Peer Analysis and Balance Sheet Strategies Update February 2024

Well, good morning, everyone, and thank you for joining us; happy to have you with us; I’m Andrew.

This is Sean, and, you know, today, we’re going to go through our Peer Analytics and Balance Sheet Strategies webinar. And if you’ve been with us before, you probably know the drill. Well, we’ll bounce around.

We’ll talk about what’s happening at big-picture capital markets, and the economy will take a deep dive into some trends that we were able to suss out from fourth-quarter call reports. And then, lastly, we’ll wrap things up with some actionable ideas that we can be thinking about on the strategy side.

So, you know, this is the part where our friends in New Hampshire, Vermont, and Maine are going to shake their heads in disgust that the southern New England folks. But last week, we were supposed to get a very big snowstorm here in the Greater Boston area. And the visual, on the left-hand side, there may have been some artistic creativity on my part, but this is what was forecast in terms of the snow drifts. That’s the Prudential Tower, which we sit in right here. So, you know, schools canceled at 2 p.m. the day before, no milk, bread, or eggs anywhere to be found in the grocery stores. But, on the right-hand side is what actually happened. It was kind of a dud. So, amongst many takeaways from that experience.

You know, I made the connection to predicting weather in predicting interest rates. That, you know, it’s not as easy as it may seem.

So, you know, that’ll be a common theme that we’re reminded of as we go through this presentation in terms of talking about the certainty of knowing what is going to happen.

You know, just be careful with the level of conviction on things.

Think your picture, there actually has more snow than we got in the city. That’s actually more than we got; you know, That’s when the sun came out, right?

Yeah, so let’s jump right in. So, we’re going to look at a handful of key indicators that are jumping out to us that, I think, will tell us a little bit about the, you know, taking the pulse of what’s happening. And then, you know, Sean will tell us when and by how much rates will drop exactly. No. I’m just kidding. I will do it. So, you know, let’s go to our first section here.

We’re going to talk about excess liquidity.

And, you know, we’ve talked many times about watching the level of balances in the reverse repot program with the Fed.

And this is important for a couple of different reasons because money market funds have seen explosive growth in their assets under management.

And we can see in the bottom panel here, first and the green line, the volume has been trending down pretty consistently since June of last year. And why is that date important?

Because that is, when the debt ceiling standoff, the most recent debt ceiling standoff was resolved, and so that brought Treasury Bill supply back into the market. So now these money market funds, rather than having the release valve of dropping that, their cash at the Fed, they’re able to term out, if they are so inclined to sop up some of that Treasury supply. And certainly, as we are potentially on the cusp of a pivot to lower rates, to the extent that they have conviction about which way rents are going to go, they’re more comfortable about terming out.

Now, you know, we look back to the last cycle, and we’ll do this a couple of times in this presentation. Looking at that, you know, late 2018 into 2019 period.

Because there’s similarities to where we are right now, in terms of hikes, into pauses, into an inverted curve. And, you know, to noticeable things, when we look on the top panel, and look at what happened with the RRP in 2017 and 2019.

The first is the absolute levels. Then, versus now, you know, it’s so much higher now, so, back, then you can see, in the top panel, the green lines went back and forth, between $100 million and 300 million before they ultimately declined down to zero.

Right now, we’re at about $500 million, whereafter comfortably cruising above two trillion dollars for over a year, so that’s first and foremost.

But the second thing to point out and we have an annotated on the top chart here, is that once the RRP effectively went to zero, right, exhausting all of that excess liquidity in the marketplace that’s not an automatic sign that cuts are coming right around the corner, so it took over a year for RRP to get exhausted before the first cuts occurred.

So, you know, again, this will be a common theme, that just because we look at a certain indicator that looks like in the hiking cycle, is getting long in the tooth. It’s not a binary situation where we have cuts and hikes only, as options on the table, Pause, and a long pause, is something that oftentimes gets forgotten.

So, we talked about the shape of the yield curve as being an indicator, as well. And there have been many breathless takes about. Oh, the curve is inverted. That means rates are going down. Run for the hills, right? But, you know, that’s not always the case as well.

We’ve talked about that, this in prior webinars that, you know, it can be awfully expensive to bet against the market if your thoughts still materialized right away.

