Providing Liquidity in All Environments

The first two weeks of March 2023 were a unique time in the markets and banking industry as the FDIC took over a few large banking institutions. Historically, credit risk has been the culprit in most bank failures, but this time was different in that interest-rate and liquidity risks were primarily involved. As the dust settles and markets digest all that has happened in such a short period, there will be opportunities to discuss and dissect specific balance sheet strategies at greater length. But here we highlight the numerous ways that FHLBank Boston provides liquidity to its members, which is a core part of our mission.

Below we cover how FHLBank Boston accepts multiple types of loans and securities as eligible collateral, the varied range of advance products we offer to meet funding needs, the Mortgage Partnership Finance® Program (MPF^®), which provides a secondary market outlet for residential loans, and Letters of Credit, which can be used to secure and collateralize large dollar municipal deposits.

To secure an extension of credit with FHLBank Boston, members must pledge enough eligible collateral. For many depository members, residential loans comprise the largest percentage of pledged collateral. Depending on the specific balance sheet, the borrowing capacity afforded from residential loans may often be sufficient to meet everyday borrowing requirements and support contingent funding needs. However, it’s important to note that other loan types can also be pledged. FHLBank Boston accepts commercial real estate and home equity loans, which further bolsters the ability to borrow if and when needed.

FHLBank Boston also accepts different types of securities, including Treasurys, agencies, residential mortgage-backed securities (MBS), commercial MBS, and municipal securities. Many depositories typically elect not to pledge securities, retaining them on the balance sheet unencumbered so that they remain readily salable and contribute to the liquidity-ratio calculation. But as the path of interest rates has pushed many portfolios into unrealized loss positions, cash flow from investments is muted, and salability may be reduced as many are reluctant to sell bonds at steep losses. Pledging bonds can be a key step to enhance liability-side and total liquidity.

In this heightened period of liquidity risk, maximizing borrowing capacity can be crucial for navigating periods of volatility and uncertainty. If you have eligible loan types and/or securities on the balance sheet that are not being pledged, reach out to your relationship manager to discuss ways to increase borrowing capacity.

As we have discussed in articles and our February 2023 webinar, over the last few months the combination of challenging deposit growth, exceptional loan growth, and unrealized losses on securities has led to a greater need for wholesale funding on most balance sheets. FHLBank Boston offers advances to members in various structures along all points of the yield curve. Members have borrowed for many different reasons, including to mitigate interest-rate risk, build up liquidity, and simply fund deposit outflows or asset purchases.

One type of structure beneficial to members in this period of uncertainty is floating-rate advances such as the SOFR-Indexed Advance  and the Discount Note Auction-Floater Advance. Term floaters allow members to disintermediate interest-rate risk from liquidity risk. A member may desire a longer average life on their funding but may not want the fixed rate that a Classic Advance affords, preferring a shorter repricing frequency to potentially benefit if the Fed pivots to cutting rates.

The SOFR-Indexed Advance, in particular, can be valuable because of the index and spread components. The SOFR index has been stable and ticked down a few basis points during the extreme volatility of mid-March, which is to be expected, given SOFR’s structure as a risk-free rate. Additionally, compare utilizing a SOFR-Indexed Advance vs. a strategy of continually rolling a position in the Daily Cash Manager Advance. The locked-in spread of the SOFR floater minimizes the risk of potentially having to replace funding in volatile periods where spreads may be widening out.

The MPF Program allows members to sell mortgage loan production to FHLBank Boston and produce fee income, reducing the interest rate and liquidity risks that come with holding fixed-rate mortgages on the balance sheet. Unlike other secondary market products, MPF 35 allow the member not just to not only capture an immediate gain on sale, but also continue to earn income as the sold loan performs. For example, a member selling a conventional 30-year mortgage with a rate of 6.50% might receive a headline price of 101.33 (premium of 1.33 points) for selling that loan to MPF 35. However, the Credit Enhancement (CE) fee pays a 7-basis point trailer in year one and then 14 basis points thereafter as long as the loan is still performing. Using an assumption of a five-year expected life on the loan, the present value of the CE fee in this example would be just under 0.50. Similar to factoring in how the dividend lowers borrowing costs when using advances, the CE fee improves the economics of selling loans into the MPF program. To learn more about MPF, contact a member of the MPF team.

In addition to using pledged collateral to obtain new wholesale funding, members can also use collateral to secure public unit deposit funding through Letters of Credit ​(LOC). LOCs can be an efficient and cost-effective way to provide municipalities the safety they require for their deposits while ensuring that the funds remain, and are put to work, in local communities and institutions. An LOC can support liquidity metrics because it utilizes off-balance sheet borrowing capacity, which is especially impactful when loans comprise a majority of that collateral pledge. This is in contrast to pledging bonds directly to secure a municipal deposit, which can be more operationally cumbersome than LOCs and negatively affect the on-balance sheet liquidity ratio as the number of unencumbered securities are reduced. For more information on LOCs, reach out to your relationship manager.

"Mortgage Partnership Finance" and "MPF” are registered trademarks of the Federal Home Loan Bank of Chicago.

FHLBank Boston does not act as a financial advisor, and members should independently evaluate the suitability and risks of all advances.