we'll see, but in any event, I hope that we have a presentation here that you all will find to be worth your while.
1:18
So, the plan for today.
1:21
We have three main sections, but a little mini one is up at the top, where I'll talk a little bit about the recent events.
1:28
After that, Sean is going to talk about some big-picture liquidity risk management types of aspects, as well as then moving on to interest rate risk and prepayment risk considerations and strategies. And then I'll wrap things up with some funding ideas where we can tie together what's happening in the world and the yield curve with what's happening on the balance sheets.
1:49
So, let's, you know, jump right into the big Silicon Valley Bank elephant in the room here.
1:58
So, you know, we've all read all the articles, had all the meetings, fielded the phone calls about what happened there and how is it applicable to our institutions.
2:09
And when we think about, you know, to try and distill what happened with Silicon Valley Bank. It was really that the risks that they were taking were extreme, and they were interrelated.
2:20
​And that term interrelated does a little bit of foreshadowing to what Sean is going to talk about in a little bit.
2:26
So, essentially, there are two main things that happened for them. Is they put all their eggs in the basket of their deposit portfolio, concentrated in a single vertical.
2:39
And then they thought that that would be a natural hedge for the interest rate risk that they were taking with their oversized investment portfolio.
2:49
And then, to further protect tangible capital, they heavily utilized the held-to-maturity designation.
2:55
So, both of those strategies worked great until they didn't.
2:59
You know, the market put them into the cross-hairs and, you know, decided that they, you know, we're going to stick around for the long haul.
3:09
But in terms of looking at what's happening with our members here in New England, I would like to think that we have a pretty good finger on the pulse of what's happening with our banks and credit unions here in our six states, as well as we look at an awful lot of call report data.
3:24
So this chart on the right-hand side looks at the uninsured deposit ratio. Now, this is available for banks only, and banks above a billion dollars are required to report. So it's a subset of our membership here.
3:37
But when you look at the uninsured deposit ratio for Silicon Valley, as well as Signature Bank, you can see in excess of 90% and compare that to where most of our members are, in that 30 to 60% range. And then, on top of that, you have those darker circles. Those represent the Massachusetts DIF members who have 100% insured deposits, above what the FDIC guarantees.
4:01
That is not necessarily reflected on the way the call report puts it together.
4:04
So when you look at how extreme that liability side was structured, there's really no one in our district that is remotely close to having that type of unsettled funding profile.
4:18
You look at the asset side, they were, again, taking rather extreme risks, right? They had a rather large investment portfolio. They were moving up the curve. And they were also very leveraged right before you get into the tangible capital aspects of things.
4:33
So, in summary, you can't take all the risks all the time.
4:38
We have some members who have, you know, similar size investment portfolios or similar type leverage.
4:44
But not all the risks at the same time, like Silicon Valley, was taking. A little bit closer to home, it's certainly been an interesting time for the Federal Home Loan Bank system.
4:56
And, you know, many of you have seen the, you know, some of the news headlines about the amount of issuance that we had in the immediate reaction of the Silicon Valley crisis. And here's one way that we can put this into context.
5:12
In that one day, March 13th, that Monday, we issued $88 billion of floating rate instruments, which is the key tool that we used to fund advances demand from our members.
5:25
And that number was greater than all but one month, looking back over the last year plus on a monthly basis.
5:35
And as you might expect, the latter half of 2022 was a very busy month or period for advance activity because of renewed demand from banks and credit unions.
5:48
So, you know, pretty incredible and a testament to a lot of, you know, the hard-working people who put these things in place and were able to execute to meet the demand from our membership.
5:59
And I know a lot of folks may have attended a webinar that our friends at Darling Consulting Group did a week or a week and a half or so ago.
6:08
And I think they put into great perspective our role in the banking ecosystem in terms of how we have to issue debt in order to meet our advances demand. And many of you who came in during those periods were able to get the funding that you needed at the terms that you wanted and needed. And, you know, we're, we're, supremely proud of that fact and ability to do so.
6:31
That's enough for looking in the rearview mirror.
6:34
Let's look ahead to where do we go from here. And I'm going to hand it over to Sean. He's going to start talking about liquidity.
6:42
Nobody wants to talk about liquidity now, right now. Everyone wants to talk about liquidity right now. Thanks very much, Andrew.
6:46
So, you know, when I present here, I try to say, you know, a lot of folks have a lot of different liquidity metrics that they use to measure their liquidity risk on their balance sheet in their institution.
6:57
What I highlight here are a couple of different ways or about a half dozen to a dozen different metrics that people do use to assess that bucketed by asset-based liquidity and liability-based liquidity.
7:05
Asset-based liquidity being those things that you could potentially sell or turn into cash or borrowing sort of easily, or liability-based liquidity being those things that you actually use to borrow.