So, it’s very interesting that in the last three months, we’ve seen this this tug of war between higher for longer and sharp pivots. So, right around Halloween of last year, we started to see greater inversion in the yield curve. And we can see that with these three combinations of steepness of the yield curve.

That I think are most applicable to depository institutions versus the two 10-year Treasury Curve steepness that, you know, many times, in the financial media, you’ll see, I think these three sets here matter can matter the most to depository institutions.

So, we saw that shift to a greater inversion and expect expectations of faster and sharper rate cuts. But around the middle of January of this year, things started to cool off a little bit. And we’ll get into that in a couple of different areas as we go through here.

And so, some of that euphoria over the sharper rate pivots has tapered a little bit. And we have seen more of this, more and more of a balancing act between when and by, how much short, rates may go down in the near term here.

So, looking more at a true economic indicator versus a market one, you know, let’s look at median hourly wage growth in green relative to CPI year-over-year change.

The oft-referenced inflation gauge. Now, those of you who have seen us before, you know that I like to get on the soapbox about the year-over-year change metrics and what that implies; we’re not going to do that today.

We will get back on the soapbox, maybe, at a later date. But for this, the key takeaway here is when the green line is above the blue line, that’s when the consumer’s feeling good, right?

You know, maybe CPI inflation is going higher. It costs more to live your life.

But if you’re getting paid more than, you know, it’s all relative.

And what we saw was in 2022, when inflation spiked up, and it was all anybody could talk about, wages kind of got dragged along with it.

But then, as CPI has cooled off back towards more normalized levels, we have seen wage growth continuing to remain high, which is a good thing for the individual consumer and translates into the banking credit union world. You know, it creates less need to spend down your savings or your checking account, in order to, you know, pay your day-to-day, week-to-week bills. And there are some other, you know, positive knock-on offense, effects for the economy, and for banking balance sheets. But, you know, that’s the consumer-centric focus. Sean, as it relates to corporate or commercial customers. There’s anything, you know, tangentially related here? Well, I mean, a couple of thoughts really quickly as you’re talking about wages relative to inflation, here as one is, there’s sort of a stratification that we’ve seen between higher income and higher skilled employees.

Hi everyone. Apologies for those technical difficulties.

But We’ll get it right back into things.

It would not be a webinar without a technical snafu for us. Unfortunately, no, it creates a, you know, an everyman familiarity. Right, but it does, it does, it’s just, it’s funny.

But what I was just saying, this is simply that, you know, there’s been a stratification of different wage earners and their perception of how their individual well-being and economic well-being have done. And in the 2010, we had a situation where wealth effect higher income higher school folks were feeling better about their position. But in 2022 and 2023, there was sort of the reverse of that. Where a lot of lower-skill, lower-wage positions actually started to feel better. There were a lot of folks who made $12 an hour who are suddenly making $18 an hour because it’s supply and demand constraints.

And so, that’s, that’s a dynamic that’s been, that’s been different.

And I’m not quite clicking here.

Our next slide, when we, when we are able to get it going, there, there we go. It’s trying to take a look at the very long-term expectations on inflation.

So, this is a look at what the five-year inflation expectation will be, five years forward.

So, it’s what will happen over the five years, five years from now. So, basically 2029 to 2034. So, a very long-term expectation, and this is a good way of gauging what the market might be, thinking about the Fed’s war on inflation.

How successful is this going to be, and how successful has it been? And so, the Fed has very famously articulated this 2% inflation goal.

And so, when you see inflation expectations go below 2%, which isn’t very frequently. You’ve seen it a couple of times.

Back in the great financial crisis, we had, obviously, a very significant economic decline, and that resulted in much lower inflation expectations for a short period of time before the full effects of QE and zero interest rate policy kicked in.

And then again, during the depths of COVID, when there was a lot of uncertainty, and the economy grinds to a halt in the spring of 2020, inflation expectations also really, very significantly declined. But recently, we’ve been, it hasn’t spiked too much. As you can see, even though inflation itself spiked, the very long-term expectations didn’t spike all that much. But we’re still, above that 2%, were about 2.3% today.

And so, one of the questions is going to be, how does the how does the market really perceive the changes and Fed cuts that could occur.

That’s something else I just wanted to highlight here as we think about Federal Reserve actions and Federal Reserve assumptions that start to affect bank balance sheets is the Fed stress test.

