November 2024 Peer Analysis and Balance Sheet Strategies Update

Good morning. Hello, everyone. Thank you for joining us. Happy to have you with us here for our latest peer analysis and balance sheet tragedies webinar. I’m Andrew. This is Derek.

And, you know, we have a full agenda here today. So, those of you who have been with these webinars for a bit know the drill. We’ll cover three areas. And for those who are new, we’ll give a little 30,000-foot view on the markets and the economy.

We’ll take a deep dive into some takeaways we have from looking at a ton of call reports across banks and credit unions in New England.

And then lastly, we’ll talk about the different ALM levers we can pull that are certainly changing like the wind these days.

But to kick things off, let’s get some member participation and see what your crystal ball says about which way rates are going.

So we’ll have this poll question up that you can see on the screen here, and where do we think the Fed funds range, which is currently 450 to 475, will be at the end of next December? So, not next month, not one more month, but 13 months.

And we can see the results starting to come in here.

And it’s really fascinating, you know, how things quickly change, and we’ll get into more of it as we go.

But you can see here, from our perspective, it’s less about the actual number but really how we tag this.

We have higher for longer.

We have the hard landing and the soft landing.

And we wanted four answers, choices, so medium landing.

I don’t think we have heard really many people talk about the medium landing per se, but it’s the difference between the soft landing and the hard landing.

So, we’ll give it a few more seconds here, and then we’ll close the poll.

Well, we have a leader here in terms of where most folks are leaning, and it aligns with me personally.

So, 63% of folks were in the camp of the soft landing, the upper limit at three and a quarter to four percent.

You know, kind of interesting, and we actually had nobody who believed a hard landing was coming.

So that would be a really more aggressive changing rate. You know, it’s pretty incredible, and we’ll get into more of that as we go through it here. So we can end the poll, and then we’ll continue with the presentation. So, you know, for those of you who’ve been, you know, part of these webinars, you know, we like to have a lighthearted start, tie some intersection of pop culture, sports, so whatever, into the banking world.

And as we were brainstorming, I said, what should we do?

And Derek said, wow, we can talk about how the Yankees lost in the World Series a couple of weeks ago.

And I said, well, one, he’s a Massachusetts born and bred, so obviously that was top of mind for him, despite all the World Series titles, the Red Sox have won over two weeks, last two decades.

But I said, Connecticut, don’t forget, is a different story.

And in my mind, I always knew that Hartford was kind of the line there.

And we did some digging.

And I know you all come to us for all different types of analytics and research.

And we found this neat map.

It’s a little tough to see the exact towns, but you can see the graduation of the reds and the blues and the purple.

And it really runs through that middle of the state.

And, you know, what’s interesting as an aside, if we were to put on here where the 99 restaurants are, it is very, very close to the Yankee Red Sox line.

So, you know, I bet you didn’t think that we were going to start talking about the Red Sox Yankee line, or as it’s known, you can see up top, the Munson-Nixon line, you know, a play on the Mason-Dixon line, you know, harkening back to two famous baseball players.

So please report back if you’re down in Connecticut and you have any disagreements about the shadings of the colors here.

So, let’s get going into talking about the markets and the economy.

So, we used this framework when we did the webinar at the end of September to really distill the commentary from the Fed.

So there are two parts.

There’s the actual amount of the rate hike that they did.

So, in September, it was a coin flip between 25 and 50 basis points right up to the very end.

But here in November, 25 basis points were the consensus the whole way.

So it was really more about the commentary.

And we had to bust out the thesaurus and see if this was a stronger adjective than what they used last time.

So when we boil it all together, our take was that there was a dovish tilt to the commentary, so supportive of more rate cuts and more support needed for the economy.

But what makes this really interesting and challenging is that there were those hawkish clarifiers.

So you can see something like the unemployment rate is notably higher than it was a year ago, but it has edged down and remains low overall.

So I hate to say mixed messaging, but components of both a dovish and a hawkish tint.

But I think the key thing to take away from the press conference was the highlighted thing at the bottom.

We were talking about balanced risks between employment and inflation.

We think about the dual mandate that the Fed has: stable prices and strong labor markets.

As we’ve talked about, if you’ve been around for a bit, the Fed was laser-focused, and they’re super transparent.

This is not the Greenspan or Volcker Fed. They’ve been super transparent about having to kill inflation, right?

We’ve talked in years past about how Chairman Powell is out there saying pain. Inflation is painful for the economy, but the alternative is worse.