7:18
And how do we really think about integrating all of these different metrics is what I kind of hope to explore today because what I think is pretty obvious, especially from the SVB situation, is that no one metric tells the whole story. But each metric that you set along the way starts to influence all the others.
7:36
So, with SVB, for instance, their loans to deposit ratio was less than 50%. It was really low.
7:42
And then when we talk about sort of getting over their skis in terms of investment portfolio or interest rate risk, a fact that I haven't heard a lot of people report – their NIM actually went up last year. So that, no one particular metric tells it tells the whole story. You have to think about all the different metrics in concert with each other.
8:00
And so part of that is recognizing that there are hidden economic relationships among different types of risk and especially with ALM types of risk.
8:10
So, here I highlighted what happens. What's the inter-relationship between liquidity risk, credit risk, interest rate risk, and optionality.
8:18
And there are these different sort of ways that they interact with each other, that may not be instantaneously intuitive, but that have real effects on each other, and, to Andrew's point, you can't take all the risks all the time.
8:31
So, as you take one of these risks, you're actually starting to influence the other risks in a way that you might not necessarily immediately perceive.
8:38
So, with respect to credit risk and liquidity risk, one of the big ways is wholesale funding restrictions can be, can start to come into play when you start to flirt with well-capitalized ratios.
8:48
And moreover, your counterparties can start to pull back from you, whether that be correspondent banks, Fed Funds Lines, derivatives counterparties, different folks that you do business with could start to pull back as you start to get, start to experience some more credit risk.
9:04
On the interest rate risk side, you know, one of the hidden relationships that I think we've all kind of learned in recent times, and I've been talking about since I started here, is the fact that higher rates and a shrinking Federal Reserve balance sheet, though that's expanding now, argues for lower deposits in the industry.
9:19
And folks are really starting to experience that. I don't think a whole lot of folks necessarily have been thinking about growth model projections in their IRR and NII simulations in which higher rates equals lower core deposits. But that's clearly a risk that's emerged, that's being identified in deposit mix shifts, for instance. More and more balances are starting to move into CDs or to higher interest-rate paying products.
9:44
And so, again, interest rate risks start to interact with liquidity risk.
9:49
Optionality tends to get short shrift, I think, in a lot of ALM modeling, but as you, as we are potentially embarking on an environment where short-term rates, which have risen so dramatically this year over the past year, could reverse, there could be real changes to the composition of the lending book.
10:08
There could be real refinancing risk, and again there could be different balance sheet changes that emerge just from the optionality that happens with respect to liquidity risk.
10:23
Moreover, between the fact that they're sort of these hidden relationships among ALM risks, there are hidden relationships across the balance sheet.
10:31
So, you know, one of the, you know, highlighted at the front, what the different liquidity metrics are, asset-based and liability-based.
10:39
I think a big headline relationship, a big liquidity metric that a lot of folks use in a quick and dirty way, is loans to deposits, but as you think about this basic balance sheet that I presented on the left-hand side of the slide, assets of cash and investments plus loans ties out the liabilities of deposits borrowings, plus equity, suffice to establish a relationship between loans and deposits tacitly, we're also establishing a relationship between investments and equity.
11:07
Then, borrowings are sort of a valve that's bridging the gap between those two things and allowing for flexibility between leverage and growth opportunities and funding contingency.
11:20
And so, if we articulate one ratio here, or one guideline around most of deposits, we're already starting to move into this realm of, well, I'm saying something about investments and equity at the same time.
11:32
I'm also sort of implying something about borrowings as well. And so all those risks start to come together.
11:38
If we think about borrowing capacity, it's actually emergent from your asset selection.
11:43
So it's one thing to say, Jeez, we'd love to have more borrowing capacity and try to improve borrowing capacity, but that's also really hard if your whole book is C&I.
11:52
And so, thinking about how those different relationships play across the balance sheet is really important.
11:58
Finally, you know, capital ratios. I think a lot of folks don't necessarily think very strategically around capital ratios.
12:05
There's an exercise around, hey, we are above well capitalized or were a percentage point or two percentage points above well capitalized. That's good. But your growth in your ROE actually determines what your capital ratios are.
12:18
Capital ratios are actually sort of a running tally about what's happening with your profitability and your overall growth.
12:24
If growth is outrunning ROE, capital ratios are shrinking, and vice versa.
12:30
So thinking about where those capital ratios should be with respect to profitability and growth is also the sort of hidden relationship that really governs a lot of what's going on.
12:41
If we turn the table, sort of inwardly, to what's going on at the FHLB and how these interrelated risks, interrelated risks, play out with each other.
12:50
With your relationship with FHLB, I want to highlight the fact of how lendable value is determined for borrowing capacity.
12:59
There's basically three steps to the process.