Again, this is the stress tests that the Federal Reserve provides assumptions about to the largest financial institutions in the country. I think this is actually 32 different institutions are subject to managing the stress test.

And so, understanding what the Fed is guiding folks to be able to withstand is really important for institutions of any size. Even if you’re not subject to this, as obviously, most of us on this call are not.

And so, what you see on this is that the Fed stress test actually assumes a 40% drop in CRE and a 36% drop in residential real estate. Again, that’s not meant to be predictive. That’s not what the Fed is saying is going to occur.

But what it is showing is that that’s what the level of resiliency that the Fed is really demanding of the largest financial players in the system: be prepared for and contemplate, and think about managing capital and liquidity, too, though, to those levels.

Again, it is not predictive, and we’re going to show some numbers here about what members have felt on credit as we get into this next section, which is around peed analysis and the call report, as Andrew talked about upfront.

Every quarter, we take a look at what happens on the call report, what can we find out about what’s happening here in New England, what’s happening with our members.

We’re going to take a look at all different parts of the Balance Sheet, and we’re going to take a look at all the different trends that we’re seeing with respect to growth, loans, deposits, and credit, as I just talked about.

I thought it would be really interesting to have a perspective on what has happened to NIM in this whole cycle to date.

You know, I think everybody realizes store thought, at the beginning, we were going to see really increasing NIMs, and there will be some pullback.

But I suspect that not a lot of folks thought we’d see quite the level of pullback that we’ve seen, especially on banks.

And so, here’s the full look since Q1, 2022. The first site was in March 2022 and through Q4 of 2023 is what that should read, actually.

You can see that thanks went from 3% to 335, and then down to 280. And the real decline happened in the first half of 2023.

That’s when you really started to see banks make up for the increases and what was actually happening there is liability rates started to reprice. Banks started to pay up on deposits.

And as you can see on credit unions, credit unions have been much more moderate in this whole cycle than banks have been.

They started at a lower level of them didn’t go quite up as much, and haven’t gone down back as much, and are actually still a little bit higher than where the cycle began.

And something to note about that, too, is that, again, you didn’t see where banks started to really pay up on their deposits. Credit unions haven’t paid up on their shares quite as much.

And that’s been the reason. And that’s the reason for relative outperformance and credit unions compared to banks in this cycle. One other thing you see here is that you know, the rate hikes obviously stopped last July.

So, we’ve had now a clean quarter with no effects around asset repricing. It’s just been purely liability repricing.

And something you see here is that NIM actually only declined seven basis points versus six for banks, and NIM actually declined more for credit unions. The cycle indicating that the bleed in NIM is abating hasn’t stopped.

And there might be more pain to come actually on credit unions more than banks because they’re starting to catch up on liability repricing in a way that they hadn’t prior.

What have our members done? What are the profiles? Because we see, OK, that’s the aggregate that’s effectively the weighted average of that prior slide for all of our members in New England.

The weighted average is not necessarily a look at what every institution has done.

Different members have had different experiences throughout the cycle.

So, what does that look like?

So, what I wanted to take a look at was to say how many of our members have actually been liability sensitive, and how many have been asked to sensitive over this entire cycle.

And so, the way that I define that was to say, if you had declines in NIM of more than 20 basis points, that’s liability sensitive.

And if you’ve had increases in NIM of more than 20 basis points, that’s asset-sensitive.

And if it’s in-between, you’re within 20 basis points, where you started, moderate.

And so, what has happened here, again, you see that credit unions relative to banks have been more asset sensitive, no surprise.

Given what we saw in the prior slide on them, and it’s actually more than 50% of banks at this point have demonstrated a liability sensitivity. And that’s been growing in the past couple of quarters; I think the last quarter was about 51 or 52 when I looked at it.

This quarter, we’re up to about 56%.

Just the opposite for credit unions.

More than half of credit unions have actually been asset-sensitive. Again, that’s starting to decline as we continue to have this slow bleed in NIM.

But this does give some perspective, I think, to folks out there about if you’re feeling liability sensitive, especially at the bank, you’re not alone.

And you can see also, too, that about 20% of our members are moderate and have kind of stayed within a pretty tight range throughout the cycle. Now, just go back to that slide for sure.