So now that they’ve pivoted to more of this balanced Perspective, they really think they potentially may have inflation under control, and the focus shifts to the labor markets. So, speaking of the labor markets, if you’re in the market for a scary or ominous chart, Here’s one because this is data going back to 1959, and this has been a pretty good predictor of when a recession may be coming down the pike.

So you can see the description of what the SOM rule actually is.

So it’s talking about the three-month moving average of unemployment relative to the minimum three-month average of unemployment over the previous 12 months.

And when that spread reaches 50 basis points to the upside, as you can see by the green line exceeding the blue line, when it hits that level, it goes up considerably more.

All those spikes in unemployment were characterized by a subsequent recession.

So, back in August of this year, it hit 57 basis points.

So far, this rule is undefeated in terms of being a recession indicator.

But I will caveat two things that have come up when we think about unemployment in the labor markets.

One, here, regionally in New England, we are doing much, much better than the broader national number, so that is something to be aware of.

And we’re also coming off of a much, much lower starting point, right?

So there’s, you know, some context there that all 50-basis point rises in a certain metric are not created equal.

But it remains to be seen, and things that have never happened before happening all the time.

We’ll see if this as a recession indicator is one of those cases.

So we’re in a really fascinating environment here where the Fed has pivoted to rate cuts, which is an easing action, but they still have a very, very large, retained bond portfolio that is rolling off that creates a tightening effect because it’s removing cash from the economy and the marketplace.

When we look at the glacial pace at which these bonds are rolling off, these are low-coupon mortgages and long-dated treasuries.

Well, this is just MBS, we stripped out treasuries.

If we were to continue at this pace, it would take about four and a half years just to get back to where we were right before COVID in March of 2020.

So, four and a half years is a long time for an interest rate cycle.

So to me, this gives me some support that the Fed probably wouldn’t hate the idea of not having to aggressively cut rates unless absolutely positively necessary.

That the more they can let time heal some of the wounds and let the retained bond portfolio, that other main tool that they have to administer monetary policy if they can let that roll off as much as possible before being forced into cutting rates, that’s probably what they’re thinking and want to see happen.

So, a little tongue-in-cheek on this question up here about what was supposed to happen to rates, but here we’re looking at not short-term rates, but intermediate and longer-term rates, and as many of us know, long rates are proactive in moving ahead of where they think short-term rates may be going in the future.

And it’s been a yo-yo over this last year or two in terms of higher for longer, watch out below, a pivot to falling short-term rates.

Well, right now, we’re not in higher for longer; we’re not in a watch out below, especially since we believe the poll results where nobody thinks that we’re going to 2% or below on short-term rates.

But Derek’s going to talk about the implications of the change in the shape of the yield curve.

But I will point out that in the middle of last year, there was a sentiment shift, and the bond market rallied pretty considerably.

And you can see those moves along the right-hand side, over 100 basis point down shock all across the board.

But since September, ironically, since it is almost to the day of the Fed meeting in September, we’ve given back some of those improvements there to different degrees, depending on the shape of the curve.

And you can see all those lines converging.

And we’ll have that as a segue into the slope or the return of slope in some ways to the curve, not quite slope, but sort of. Good way of putting it.

So, as Andrew mentioned, yields have been down across the board since last year, and there has been a bit of recovery since the cuts happened.

But the important thing to look at is the actual shape of the yield curve.

So back in September, the day after the cut, we were pretty negatively inverted, with high short-term rates and lower long-term rates.

But since that cut, the yield curve has moved significantly.

I track this almost every day now because there’s massive movement almost every day.

And it’s becoming much flatter.

So, short-term rates are starting to drop with the Fed cuts, but the longer-term rates are starting to move higher as well.

So, kind of flattening the curve and normalizing the curve, if you want to call it that, might be a very good environment for some of our members to start building their loan portfolios back up.

But it provides some more opportunities that we haven’t had in the last couple of years with a negatively inverted yield curve.

So, it’s something that I’m watching closely and trying to see what the repercussions of this can be and how it could be beneficial as well.

And one of those areas is, like I was mentioning, mortgage market.

So, we’ve done this graph a couple of times, but I think it’s important to take a look at it because it identifies where the spreads are on those mortgage rates.

Some of the anecdotal evidence we’ve heard is that loans aren’t growing, not doing as much for families, the residential mortgages, but the spread is currently still there.

There are some other factors impacting members in terms of how they grow their portfolios.