13:02
The first step is valuing the assets. And so what we saw with one of the challenges with SVB is that they had so much in investments that were readily market observable. But people's lending books have the same sort of dynamics as the fixed income point.
13:17
So the fixed income book, we can go look up, you know, what bond rates are, and what bond yields are, and do some math on that.
13:23
People with fixed-rate lending portfolios, it's a similar dynamic, except it's not priced in the market.
13:29
But when lendable value is calculated here at the at the Home Loan, that market, that market dynamic is contemplated in the underlying asset valuation.
13:40
The second piece of the puzzle in determining sort of the overall lendable value is what the haircut is, and the haircut is based on the possibility of the assets' value being lower in a future liquidation process. And that could happen either because interest rates move against the asset over that time or credit or spreads widen.
13:59
So if credit declines and there's some level of organic risks that happens in a liquidation process, this is not dissimilar to what any depository is doing on their own borrower's capacity, where they're saying, OK, the asset is worth X. And we're going to take some LTV that's lower than X in order to sort of hedge our risks in the process.
14:22
Then finally, there's a collateral adjustment factor, which is basically based on the history of depositories pledging, the eligible collateral. I shouldn't say depository. Depository or insurance company pledging eligible collateral.
14:38
And so, if you think about this, again, you know, what we've seen with interest rates really screaming up over the past year, is that, for a lot of folks, they've seen lower levels of lendable value. And it's happening, basically, because of that fixed income math that's affecting the value of the asset more than anything else.
14:54
Sometimes, however, it's also the haircut, which is, again, sort of this complicated interplay that exists between the credit risk and the interest rate risk affecting your liquidity risk.
15:05
So if we look forward and think about what could happen if interest rates decline, that would argue for higher general asset valuations because of that discounted cash flow, fixed income math that will result in a better lendable value.
15:19
But if that's accompanied by increasing credit risk, the credit risk might offset the value that would happen from the improvement on the discounted cash flows valuation.
15:28
So it's something to think about here as you think about stress testing, contingent funding planning about how the different parts of the puzzle come together, figuring out lendable value. It's not a very, super straightforward calculation.
15:47
OK, so we talked about the interrelation of the risks. We talked about the fact that there is hidden relationships amongst different types of ALM risks. That there's sort of these hidden relationships that exist across the balance sheet.
16:02
And that even with respect to lendable value at the FHLB, interest rate and credit risk affect your liquidity risk. How do we actually start to set guidelines around this in a way that's thoughtful?
16:15
I think there's two temptations that a lot of folks fall into.
16:19
Risk metrics that are really loose because they don't want to ever hit those metrics, and there's also a temptation to be too tight. We don't want to take risks. We want to be super conservative about risks.
16:31
And what I'd offer is that a best practice is probably to try to find a narrow path between those two things, between the temptation to say, geez, we never want to get anywhere close to risk limits, and to be so super conservative that, ironically, in many instances, might actually be increasing the risk.
16:47
You know, we have heard from folks who say, You know, that's great, but we don't want to use a whole lot of wholesale funding.
16:52
It might be increasing your risk, actually. Right?
16:55
If you're not participating in derivatives activity because that seems like it has risks -- that might actually be increasing risk because you're not hedging the things that are happening on the other side there.
17:05
And SVB, for instance, might have benefited from doing some more hedging.
17:08
So, trying to find this narrow path is sort of a way I think, to avoid the twin temptations of being a little too loose and a little too tight.
17:21
Then, another practice that I would highlight, that's probably the best industry practice, is not to think about these risk metrics as a binary. It's not that loans to deposits at 100.1% is a disaster. And it's not the fact that you know, an NII simulation at -5.1% is a disaster when the guideline is 5%.
17:39
You know, there's very little difference that it's not giving you a meaningful information if there's only a pass-fail grade on all these metrics. And what I'd offer is there's a spectrum.
17:51
There's a spectrum of risk, and when you think about what your guidelines are, having a spectrum of sort of green, yellow, red, or even four or five different categories provides more meaningful information about how to operate. Where the lower levels of risk categories are actually showing where you probably actually want to operate day-to-day, and the higher-level categories are showing you those very extreme situations that you're going to avoid at all costs.
18:18
So then you do walk that narrow path between too loose and too tight. It's giving you good meaningful information about how to operate. While also showing you where those limits are, getting a little over your skis.
18:33
OK. Another sort of factor, how do we actually then say, OK, we want to set up a different risk spectrum. We don't want to have pass-fail metrics. There's all these hidden relationships that exist across the balance sheet that exists across the risks.
18:48
How do we actually think about determining principles for assessing what the risk metric should be?
18:54
And the final piece of the puzzle here, to me, about trying to figure out how all these things come together is identifying what your business strategy is and who your client verticals are.
19:05
It's a sort of an obvious fact, but it's also the type of thing that folks don't necessarily think about when they're prioritizing where their risk metrics are.