And if, if we had asked members two years ago to self identify where do where do you think you fall in those three categories, would there be we don’t think that there would be many people in those first two buckets relative to what actually happened over the last two years. Yeah. I think that’s exactly right.

I think a lot of folks thought they were more acid-sensitive than they’re proving to be.

And one thing that I do wonder about as we think about lessons to be learned for a future cycle someday is how much the speed of this cycle influenced these numbers.

Because the speed was so dramatic that, I think it forced a lot of liability pricing.

So, let’s take a look.

So, margins have declined, and more folks have been liability-sensitive than they thought they were.

Has volume been able to make up for the difference? So, if you put on, you can grow your way out of some of the margin problems, potentially.

So, here’s a look at what happened to our member banks.

And this is all these numbers for member banks are below $100 billion in assets for member banks, or it’s not unduly influenced by very large members. And what you can see here is that actually Bank NII, for the year of 2023, this is just the year, not the whole cycle, just 2023.

And I was actually down, and it was down because liability repricing has offset asset repricing to the tune of two to one about and that more than made up for the change in asset volumes that actually had growth. So, profit is actually down and most of our member banks.

And then what about credit unions?

Basically, held par for 2023, basically held serve.

And what you see here to again for comparing to the prior slide there where liability rates for banks was one billion, 1.2 billion dollars of extra expense compared to only $665 million of extra interest income associated with assets.

It’s on credit unions.

The pay up on the shares hasn’t been anywhere near as dramatic compared to banks.

And so, you see that the NIM is pretty tight, and the growth that you see in credit unions actually makes up for it. So, you end up with a higher overall NII.

Something else I’ll just really quickly highlight on this phenomenon, compare something that we’ve talked about, and prior webinar webinars, is that what was the single biggest driver for those banks that had the most liability sensitive?

It was loans declining deposits.

So, the loans were pushing the deposits, which caused the overall margin to decline. That’s the pattern that you see.

Higher loans declining deposits drive liability pricing higher to try to get more funding and then that pushes the overall margin down, more than probably you might expect.

So, let’s take a little bit of a look at some of the balance sheet components.

So, the first thing we’ll talk about is deposit growth, and we’ll look at it in the extremes or, in our parlance, a barbell, Alright? We’ll look at who was able to grow deposits more than 10%, which it sounds like an impossible task in this climate.

And then at the same time, we’ll look at what percentage of members had negative deposit growth quarter over quarter.

And if you’re in that boat of having negative deposit growth, you know, one of our goals here is to tell you that you’re not alone, as you can see from some of these numbers. So, first on, the outperformers, that greater than 10%.

So, 12% of credit unions and 15% of Banks saw exceptional growth last quarter, and some of it was brokered deposits, Not all of it, some of it was money flowing into term deposits, but not all of it.

So, I think what it really highlights is that there are some macro headwinds right now; nobody is. There is no denying that.

But, you know, to be able to just show up and have deposits fall out of the sky is not the environment that we’re in. So, we’re so really, the onus is on your market
.
Your business strategy, your verticals.

You know, what are you doing, You know executing upon successfully to be able to bring in deposits.

So, on the flip side, on the right-hand side, we can see that 55% of banks and 58% of credit unions saw negative deposit growth.

So, the macro headwinds are coming in at 50 miles, an hour, that make it challenging just for the average institution to be able to forget eclipsing that, you know, a mid-single digit hurdle, like most of us will put on probably during budget season, but we’re just talking about positive versus negative here

So, more than half have experienced that.

You know, let’s switch to loan growth, and as a reminder, if anybody has any questions or anything along the way or anything in general, we’re happy to field that as we go.

On the loan growth side, Again, we look at the percentage of members who are growing quarter over quarter by each of these various segments.

So, when we look at the percentage of members, it’s important the two ways to think about it is that the 40 to 60% range is kind of where you’re usually going to be, and we’re looking for the long-term directional trends that will tell us something as well.