But it’s kind of refreshing to see that the spreads are there, the spread to the SOFR rate is there. So, as our deposit rates are coming down, maybe this spread will move back up.

Another important note to see is that at the time of the Fed meeting, rates were a little bit lower. Rates have moved up, but the spread remains.

So that shows a flat movement across the forward, which hopefully will make a more stable environment for members, and maybe that budgeting forecasting will work out a little bit in their favor going forward.

High rates and widespread, it’s music to the ears.

So, one of the things we would like to look at is the equities market.

So it kind of gives us an idea of where the economy is going and how strong we are doing right now.

And as you can see and as everybody’s been talking about, it’s just been an upward trend lately.

Typically, as rates go lower, the economy likes it and starts to show some strength, but it’s those market shocks that really disrupt the growth. Hopefully, we’re not moving into kind of a shock environment now, but as rates come down, we see the continuation of equities moving higher, and S &P continues to make daily highs.

So it’s really good information for us and a good indicator of where we’re heading into the future. So, all signs are looking up, just like the curve.

So aside from looking at the broad-based S&P 500, if we drill down a level and say, you know, what is the banking industry?

How are those publicly traded stocks fairing?

So, even if you’re a mutual or a credit union, I think it’s beneficial to monitor where bank stocks are going because it gives you a view of what investors think of the outlook for our industry.

And it’s almost the inverse of what we saw in the yield curve slide a few back, where since that middle of the year, as rates started rising and as the prospect of lower short-term rates was approaching, bank stocks very much enjoyed that, and have had a considerable rise higher, and we have seen more outperformance in larger, so we’re stratifying our member banks by the market capitalization size.

So, the larger banks have been greater beneficiaries; there’s more liquidity and volume in the stocks.

But the other thing to point out is, all the way along the right-hand side, you can see a little bit of a leg up, and that’s been in the last couple weeks here, where the curve has steepened that much more.

And that is, again, that has been music to the ears of many as well.

We had a member event last week, and people were doing cartwheels basically about the
Ironically, the curve is flat, right?

We’re not talking about 400 basis points of slope and a curve, but it’s all relative to where it’s been to what Derek was talking about, right?

The curve was inverted for two years, making things very, very difficult.

So a flat curve at this point, we’ll take it.

So, let’s jump into what’s actually happening on balance sheets, and there is no better place to start than what’s occurring in net interest margin.

We’ve been on the radar, but the hope was that we’d start to see some real considerable lift in the margin as a lot of those assets that were put on at low rates and low spreads in 2020 and 2021 start to roll off organically.

And maybe we will hit some exhaustion due to the rise in funding costs. But we’re not quite there yet.

So, interestingly, when we look at banks, we look at the top decile and bottom decile, the core tiles, as well as the median.

We see an interesting result where the median bank has not budged on NIM at very low levels, mid-2% range.

We have started to see some lift for at the high end, so both the top quartile and the top decile, and that makes sense because those folks who are truly asset sensitive or have been able to reprice their loans faster or have that much more discipline on the deposit side.

Credit union side, the improvements have been more broad-based.

So, we can see that in every grouping, we have seen at least 10 basis points of lift there.

And that’s an interesting dynamic.

We also know that scaling matters here.

So, look at the median NIM for credit unions at 335 as of September.

That is significantly higher than where things were just going back in 2022.

Contrast that to the bank side, where we’re 50 to 75 basis points lower in NIM than where we were just two short years ago.

So, what’s driving that?

And again, fascinating, maybe fascinating to Derek and me and not too many others.

But the answer is different for banks and credit unions.

So, when we look at the correlation or lack of correlation between a net interest margin and some key balance sheet and income statement metrics, what we see is that the asset side matters much more for banks.

So, the strongest correlation between NIM and NIM was the yield on load.

So that makes sense intuitively if you are able to reprice that much faster.

But I think it also gets to if you’re able to extract compensation and spread by your solid underwriting and your credit decisions, then you don’t have to rely on the yield curve and interest rate risk in order to drive a portion of the earnings and their spread.

However, I would point out that we should look at the cost of interest-bearing deposits and the loan-to-deposit ratio. There is really no correlation at all between what you’re paying on your deposits versus NIM.

When we flip to credit unions, it’s not the asset side, it’s the liability side that has the biggest driver.

The cost of interest-bearing deposits has a negative correlation.

It matters.

The cost of funds overall, it matters.

And I think we can attribute that to the structurally higher cash levels and the shorter loan portfolios we can see.