19:14
You know, upfront, I tried to highlight the fact that any one of these metrics starts to influence all the others.
19:20
If you pick one level on one metric, you're tacitly starting to assert where the other metrics should start to be.
19:29
If you're saying that you don't ever want loans to deposits to ever be above 90%, you're saying something about a minimum liquidity ratio that's pretty high because they are going to start to crowd each other out.
19:40
So, why should you pick one or the other, or how should you think about it? And I would say that it's institution-specific and it's institution-specific based upon your strategy and your client verticals. All right, so in this example, we say, you know, this particular depository has a strategy of saying, "OK,we serve small businesses and private practices, sole proprietors, and people in this immediate community.
20:03
And we do so with a lot of working capital lines, equipment loans, and construction loans, and then mortgages for people associated with it." Sounds like a commercial-heavy sort of an institution, a commercial bank that's probably doing a lot of C&I-type lending.
20:16
So if you're that type of institution, for instance, that has a commercial focus, a C&I focus, probably your biggest risk among those risks is credit risk. That's probably the single biggest one.
20:27
And then probably after that liquidity risk because you're choosing that higher level of credit risk, those that have assets with a lower borrowing capacity, generally speaking, liquidity is probably the next piece of the puzzle.
20:41
Then after that, it's probably option risk.
20:43
Probably interest rate risk is last on the docket because there are a lot of things that are going to float there, and there's probably a lot of DDA accounts that aren't going to reprice a whole lot.
20:50
So, if we recognize that the business strategy is then determining what the sort of prioritization of the risks is, then you start to calibrate what the different metrics are, based upon what type of risk you're organically assuming as an institution.
21:05
So, in this case, you probably want to have higher capital target ratios. They probably want to get the capital ratios a little bit higher.
21:12
Because the credit risk is where there are real problems. Then you probably want to have a higher minimum liquidity ratio to help offset the fact that you're probably not going to have great borrowing capacity.
21:23
Then, you probably want to establish a higher brokered CD limit because you're going to need that in order to help supplement some of the other liquidity challenges. You probably want tighter NII limits because everything's floating, and you don't have to worry about that as much.
21:36
That same type of thinking would apply to all kinds of different institutions, but it's just figuring out what are the interrelationships between the risks. And then, what type of risks are we organically assuming as a firm?
21:49
All right. So, I would just want to highlight some other ways to think about identifying principles for integrating these guidelines.
21:57
For Capital ratios, I would highlight that establishing a minimum at well-capitalized for all those reasons about restrictions to wholesale and counterparties and correspondent banks, establishing some minimum, bare minimum guidelines of well capitalized plus some internal buffer. And tangible common equity, about 1% plus some internal buffer.
22:18
What do I mean by that internal buffer? Maybe a percentage point? Some level that lets you sleep at night. "Hey, we don't ever want to go below well capitalized, plus 50 basis points or well capitalized plus 1%", or something like that.
22:30
Then, how do you actually determine the capital ratios?
22:34
I think a best practice on this, too, is to figure out your institutional stress test. Figure out something about what could happen under a severe situation. And then, look at peers. Where are peers at? If you know that you're a commercial, in that example, that commercial bank with a lot of C&I, and you look at your peer institutions, and they're all at 16% capital, and you're at 12% capital – maybe that says something.
22:56
Vice versa, if you're, if you're in a situation where you have 18% capital, and you have a sort of a balance sheet that looks a lot like a thrift where there's a lot of mortgages, residential mortgages. There's not a whole lot of credit risk. There are a lot of diffuse deposit accounts. Maybe the capital ratio is a little bit high, and there's an opportunity to do something more with that capital.
23:19
Loans to deposits. Again, we kind of highlighted that loans to deposits and the liquidity ratios around what liquid assets should have on the balance sheet are also highly related. When you start to articulate one, you're articulating the other because they're crowding each other out on the balance sheet
.23:35
So, again, I would offer an idea about a loans to deposits maximum of being 100%, which is an organic ratio that's going to exist. Organically, you would lend out your deposits plus some risk tolerance around maximum borrowings.
23:49
And that's going to vary significantly from different institutions based upon their clients and based upon their strategy.
23:58
Liquidity Ratio is basically the inverse of that. But what I highlight here is that because we are tacitly assuming something around equity going into liquid assets, that the minimum here is at least adequately capitalized, plus some plus some extra buffer, basically. And it's going to be inversely related to loans and deposits.
24:16
Then borrowing capacity is sort of, again, the function, trying to absorb the different losses that could exist on the liability side or that sort of hedging everything else that's happening between these other ratios.
24:29
So, again, all these different risks are correlated, and they all function amongst the different ALM risks.
24:34
They all function differently across the balance sheet, but we can still integrate different guidelines here.