So, on the auto side, bottom left, for credit unions, we can see things have been gradually declining over the last handful of quarters, and many of you remember in 2022, as some of the supply chain issues alleviated. Back then, that the activity really has been gangbusters and is, and it’s normalizing is how I would put it now.

one interesting thing there is that to look at that back and forth between when used a new autos go higher or lower, and that made to tell you something about, you know, The health of the consumer, right in periods where things are feeling, people are feeling good. New autos are above, and people are pulling back a little bit. Maybe it’s used autos where we’re seeing the demand for, moving to the bottom right, banks with their commercial activity, multi-family is steady as she goes, as one might expect.

CRE is similar to the Credit Unions and autos.

It has been coming back after, really, very, very strong levels in 2022, but still, what we would characterize as a, you know, positive levels of growth there. Now, on the CRE side, you know, certainly there’s a lot, you know, a lot of noise and news right now about the fear and chaos that I know folks are seeing on the commercial real estate side. But I think it’s important to remember for most community depository institutions, the type of commercial lending that they’re doing is not class A office space in major metropolitan areas, right? It’s much, much more nuanced than that.

So, you know, when there’s, you know, the breathless headlines about the world’s going to end in CREs is going to be the cause of it.

You know, as it relates to bank and credit union balance sheets, you know, a little, like we said, a little nuance and a little deeper understanding is probably warranted.

Up, top on the residential lending side.

You know, this has been one of the more fascinating things for us to observe, right, with the path of interest rates. It’s been to call it a challenging purchase, the market is probably underselling it, right? But we have seen balance sheet lots, loans, and residential loans growing more and so much more. So, and banks and credit unions. And, you know, I have a couple of theories as to why that may be. The first is, I think, you know, it might be that banks have more of a robust product set as it relates to arms and things like that, Where, you know, you can get the right data a little bit versus the, the conventional mortgage rate.

The second part is, now, I think it’s the NEV test for credit unions. That means that the long-term asset interest rate risk certainly, in this part of the cycle where deposit gathering has been challenging, the shift-to-term deposits will see that in a little bit. I think you know credit unions generally probably more sensitive to the idea of putting fixed rate duration long-term fixed rate duration on the books.

So, I mentioned that, you know, term deposits in the shift there.

So, this is this is again another fascinating thing that we’re seeing much like when Sean was looking at the NIM performance, that, you know, really banks and credit unions experiencing similar things, but there are more differences, really, than you might expect in this part of the cycle.

And what we see is whether this is looking at term deposits as a percentage of the total deposit book, and credit.

And as we might expect in this higher rate environment, more deposits, more term deposits are coming on the books.

And there’s certainly a shift from them now maturity side, but if you see where credit unions are today, both or are from the 25th percentile to the median to the 75th percentile, there are about 2 to 4% above where they were again, let’s call back to the 2019 cycle, where we’re 2 to 4% higher as a percentage of the total deposit book than we were where we were in 2019.

For banks, we’re about 3 to 5% lower, in terms of the CD concentration, and, you know, that’ll segue into, you, know, trying to figure out some of the explanations there.

So, I think it’s probably intuitive for most to say, if you have a greater reliance on term deposits, well, then you’re going to have higher interest costs, right? That’s one of the things that, you know, we think we all know about banking, and so when we looked at the combination of those two factors, right?

Term deposit concentration versus the cost of interest-bearing deposits. So, it’s not cost of funds or removing wholesale funding. We’re not even looking at cost of deposits to, which will get now maturity, you know, non-interest-bearing accounts in the mix. So, just interest-bearing deposits and back at the end of 2021, very similar correlation for banks and credit unions point seven, approximately, where, if you had term deposits, that meant you had higher interest costs.

What’s happened now as this cycle has moved on and rates have moved higher, and you can kind of see it by the shape of the blobs there, on the scatterplot, is that credit unions have maintained and actually improved. You know that relationship. Right?

Where rates have gone up, but so has, and so does the concentration on CDs. With banks, it’s a little more over the place, and that’s and that’s borne out by that, the lower correlation that we’re seeing.

And I think the biggest explanation here is the customer base. When you think about the credit unions, you know, looking at in aggregate at the credit unions, it really is a very nice proxy for the retail customer. We don’t have the granularity just by looking at call reports that many of you do and slicing and dicing your deposit portfolios ever every possible way.

But when we look at, particularly on the left-hand side and look at the experience that banks have, and seeing that that drift is moving to the right in terms of higher cost of interest-bearing deposits and not necessarily perfectly correlating to the shift in term deposit.