Used autos as an asset class tend to produce an awful lot of cash flow and allow the ability to reprice that much faster.

So, it really is about the durability and the strength of the liability side.

So, you know, sticking with the deposit conversation, so when we look back over the course of two decades, there really has been this big shift away from CDs.

And every now and again, when we have rates tick back up, we get a little bit of a bump.

And so, whether it’s technology or demographics or just the appeal of rates, the landscape has been changing.

And, you know, again, we mentioned we had a member event last week, and we had a lot of conversations about, you know, thankfully, it looks like we have in the rearview mirror the 5% for five-month CDs.

But a lot of folks are talking about what types of strategies and what types of things that we can do to be, if we want to lead and be competitive with rate for a particular reason, how do we do that in a non-maternity deposit instead of just saying, here’s a term deposit, here’s a special, let’s go for it.

So it’s the exception pricing, it’s the reactive pricing, things like that.

Because I think if we do see, and what it will be fascinating is, yeah, at 5% CDs have appeal, at 0% they have no appeal.

But if we do get to that soft landing, right, that 3% plus or minus level of short-term rates, how are CDs going to be viewed there, right?

Is there going to be demand for a 2.5% CD?

Or is that just going to be, well, you know what, give me the optionality of having a checking account or a money market account.

And strategically too, just based on that point, one of the things we were hearing is that there’s so much demand now that deposits are essentially digital.

You’re not going into a branch to get your money.

That’s a new play strategically that a lot of members are starting to utilize and look at to try to bring in that new money as well without necessarily having to chase the rates and drive that cost up.

It used to be a drive around and look for the big signs in the window. And now it’s more when I’m reading the online newspaper where the banner ads pop up with the CD rates.

So, sticking to the topic of CDs, we want to look at the maturity distribution and how short or long it is.

And it’s funny, depending on the rate environment, it can be a good thing or a bad thing to be short or long.

So when we had an outsized amount of CDs that were on the short end of the yield curve, in 22 and 23, that was not great because that just meant we had a lot more repricing and defense to play in order to retain and keep those deposits or even grow.

And we’ll talk about the marginal cost of funds analysis in section three.

But, as we sit here today, over 90% of CDs for banks are inside of one year.

So that does create some NIM tailwinds here.

And it may sound crazy, but if you had one of those 5% for five-month CDs and you’re going to replace it at four and a quarter, that’s an improvement in NIM going from five to four.

It doesn’t feel great paying four and a quarter for deposits when you still have a fair number of lower-yielding assets on the books, but that will lead to some incremental NIM expansion.

It’s a similar-ish story for credit unions, where we’re not quite at 90%, closer to about 85, 86% in terms of being inside of one year, but it is interesting that it wasn’t necessarily a straight shot from that 60 to 65%.

We did see some lengthening in 22 and 2023 or a reduction in the number of short CDs. And that’s kind of interesting.

You know, I’ve always been a proponent of testing the waters on longer CDs with low expectations for the ability to succeed in getting that because it’s very difficult, right?

Where’s the natural buyer of long-term CDs?

But, you know, test the waters because it does give you some flexibility, liquidity, and the rate risk cycle, and it gives you chances to talk about the value of a deposit beyond just the rate necessarily.

So, let’s shift to looking at credit performance.

A lot of talk has been about interest rate risk, liquidity risk, and all the pains and pressures that we’ve seen there, but many of us know that it’s usually credit that rears its ugly head, especially as we see pivots in the economy and the market cycle.

And, you know, this section on credit, our newest team member, Tyler, was a big part of putting this all together.

So many of you will meet him in person or digitally on screen in short order, but I wanted to shout him out because he did some very good work here on pulling together some of the credit metric analysis.

And here we’re looking at, for banks, CRE loan delinquency rates, but also looking at it in the context of where short-term interest rates were, and this is going back 30 years here, and you can see we’ve outlined how long of a lag there was between the peak in short-term rates and the peak in delinquency rates.

And the thing that jumps out to me, so anywhere between one and a half to just about four years, the thing that jumps out to me is that the longer the pause at the top, the longer the lag before we get to the peak in delinquency rates, right?

So you can see a very brief pause back in 2000 and then even a very brief spike in delinquencies.

In 06-07, we held at the top for a very long period of time, and then the ultimate peak in delinquency rates wasn’t for a number of years, closer to 2011 or so.