24:41
And, you know, finally, I just want to highlight what peers look like. This is peer bank institutions because we're highlighting wholesale funding here on the right-hand side. Where do loans-to-deposits shake out amongst peer banks? The center of gravity is 90%.
24:57
And the boxes are showing you the 25th to 75th percentiles, and sort of the whiskers, the lines at the end are showing you the real maximum range. So, it gives you an idea about where where different folks fall on these different metrics.
25:10
Liquidity ratio elevated, from where it would have been about three or four years ago, prior to the COVID environment.
25:17
That mean is around 20%. Then total wholesale funding, upper single digits. That has, actually, probably the widest range of all for where people fall.
25:25
We got folks. You know, the bottom of the whisker is zero.
25:29
There are some folks who just don't want to use wholesale funding.
25:32
Then, there are some folks who are also funding vary very liberally in order to fund.
25:37
So, I think understanding where folks fall on this, too, is also a nice way to think about where you are and what your clientele is like.
25:48
Let's drill down into some more discrete strategies about, you know, the fact about where we are in the world, moving away from this sort of a liquidity metric guideline but thinking about actual strategies that we can apply day to day.
26:03
We've talked ad nauseam, everyone's observed ad nauseam all of the different extreme changes that have happened on the interest rate environment.
26:12
We've never seen the changes to Fed Funds in 40 years like we've seen here. The last time that we had so much of a change of 470 plus basis points in Fed Funds changes within a single year was 1981.
26:26
And outside of the early, the early seventies, late seventies, early eighties, kind of timeframe, we've never seen rates move like this.
26:34
Speed of the tenure gets a little bit, probably less press or less coverage around thinking about how much has changed. But last year, we had a move of 270 basis points or so within the year. The last time that happened was 1984. And that was the 10-yr going from 10% to 13%, a very different world, from the 10-yr going from about 1% up to 4%.
26:55
So it's been a long time since we've seen anything like this. And I would argue we've probably never seen anything quite like this.
27:02What, what does that left folks with? It's left folks with this really uneven distribution of mortgage coupons that are out there.
27:11
So, a lot of folks are bragging about their mortgage rates right now, rightly so.
27:17
And what that's left is depositories with a heck of a lot of lower coupon, lower-level mortgages.
27:22
This is an estimate based on what's publicly available for MBS coupons out there, and fully, 70 to 75% of MBS coupons are below, are 2.5% or less. And only a few percentage points or anything above levels that we see today.
27:37
So the vast majority of people's lending books probably look like this, where there's an awful lot of loans at the lower end of the coupon range. What does that mean?
27:46
Even if you're organically asset sensitive, normally, you're probably more liability sensitive than you think right now.
27:52
Both because catching up on the liability side and on the deposit pricing side is starting to happen, I think everyone's feeling that. But also because if rates do come down, it's because there's an air pocket that exists right now between where rates are and where you're actually going to see a whole lot of refinancing activity or a whole lot of resets of lending rates. It's, it's going to be a while.
28:16
So, if you're more likely to be sensitive then than you might normally otherwise be, and you're looking for liquidity in this environment where everyone's looking for liquidity. What are some strategies that are out there on the asset or liability side?
28:28
And so, on the asset side, to try to improve income today while managing these situations, selling lower coupon fixed rate assets kind of stands out as an opportunity that could be out there. Or slowing loan growth and reducing unused commitments.
28:41I
think that's starting to happen in earnest in a big way. If you look at sort of the industry-level data in recent weeks, loan growth really slowed, last week, it increased a lot, and I think that's line draws. I suspect that's actually a lot of clients going out there, just proactively drawing on lines in order to sort of hedge the risks that their line might get reduced in the near future.
29:01
So, slowing loan growth is a popular strategy right now.
29:05
On the liability side, it's a couple of different advance ideas that we have out there, but the one that would improve current potential income and potentially save the day for a lot of folks in 2023 is the HLB Option.
29:16
Let's talk about that first piece around selling lower couponing fixed-rate assets.
29:22
So, a program that some folks may be familiar with, a lot of folks use, obviously, but a lot of folks may not be as familiar with.
29:29
That we have at the FHLB is the MPF Program, which is Mortgage Partnership Finance.
29:34
And member banks that participate in this Program are called PFIs.
29:39
Basically, what this Program allows you to do, is to sell mortgages directly to us. So it's not pledging them as borrowings. It is actually selling them outright to us and selling them outright to us in pools.
29:49
​And what's different about it from sort of other opportunities. It's not a complete sale of the entire asset.
29:55
It's a loss-sharing arrangement where the asset is sold to us in exchange for a usually a low- to mid-single-digit credit enhancement obligation based upon the credit characteristics of the loans that are actually sold to us.
30:12
So, what this means is something like some nearly $10 million worth of loans, with a CEO of $350,000, 3.5% of the overall amount.