So that tells me though those commercial depositors, who you are, probably not the biggest fan of the term deposits, that under the hood, there’s an awful lot of exception pricing and tiered pricing that some of those money market accounts are receiving. So maybe the term deposits aren’t growing, but it’s really so when you get down to strategies in the deposit portfolio that’s knowing it inside and out and knowing what you have to do to meet the needs of each customer that you have, to keep them there at a cost that makes sense for you and your balance sheet. Right. And Sean mentioned before, you know, the loan to client deposits being something very important.

That if you’re lending then maybe that gives you a little capacity to go out and gather deposits even at a higher rate. So that was so since we’ve had that exceptional loan growth, you know, that’s a next-level analysis that maybe we can do and see those folks who have really moved far to the right on that on that chart, I would suspect that those are the ones who have seen the phenomenal loan demand.

So, let’s look at the investment portfolio. And, you know, the move in interest rates this last quarter was a good thing for that anchor around their neck, which is the unrealized loss in the investment portfolio.

So, somewhere between 2.5 to 4% improvement in terms of the median unrealized gain that banks and credit unions are currently exposed to. And now, that’s, you know, when you think about the five-year Treasury, use that, as a proxy, moved about 80 basis points from 930 to 1231.

That gets you in that that 4% range when you do that back-of-the-napkin duration math. But it’s probably a little light.

So, what does come to mind is that after digging through and analyzing the bar chart on the right, we have seen an improvement in the quarter-over-quarter change in yields. The last few quarters, which my initial theory, going back a couple of quarters ago, was that we’re going to see that slow down. Because of the tightening of liquidity. And folks, not just necessarily growing the investment portfolio but even replacing the cash flow.

So, whatever meager cash flows are coming off from the 1.5%, know MBS that you may have bought it at low rates in 2021. Well, if you’re just maintaining a constant level, you’re going back in at 5.25 or 5.5, so that’s going to lead to a little bit of a bump all else equal.

But I think, no, there has been some balance sheet flexibility. And, certainly, liquidity and capital are at a premium. So, it’s difficult.

But, to the extent that you can put things back in at much higher rates, much wider spreads. Sean has talked about in past instances about putting on positive convexity on the asset side of the balance sheet, which can pay dividends if and when we do see a turn on the rate cycle.

So, I think that that’s something that, you know, in spots we have been seeing occur across the district.

So, let’s talk about credit stress. So here we’re looking at reserves to non-performing assets. And, you know, there’s two ways we can tackle this, right, we can increase the numerator, or we can keep the denominator flat.

And, you know, this is looking at all quarters going back to 2019 and breaking it out by the median, but also those who are more or less conservative on their approach, you know, to these coverage ratios.

And I think what we’ve seen in recent quarters is that you know whether you’re conservative or aggressive or right in the middle, you know, the coverage ratio has come down a little bit in prior quarters, and. And.

That’s OK. And it’s not necessarily. Non-performing assets have started to tick up a little bit. Probably not to work up to troubling type ranges.

I think part of that was we were so well reserved in 2020 and 2021, waiting for that credit storm that never really came.

Then, with the implementation of CECL, reserves were in a good place.

And, we weren’t really seeing assets go bad, but, you know, the last thing I’ll point out about credit here is certainly, over, call it the last 11 months, liquidity risk and interest rate risk as it relates to banking industry health has gotten a lot of press, right? You know, especially going back to March of last year. But many of us who’ve been around for a bit know that, usually, it’s credit. That is, is that the scene of the crime? So, you know, certainly, no one is forgetting about credit. You know, put aside the, you know, the CRE, you know, conversation. We just had a few slides ago. But, you know, all in all, I think credit from both the numerator and denominator side of things is a pretty healthy point.

And, if we think about this, you know, our folks getting paid, or folks getting paid to put out to take on that credit risk into it and to assume those deposit costs. So, I want to take a look at what, what is the distribution of loan yields across member banks and credit unions, perhaps surprising, at least surprising to me when at first blush, is that remember, banks actually have slightly lower loan yields than credit unions, but both are right at about 5%. And here you can see the distribution. It’s no surprise that an S distribution where there’s a small percentage of folks very much at the top of the distribution with much higher loan yields and other places, And a small percentage of folks with much lower loan yields at the other end of the distribution. But again, you can kind of see where folks are. And what you see here is that that middle 50 percentile, middle, 50% of institutions are in the high fours to the low fives and overall loan yield.