So, 2020 is similar to the first example. Now, what’s going to be interesting about this cycle is, as many of you know, We just had one of the longer pauses than we’ve had in a long time In fact, when we look at the inversion and how long the curve has been inverted The five years been looking at its watch for a while saying how come short-term rates haven’t met me down here low so this will be very something very interesting to track here, that if we do see pain in the credit books, is it going to come in a heartbeat or is it going to mirror this lag related to how long or short the pause was?

So, let’s get a little more granular and look at banks regarding individual loan types.

When we look at year over year, and then the prior year, we look at where there’s been some softening in past due and non-accrual rates.

Not surprisingly, construction and credit cards are where you probably would expect.

If I gave everyone a guess as to where things are starting to soften, that’s probably where we would all look.

It is interesting to look at the difference in the owner-occupied versus non-owner occupied CRE, where owner-occupied continues to trend lower into very, very low levels; well, non-owner is moving in the other direction.

I’ll also point out how low multifamily past due, and non-accruals are.

We don’t have the same type of granularity for the credit union call reports when it comes to this set of metrics.

So, we’re looking at something similar-ish way. We have seen gradual increases in non-performing assets.

When we look at consumer loans versus commercial loans in terms of dollar amounts, you can see that we are, as of the most recent quarter, a little more than 300 million across our entire district.

So this is like one giant. We put everybody in it, and it’s like one giant credit unit.

Over 300 million consumers have non-accrual loans, in contrast to about 75 million in commercials.

And obviously, we know that the consumer loan category is much more comprehensive and an important part of the balance sheet than the commercial.

However, I will point out that the non-accrual ratio of consumers to commercial loans on credit union balance sheets is about three and a half times that of consumers to commercial loans.

Going back two years, it was closer to about six and a half times the size.

So even though commercials are a much smaller portion, in terms of the actual loans themselves, the amount of non-accruals has been accelerating more relatively on the commercial side.

So, time heals a lot of wounds, even in the bond portfolio, but what heals wounds even more than time is bond market rallies.

So, you know, investments and the market values of investments have been the bane of a lot of people’s existence the last couple of years, but we have seen some improvements when we think about the unrealized loss position.

And so even in just the two quarters since, you know, rates in the middle of the curve really started to move, about 57% of banks and 38% of credit unions had a cost basis at 90 cents on the dollar or worse.

Fast forward to two quarters to September, and those numbers have come down by 20 to 25% of numbers.

And in fact, if you squint and you look at the top right of each one of these charts, there’s actually 3% of banks and 3% of credit unions who actually, amazingly, we haven’t seen this for a while, have cost basis above par, unrealized gains, right?

We don’t have to call them just unrealized losses.

It’s unrealized gains or losses.

So this owes to the ability to be opportunistic and add back into the portfolio at favorable yields and spreads.

We’ll talk about that a little bit more.

Now, pump the brakes on some of Andrew’s enthusiasm here.

We’ve marked this at 930.

We’ve seen the yield curve continue to move up a little bit since then.

So, hold the horses on the directional shift so that we may see some bleeding a little bit.

But again, time heals.

That’s the good thing about duration and fixed income math: they get shorter, and they get less risky, all else equal, as time goes on.

Yeah, so as we look at the yields, that’s a promising story, too.

Last time, I said I would have to update our buckets, and well, I had to do that.

So yields continue to rise quarter over quarter.

There are a lot more members within that three-and-a-half and above bucket for both banks and credit unions.

A couple of things at play here that could be driving the increase in yields is not only is the environment a little bit better, but there’s been a rally in the bond market.

However, credit unions typically act more bullet-like in terms of their investments.

So, you take a four-year bond, it rolls off, and say it was 1% during COVID, now you’re going to reinvest that into a 4% or 5% bond, so you have that pretty much immediate change in yield, and you can see that in the aggregate.

On the bank side, it takes a little bit longer, and there’s more duration risk there, an average life of an MBS bond is about five years, and you’re slowly adding back into that as payments come in the prepayments are down they’re not rolling over as fast as they would have in previous markets but slowly but steadily it’s coming here the yields are increasing, and now there’s more chance to invest back into the investment portfolio too in the new yield environment.

One of the things we’ve been taking a look at too over the past couple of years is the OCC interest rate report.

Basically, what they do is take a look at the OCC member banks and stress both NII and EV across different interest rate environments.

So we’re looking at down-rate environments, a hundred, two hundred points, all the way up to an up-rate environment of 400 points.

So, the results are pretty standard. It looks like most banks within the OCC are asset sensitive.

If they’re reacting the way we’d expect them to.