30:24
Then, as we think about what could happen in the last sharing agreement, the first 35 basis points of losses that would happen within the pool are absorbed by the FHLB.
30:34
After that, the potential losses are absorbed by the CEO. Again, upfront is, if any, equity you would get out of the situation and mortgage insurance would hedge it. But then, if there are any losses beyond equity and mortgage insurance, the FHLB absorbs the first 35 basis points of losses. And the most that any PFI is on the hook for is the CEO, the amount that's identified upfront, on the sale.
30:59
Then the benefit that occurs from this, too, is that there's a fee paid for participating in the Program of 25 basis points upfront if you participate in the upfront Program, plus, after a one-year time, seven basis points for ongoing performance based on the CEO.
31:16
So it's a little bit different than some other programs that are out there, but it is a way to sell assets to us while earning some fee income along the way.
31:26
And what's going for the MPF Program right now is the fact that a few different things have changed.
31:31
So if you haven't looked at this Program, or you looked at this Program in the past, a lot of things have actually changed that have improved sort of our positioning of it. First, our pricing got better. Like what happened with advances about a year and a half ago or so, with some of the resets on how advances were priced. Some changes were made internally about what the pricing is on the MPF Program. And so our pricing is probably more competitive than it has been in the past.
31:59
And second, you know is the liquidity environment out there, creating an opportunity to try to think about selling assets.
32:08
And third, it's the fact that Fannie Mae is changing some of their rules. So, if you're thinking about whether what other alternatives exist in selling your mortgage assets with, whether it be through us without the MPF Program, directly with Fannie.
32:23
Fannie's rules are actually sort of getting more onerous in many instances.
32:29
And Fannie charges loan level price adjustments on their mortgage program based upon characteristics like credit score, what type of property it is, what the balances are, exactly. And those loan level price adjustments don't actually happen with the MPF Program. It's kind of baked into the CEO.
32:47
And so, we have a tool that, if you contact your RM, they can talk to you about it.
​32:53
Jennifer Cowles is the Program Manager here at the FHLB and would be happy to talk to you as well about what the different opportunities are for MPF. But there's an opportunity here with the MPF Program that is better and better than it has been in quite a while.
33:11

And then, on the liability side, HLB-Option Advances. We said, you know what can we do to sort of improve liquidity while at the same time improving profitability? And HLB-Option Advances are sort of narrowing that in between two things here.
33:24
So what is happening with an Option Advance, again, is that you're selling the FHLB an option, and so you're getting a discounted price relative to a comparably term bullet on the lockout period.
33:37
​What's happening as you articulate a final term for the Option Advance and then a lockout period during which the Advance can't be called that overall rate that's being assumed in the Option Advance is lower than a comparably price bullet because you're selling us the options.
33:54
What's the risk? If rates are turned down tomorrow really quickly, the advance would stick around at the high rates compared to what you would otherwise experience. What's the benefit? You're getting a cheap advance in the meantime, for sure, and if rates are more or less the same, you can continue to have that advance on for an indefinite period of time at relatively advantageous rates.
34:17 
​And so a way to kind of think about this, and here's a look at what our pricing is relative to these bullets right now
34:23A way to think about this is to say on the term of the HLB-Option. What's the, what's the most I can live with, and what I'd highlight in this uncertain environment is, maybe shorter is more conservative, a little bit more in having a little more prudence around it.
34:38
It might be wiser for a lot of folks instead of getting way over your skis and being stuck with the advance for a very long time. Shorter tenors can work.
34:47
But then also thinking about on a lockout period, how long do you want to preserve that improved profitability, and if you're trying to figure out, how do I navigate 2023, where NIM is probably declining. We're not certain what's going on with interest rates.
35:02
Finding a term that's relatively conservative, like, two, three years, maybe, five years, and then a lockout period of six months, a year. It's kind of guaranteeing performance within a period of time, and it might complement the rest of your balance sheet when you're talking about being more liability-sensitive than you otherwise would.
35:21
Well, thank you, Sean. That was great stuff.
35:24
So, in this last section here, first, we're going to talk about what the heck has been happening with interest rates and the yield curve.
35:32
What does that imply for going forward?
35:35
And then, we'll play out three different scenarios related to Fed movements and how that impacts some potential borrowing options in which one bubbles up to the top of the surface as being better than some others.
35:47
So, first, on the yield curve, so. We're looking at the yield curve at a couple of different points in time.
35:55
And, you know, it feels like 100 years ago, what happened in February, but, if we remember, it was a pretty interesting dynamic that occurred that, in that, the phrase "Higher for Longer", had started to come into play an awful lot more, right?
36:12
The terminal rate, right, where the, what, the expectation, for the peak of the hiking cycle is going to be. Starting to drift from around about that 5% range, where it was at, to closer to 6%, from about 5.75% or so.