So, a good perspective, again, on how your institution might be doing compared to other institutions is to see how have you performed on ask the sensitivity in your loan yield relative to other folks.

So how do we use this? How do we use all of this?So, we talked about all this peer, peer analysis and peer data. We talked about the macroeconomic backdrop.

I’ll talk a little bit here about margin headwinds before Andrew is going to talk about how you can actually actionable, take care.

Take advantage of this situation with an inverted yield curve and given the margin pressures that are out there.

And to that point, I want to talk about, again, a little bit more about the margin pressure and to try to think about a perspective on how much more is there to go.

So, this is a slide that I’ve shown in the past, which is a look at what has what happened in the 2004 to 2006 cycle, And then, and just beyond it as the pause happened in 2007.

What happened to interest rates on what happened to deposit expenses are member institutions or member banks. In this particular instance, if you can remember that cycle, Fed funds went from 1% to 5.25% over the course of two years.And this cycle, we went from 25 basis points to 550 over just over a year, about 15, 15 months. So, a much faster cycle to the point that we raised earlier.

But similar, pretty similar in coming off a very low level of rates for a period of a couple of years to a much higher level over the course of a relatively short timeframe might be a good precedent for us to think about where deposit expenses could shake out.

And in that cycle, at the peak of the cycle, it was during the pause an extended pause where deposit rates topped out just below 3%.About 2.9% off a base of 1.18%.

And, again, like the last cycle, this time deposit rates were actually slightly higher than where the Fed Funds Rate where it started.

And then, piqued seemed to be piquing getting to a place significantly below where they were to no surprise.

But also, of note, here is that deposit rates didn’t come down quite as fast as Fed funds came down.

So, something else to think about as we go through the cycle here.

And so, if we think about that data, what has happened in that prior cycle, and what could happen in this cycle?

In that prior cycle, the effective beta for banks was 41%, just over 40%.

I think a lot of folks in the industry have recognized the fact that a lot of banks model about 40% effective betas over the course of the cycle. That’s what they saw in 2004 to 2007.

What has happened so far?

If we just want to look at the bold numbers at the bottom, there between banks and credit unions in this cycle to date.

Banks are at about 34%, and credit unions are at about 24%.

And so, if we do the math, if we apply that prior beta to that 2004 to 2006/7 cycle and apply to this cycle, that means there might be another 37 basis points of potential exposure out there.

And that doesn’t mean it’s necessarily going to happen.

But I think that starts to give a ballpark at how much more deposit rates could bleed over the next couple of quarters while we’re in this pause waiting for the Fed to act.

And nobody’s quite sure when that next shoe will drop. Next, you will drop on the rate cut.

There might be another, you know, 37 basis points of deposit, expense exposure out there.

And to Andrew’s point to a little bit earlier, it’s hard to wake. You can’t really roll out of bed and make a 3% margin right now.

And why?

Because we’ve your funding, probably in the fives on the margin, through CD issuance, through borrowing from the home loan, or other wholesale sources, funding is probably in fives at this point. And then loan yields are because of the inverted curve, largely.

Nowhere near that, 3% extra spread above that. So, here we take a look at just different indices and different spreads across those indices. If we took a look at something like SOFR plus 200 or 250, you’re in the mid-sevens. If you’re taking a look at 10-year treasuries plus 250, you’re in high sixes. You’re taking a look at a five-year home loan advance, plus 225, you’re in the high sixes or so.

If you’re funding in the fives on the margin, and you’re putting on assets in the high sixes and sevens, obviously, that’s going to be not accretive to margin on day one and identifies the importance of putting on some of that positive convexity that Andrew has talked about on the one side.

Well, with that, terribly uplifting note, let’s, you know, what can we do? Right.

So, Sean mentioned the yield curve is inverted.

And, you know, one refrain we hear from a lot of folks is what we’re staying short on our funding because rates are going to go down.

Well, no, there’s no free lunches in a yield curve.