But one thing to note is that comparing these to November’s report of last year, the results
There’s less variance and variation between the high and low bands, and it’s much more centered, if you will.

So that’s a good sign.

It shows the banks are a little less reactive to sharp rate cuts, and possibly a good sign moving forward as well.

One of the things we’ve been taking a look at as well is loan growth.

One thing we hear from members all the time is that loan growth isn’t building.

We’re locking down loan portfolios.

And while that may be the case, it looks like there’s a pretty drastic shifting going on.

So in the bank space, you see construction and land loans going down, but at the same time, multifamilies are kind of picking up the pace and increasing as well.

Then, on the credit union side, new autos are obviously down quite a bit, but they’re just reinvesting in commercial loans.

So, while the overall growth is marginal and pretty flat, there is a movement going on inside the portfolios, which is something to watch, too, as the portfolio competitions tend to move over time.

So, something we’ll continue to keep an eye on and see how that can impact those loan yields and overall impact on NIM going forward.

So, staying on that topic of growth.

So I had lunch with a credit union CFO a couple of weeks back, and we were talking about how the pressure on earnings can be a potential barrier to growth if you’re sensitive to capital ratios because if your growth is outpacing your return on equity, then your capital ratios are going And he smiled and said, I put this chart in front of the board every time we see them, but great minds think alike.

So, thank you, Larry, for the inspiration here.

And we put our spin on it where we’re looking at quarter over quarter, the percentage of members who saw growth exceed ROE.

So, we can see those big spikes in 2020 and 2021.

That’s when all the deposits came flooding out of the sky, and we had six years of growth brought into one very small window.

But as we sit here right now, this was surprising to me, frankly, other than those first-quarter spikes that we see in credit unions because they get a little bit of a deposit influx. About 25% to 40% of members are seeing growth exceed ROE.

And again, that was surprising to me because of how stressed earnings were.

So you can see the hand side, you can see the area chart really drifting down to where the median level of earnings was just about 5%.

And growth has been scaling back as well.

So, the existential question is, are customers tapped out on loan demand?

We had phenomenal loan growth for a number of years there.

Are they saying no more in terms of finding the next incremental loan?

Or is it the institution themselves saying, hey, we don’t have the capacity to grow loans or grow the balance sheet at 10% anymore because we’re cognizant of where our capital ratios are?

And if we’re only earning 6% RLE because of the challenges in the shape of the curve and other factors, we don’t want to. We want to build up credit right now if we’re going to go through a change in the economic cycle.

So, let’s tackle section three here, where we’ll talk about some balance sheet strategies that are interesting to us.

So, you know, we’ll start it off with the question, where do we go from here, right?

We’ve talked a lot about where we’ve been.

And so here, when we look at where the Fed funds rate is and the fiber treasury, I think we have to have a perspective on where rates may end up.

You know, we put the poll question in there, not necessarily just to kill three minutes, because I think it is interesting and fascinating and because there’s a lot of uncertainty out there.

And if we were sitting in an environment where you could snap your fingers and get 10% loan growth, 10% deposit growth, and a 4% NIM and feel comfortable about credit, liquidity, and interest rate risk, then we really wouldn’t have to concern ourselves with that. But that’s not the nirvana that we live in right now.

We’ve learned from the last two years that getting caught offsides in terms of interest rate risk can be painful, not painful in the same way that credit decisions can be painful, but important, nonetheless. So, I think it behooves us to have a perspective.

And I think when we think about higher for longer, soft landing or hard landing, we touched upon this before, and we did certainly in September. When the five-year treasury is at 3.5%, there is not an awful lot of room for short-term rates to get to 3% and for the five-year to be an attractive point as a lending or investment reference point.

But now that we’re back north of 4%, I think you’ll see this in the following slides, I’d feel a little more comfortable about taking some fixed rate asset duration because there is some opportunity there and accordingly shifting the funding a little bit down.

So you look at this very fancy chart with no numbers down on the bottom here, but this is meant to be more of an evergreen thing.

So I think on the margins, when we think about our tactical decisions, as I said, now that we have a significantly less amount of cuts priced into the market. You know, that should direct us in terms of where we want to put our funding and what our thoughts are in terms of, you know, moving out the yield curve.

The opposite holds true; for example, in September, when the curve was priced perfectly for six, seven, and eight cuts, that created funding opportunities.

We certainly saw a lot of consistent long-term borrowing activity to say, well, goodness, I might as well borrow at 380 instead of just rolling 5% all the way down because, from an arithmetic perspective, it gets us to the same place.