36:27
So accordingly, the entire curve that transition from the green to the dashed blue moved higher.
36:33
So this is in contrast to from late fourth quarter, all the way through January, where the yield curve came down and became more inverted which certainly was a relief for those unrealized losses in many bond portfolios.
36:48
Then from comparing March 1st - March 13th, we had the Silicon Valley Bank situation, which was a classic flight to quality. Treasuries were big. And we move down and rates, right? Greens to blue.
37:02
Then as the initial shock of SVB wore off, we're still in risk-off mode.
37:09
We had Credit Suisse, a globally systematic, important financial institution, was taken under.
37:17
After getting a lifeline from the Swiss Central Bank, which kind of, I won't say, went under the radar, but it didn't really break anything. So, the market was still in that risk-off mode. And then here we are today versus the beginning of March. We're in a staring contest, and we'll get to come back to that at the end between what the Fed has been signaling they would like to do versus what the market is beginning to price in.
37:45
So what's priced into the yield curve? We're talking about the inversion of the yield curve, and now we have the ability when looking at the advanced curve.
37:53
And knowing when the Fed meeting dates are, is to run some scenarios between fixed and floating alternatives and see what would have to happen with short-term rates to adjust those floating rates up higher to match what we can get on a fixed-rate advanced today. So for the example, looking at the left-hand side, we know that a three-month classic as of the other day when we pulled this, and I held my breath for three days, that rates didn't go completely wacky, and through all this out the window. But it was at 5.09% the other day.
38:24
And the starting rate for a rolling floating rate advance was at 5.07%.
38:31
So that tells us that there's a few basis points of hikes built into the May meeting.
38:37
In order to have those both equal 5.09% at the end of the term. We look at it, the six-month term. It's a little bit different because the fixed rate is lower 5.03%. So that implies, as we get to the June and July meetings, that there are some cuts built into the yield curve.
38:54
Now, when we think about the types of borrowing alternatives that we want to focus on, certainly as wholesale funding, is that much more important to the balance sheet versus the last one or two years, it comes down to two questions that you have to be able to answer.
39:10
What do we want our repricing frequency to be, and how much term liquidity that we're targeting?
39:18
So, now, let's think about the Daily Cash Manager, our overnight advance, pretty straightforward.
39:24
You get liquidity for one day, and, obviously, as the one-day advance, it reprices, on a daily basis. Classic Advance. Everyone is familiar with that.
39:33
You take a three-month borrowing, you get your term liquidity for the entire three months, and you get your locked-in fixed rates for all three months. Now, where the SOFR-Index Advance or Floating Rate Advances can be in supreme value is that you may not necessarily have the same target for your interest rate risk needs and your liquidity risk needs.
39:54
Let's look at a scenario where you are fortunate to be a very asset-sensitive institution.
39:59
But maybe you're liquidity light, like some of the examples that Sean walked through before. The term liquidity may have supreme value to you.
40:08
But you don't want or need the fixed rate protection.
40:12
You want your liabilities to be priced at the shortest part of the curve. So that if rates turned down, you'll be able to reprice. So, that's where you can unbundle. Just like our cable bill, we can get the long-term liquidity. But the short-term rate exposure.
40:30
So, this is an example of just showing you the variance in the spread for the overnight advance rate. As relative to SOFR and then this is dependent on a lot of factors, the shape of the curve and the expectations built into the upcoming Fed meetings. So, there is some convenience and operational efficiency to having the floating rate advance that is at a low locked-in spread.
40:56
Certainly, as you have a more permanent need for wholesale funding.
41:00
So, let's run through three scenarios and compare what happens to the fixed rate alternative, the floating rate alternative, and then we'll also throw in an additional advance that may have value in this particular scenario.
41:15
So, what happens if, despite what the Fed is talking about, we get an abrupt pause and pivot, where maybe there's regional banking crisis. We're not out of the woods yet that something else breaks aside from SVB or Credit Suisse, and the Fed is forced to cut rates at the next three meetings - 25 basis points at each meeting. As is pretty intuitive in that case, the floating rate liability would outperform the fixed rate because it adjusts and moves lower. You get an advantage by about 35 basis points or so.
41:48
Now, when thinking about, ok, well, there's the floating rate SOFR or does the rolling the overnight, which is kind of like a do-it-yourself Floater, which one will do better? In a scenario where the Fed abruptly pivots to cutting rates?
42:04
It's possible that and probable that's not going to be supportive to credit and volatility and that we would see some spread widening, and then that, again, is where the value of the locked-in spread would come into play.
42:18
We mentioned this at our last webinar in February. But, you know, this is a ripe environment for Floating Rate Advances given what the curve is, implying, in particular, the Discount Note-Auction, Floater Advance, or DNA floater.