But really quickly, I just have some questions about some of the key categories on the balance sheet.

This comes up with conversational numbers, too.

For as tight as liquidity is, for as challenging as the shape of the yield curve has been, the potential end of the credit cycle, loan spreads aren’t wide or widening probably more accurately.

So it’s no fun to tell your lenders, hey, we’re going to jack up rates, or we’re going to widen spreads a little bit.

But from a balance sheet perspective, certainly, if you are on the tighter end of liquidity, then there is a 30,000-foot justification for that.

Investments we’ll cover in a little bit.

But deposits, I think it’s important to note, you know, despite that that multi-decade secular shift away from CDs, you know, we spent a lot of time in a recent conversation with folks talking about depositor philosophy, excuse me, psychology, philosophy too, is that if you run multiple NII scenarios and it’s art and science, so when you look at the assumptions that you have for any migration within the deposit portfolio, if you think that the shift has occurred, that the plateau has occurred, that there’s no more CDs to, excuse me, non-maturity deposit to CDs, then you’re probably going to look good.

But if you continue to stress, have some stress assumptions, and say, you know what, as long as rates are still where they are, we’re going to see some people trying to lock in and turn out their deposits, then that’s an important question that you have to ask. And honestly, that feeds into everything.

That feeds into the question of whether we should continue to grow loans? Should we take out wholesale?

What do we do in investments? All those things, I think, start with the deposit side.

So, as we’re going through and talking to members about their funding options, we always start with the same couple of questions.

What’s important to you?

What are you looking for in terms of what your funding is going to be?

Is it your liquidity protection?

Is it term rate protection?

A lot of different answers are coming up now, especially in this downrate environment.

So, is frequent repricing important to you?

That’s one that we started to hear is becoming important, especially as people are anticipating cuts coming.

They don’t want to extend too long.

So maybe that’s an option for you.

Another good thing to look at is whether you want to have a call option embedded there.

So, it’s a little bit of a premium to own that call, but you have the ability to call the advance after a certain amount of time.

Business needs change. If deposits have increased a bit more, you have a chance to call that back and give it back to us.

So this matrix really lays out those different options, and depending on how you answer, the corresponding advance might be the best fit for you.

And in today’s world, those SOFR Callables and SOFR Index Advances have become much more attractive, much more favorable for many members.

So, looking at an example here, what we have is a three-month bullet advance at 471, and then you have a SOFR Advance across a couple of different markets there now.
42:07
So we just have our standard base case, soft landing, essentially hard landing, and almost crashing through the floor there.
But it just shows you the way the advance works with the market.

So, at the end of three months, if we have another two cuts coming, it’s time to make a decision.

You could call the advance.

If your deposits have increased, if we’ve seen that shift in the yield curve, and you’re self-funding through those means, that’s an option for you.

Whether you’re doing investment leverage, if you’re seeing prepayments beat up, if some of those mortgage rates are looking a little more attractive, and if some of your banking members are prepaying their mortgages, that could be an option.

It gives you the flexibility to not be locked into the advance for a full term, but it gives you that extension as well to help with some of your liquidity metrics.

So it’s a very flexible option.

It seems like it’s positioned very well right now in terms of this downgrade environment.

And again, it just gives you the option of flexibility, so you’re not locked in the long term, which we’ve heard is kind of one of those points for a lot of members not knowing which way the market’s going right now.

Yeah, so pivoting back to the deposit side of things.

This is a positive development, right?

We talked before about how the ship has sailed on 5%. We’re now in a 4% world. That’s going to help with the cost of funds.

But one question that I’ve asked people when we go around and almost to a person, they say, Yes, short-term rates are going down.

Funding cost relief is coming.

We’re so excited.

I’m kind of the fly in the soup when I say, well, has the spread changed in terms of where you can bring in a CD relative to the comparable term advance or from the non-maturity or money market side? Is the spread change between SOFR or Fed funds, right?

At the end of the day, we’re all spread managers managing the balance sheet and trying to maximize that differential.

So whether we’re in a 2% world or a 5% world, if you’re bringing in funding that is very close in rate to where you can get just-in-time readily available wholesale funding, then that doesn’t give you the room to generate that spread when you deploy it into the asset side, that’s independent of what the yield curve is giving us, right?

The positive slope, 400-basis points of the slope, is great, but you’re just extracting value because of what the shape of the curve is like, not because you’re getting plus 300 on loans and minus 200 on deposits.