42:33
So I would encourage you to look at those three characteristics, highlighted in the blue bars there, and see if those things are boxes you would like to check in terms of having longer-term liquidity but maintaining that short-term rate exposure, but also having the flexibility to prepay advances. In the fourth thing that's not mentioned here is that, of late, there actually has, in addition to those three features, has been a pricing advantage relative to the one- or three-month Classic Advances. So it can be a very attractive proposition.
43:06
So let's look at scenario number two.
43:08
What happens if the Fed doesn't hike, they don't cut, and they just stay where they're at 4 75% to 5% range on Fed funds right now.
43:17
Now, if the floating doesn't float, the math is pretty simple, and that you're talking about you're starting day one rates. So, which one is going to perform better, is going to be a function of where the starting rate is.
43:29
And you can see for the shorter maturities like we outlined a few slides back, the floating is going to have a slight advantage. But, as you get further out, the yield curve and you can see that inversion where the 12-month rate has a four handle on it, that's where the fixed rate would have some advantages if you were to extend your liabilities versus being in a floating rate liability. Hoping for a cut that never comes.
43:56
Sean mentioned the HLB-Option. That would be another advance type of funding solution that would benefit greatly in a drawn-out pause scenario because with everything on the table right now, hikes, cuts, big ones, small ones.
44:12
Interest rate volatility is at exceptionally high levels. So you get the benefit of the lower starting rate versus where the classic advanced curve is. And you can see some of the highlighted structures depending on the interplay of the maturity and the lockout. You can save anywhere between 100 and 250 basis points versus the classic alternative.
44:31
And, through all the points Sean mentioned before about especially being of value to those looking to enhance or support NIM today.
44:39
At, particularly if you're liability sensitive, then, you know, this is something that we've seen exceptional activity in, and it continues to be the case.
44:49
Let's look at Scenario number three, higher for longer., That, you know, let's say that this Silicon Valley stuff, the Fed, and the actions they've taken have kept it in check.
45:01
And that they turned their attention back to taming the inflation beast.
45:05
And they continue to push along and hike rates. I think it was one of the Governors – Bullard, maybe -- the other day, who was talking about 5.75% terminal rate is still on the table.
45:17
So, again, intuitive that in that scenario where we see hikes at the next three meetings, then the fixed rate alternative is going to outperform the floating rate obviously because rates are going higher, you've already locked in your funding cost.
45:34
In addition to that short end of the curve, that six-month portion that we were looking at in that example, extending out further would likely have significant value in this higher for longer scenario, as well.
45:48
And in fact, in the last couple of months, we have seen exceptional long-term activity.
45:53
So that's beyond one year from our banks and credit unions who have been recalibrating their overall interest rate exposure by extending their funding and also getting the liquidity benefits from that as well.
46:07
So, know, for those of you who did extend out your liabilities in 2022, or even earlier, kudos to you, and if you need someone to come to your ALCO meetings and tell everybody how great and smart you are, we are for, you know, we will be there in a jiffy. We're pretty liberal with handing out compliments to our member CEOs and CFOs. So just shoot us a note if that's something that you'd be interested in.
46:34
But in this scenario, where the short end continues to rise, you know, the long end today, as we're calling it, the one- to five-year range for most depositories, you get a starting date one rate at a lower rate than where you would be rolling short.
46:51
But in this scenario where the terminal rate goes closer to 6% versus 5%, well, then there is going to be this natural gravitational pull. That's going to pull that to a three-year part of the curve a little bit higher.
47:04
So if you are thinking about extending out liabilities, you can see noted here, in addition to the Classic Advance, is a symmetrical prepayment event. So I'd implore you to familiarize yourself with that. We have some material up on the website, and we're always available for a call and to provide further information.
47:21
But the key feature there is that just a two-basis point price differential versus the classic but in a rising rate scenario.
47:29
It allows you to collapse the advance, give the advance back, and capture the market value, and potentially produce again. So, doing some back-of-the-envelope math. Someone who had the foresight to put on the advance in 2020 or 2021.
47:46
You know, if they were to collapse the advance today, they'd be looking at a 4% or  5%, depending on the term that they went out, gained, Much like when you buy a bond, rates go down, and you capture the realized gain. It's the similar exercise, but just on the liability side.
48:05
That brings us to the end. Thank you very much, everyone, for your attendance. And we'll be following up with an e-mail where recording will be available, as well as the slides. I know there was a lot of information there, so you'll have it at your disposal.
48:24
And, you know, thank you again for your time and attendance.
48:27
And as I mentioned at the top, it's certainly been a wild last couple of weeks in our industry. And I hope everyone out there is navigating this as best they can for their institutions, and their customers, and their members.
48:41
And again, we are proud and thankful of what we've been able to do in supporting our members, and hopefully, it's been of value to you.
48:51
So, again, many thanks to you all, and have a great day.