So that being said, deposit pricing has gotten a little bit easier because of the passage of, you know, the passage of time and the direction of rates because, think about from this context, the marginal cost of funds analysis, which many are familiar with, and we have some analytics and quantitative things reach out to us if this is something that you’d like to take a look at. You can withstand more cannibalization right now for two reasons.

One, because simply rates are lower, right?

It’s not 5%, which is the clearing level; it’s probably closer to four and a quarter.

But the other part is, and it’s crazy that this is a good thing, is that it matters what the existing cost is like.

So when we were first losing deposits from 0% checking accounts, going into 3%, 4%, and 5%, the marginal cost of funds math did not look great.

There was a very, very small amount of cannibalization that you could withstand before, and it was not economically favorable to just borrow in advance, which is not just all about the math.

There are other things that go into that.

But math is math.

So, right now, you can withstand a little bit more cannibalization in order to price aggressively and bring in deposits.

So, this is just something to consider as you think about and as we talked about the depositor psychology in terms of how we communicate the value of a deposit beyond just I have the highest rates. Don’t go buy a treasury bond; this is the way to go. So, food for thought.

So, we talked a little bit, we teased a little bit about investments, and we talked about the ebb and flow in market rates and the opportunities, and we try to be, you know, in our position in the world here, point out things that are relevant and timely and potentially applicable and actionable.

And hopefully, you’ll notice that at certain times in certain market conditions, we don’t talk about certain things because we don’t think it’s particularly attractive.

But when things do come into perspective, and I know our team members probably have me muted on our internal Microsoft Teams chat, sometimes when I start pounding the table and saying, this is a great idea, they’re like, all right, I get it. It’s a great idea.

I think investment leverage or even investments right now look an awful lot better than they did just a few months back.

So we talked about people, really, you know, the sentiment of doing cartwheels over the shape of the curve.

Who would have thought a minus-eight basis point slope between the one-year and the five-year would have people excited?

But it’s more about where we’ve been and the relative change.

So, as you can see in the visual, there’s been an almost 100 basis point rise in the rate itself, the nominal rate, but more importantly, the slope of the yield curve.

So, a couple of things to point out: I’ve always been a fan of that mismatch leverage, that three to five-year asset versus the one to two-year funding because it gives you locked-in a spread for the short term, and then it punts the liability sensitivity to down the road where you have more capacity.

Most folks have more capacity to have an interest rate mismatch in months 12 or 24 and beyond than over the next 12 months because the deposits plateau or all those low-yielding assets start to roll off.

So, I think that gives you the ability to capture that spread.

And talking about that spread, and I’ve mentioned it two or three times already when the curve is inverted, or the curve is positively sloped, the return is driven by your interest rate risk choices.

And that is not a community-based institution’s edge.

Your edge is in your credit decisions and your ability to bring in funding.

So when we have a flat yield curve as we have right now, if you have the balance sheet capacity to look at some kind of a leveraged transaction, it’s not about the interest rate risk choice because if the advance rate and the treasury rate are very similar rates, then in order for you to get above 75 or 100 basis points, whatever the level that you have to clear is, it’s coming from the excess spread on the asset, whether it’s a loan, a mortgage-backed security, whatever the case is.

That is a much better place to be than, well, I’m going to take five years of interest rate risk and hope things don’t go against me.

So certainly, there are a lot of interesting opportunities, not just from the perspective of the asset side itself, but how you can fund it.

We’ve had conversations with folks where they’ve gotten closer to matching funding or really turning that out, right?

They do have interest rate risk front and center.

But then to Derek’s point, talking about the value in the floating rate funding right now, especially the SOFR Index Advance, then there really are opportunities to see that repricing and enhance the liquidity profile, but also getting the interest rate risk profile where you need and want it to be as well. So that brings us to the end.

And I think we went over by five minutes, which is better than the seven or eight minutes.

So, directionally, kind of like industry, directionally, we’re moving in the right direction, even if we’re not exactly where we need and want to be.

So, as always, thank you very much for everyone tuning in.

Thank you for your partnership as members.

We can tell you, and I’ll say the same thing, this is one of our most enjoyable things that we get to do because we get to take a deep dive into what’s happening out there across our footprint here in New England.

So, as always, if there’s anything that we can do, we can be a resource.

We can share a chart for you for ALCO or anything like that.

Just let us know, and we’ll be more than happy to oblige.

So thank you again, everybody, and I hope you have a great rest of your day.