It’s you know, we can do the math all day long, and you know that the refrain that should be amended to, say, where we’re staying short on our funding because we believe that rates will go down more than what is currently priced into the market, Right? So, you know, the shape of the yield curve effectively prices in the future expectation of short rates, so without going on too long of either speech or rant about the yield curve, pricing, implied rates, and whatnot. So, let’s look at where rates were in mid-January, right? When we talked about the sharp pivot had really kind of picked up steam, versus now where things have softened a little bit. So, the one-year rate hit 476 on January 12th, the one-year classic advance.

You can get to that total interest cost of one year, 476, in two ways: borrow the easy way for one year for 476 or roll short-term advances based on what is implied in the current market rate. So, three months borrowing, again, in three months borrowing to get three months, and then do it again for a fourth period.

So, we can find out what that rate going forward is.

So, if you look along the bar chart on the right-hand side, back when the one-year rate was at 476, that was implying that the three-month rate nine months from now, so that’s months 10, 11, and 12 is implied at 401.

So that’s approximately 150 basis points lower than where we were at that time. So, if you’re about, if you’re of the mind and your balance sheet is in position to take advantage of that and say, you know what?

I don’t think that, you know, we’re going to see that level of, of rate decline over that period or it’s complimentary to my balance sheet to, to hedge against that. Then rather than rolling the short term, you know, incrementally extending out, can have some value.

We’ve talked a lot in the past about how the HLB Option, the putable advances, have been very attractive and very popular with our members to create some cost savings, certainly in this challenging, margined environment. But a wrinkle to that that you may or may not have noticed. We noticed Dan Redmond noticed and be curious to see if anybody else noticed it in our daily rate e-mails. You know, often put rate indications out there for a variety of different structures to give you a feel for, you know, it would be overkill if we put all 56 structures in there every single day. So, we put a sampling of three or 10 in there. But recently, we’ve seen a lot of value in some of the shorter maturity finals, namely, 12 months and 18 months. Now, the cost savings versus the classic advanced curve are not going to be the same as the three and five years because you get more bang for your buck there.

But it’s a tradeoff, right between the potential extension risk that if rates do pivot sharply to a lower rate environment, that you have that shorter maturity, that will allow the maturity to naturally roll off and not extend.

And then, you can be in that advantageous position of a lower rate environment, an environment more conducive to gathering and retaining cost-effective deposits, then gladly take that wholesale funding, pay it off, and grow that deposit portfolio backup. So, you can see some of the cost savings here for some of those shorter maturities.

So, I said, I think that if you’re rolling short-term advances, you know, you’re well into the mid-fives, that there’s some opportunity here to peel off some of that piece and maybe take a look at some of these shorter structures.

You think we’d have a 50% chance, right, up or down. Or if it’s a confusing click or batting like, it’s a really a few hundred, here.

Um, so to that end of putting on some funding, that, that’s liquidity, metric friendly. The rub is always that. OK, well, you know, maybe I liked the idea of extending out to one year.

But what happens if I get a flood of deposits or my asset cashflows accelerate?

Well, I would argue that for asset cash flows to accelerate, you’ll probably need 300 basis points of rally, maybe even more, right, so the likelihood of that happening is probably pretty low. Unexpected deposit inflows, your mileage may vary, but that’s probably a greater probability than the asset cashflows, but, you know, from a conservative standpoint, if you’re saying, Well, I want to extend my funding, but I don’t want to get caught with too much wholesale funding. Well, then, you know, we have some advance rate advance products where you, you control, the member controls the option to pay down the advance.

So if you’re rolling short-term advances, like a three-month classic advance, for example, our DNA-Floater, Discount Note Auction-Floater Advance has recently been pricing, and it has been for a while. Very, very similar. All-in rate. And you can see it.

In fact, it was one basis point, cheaper when I priced it out the other day, but on the right-hand side is really where the value is. Because it is a 12-month advance. You had the benefit of, from the liquidity metrics, saying, this is a 12-month funding reprises every three months.

But the beauty of this advance that every time it reprises in this case three months, we do have a one-month version as well.

You have the ability to prepay the advance with no fee, so this creates the opportunity that you can have liquidity-metrics friendly funding, but still retain that flexibility to recalibrate the amount of wholesale funding you have.

Got it on the last slide here.

All right. So, another idea that I think is a value. It’s under the advance side. It’s on the mortgage purchase side.

So many of you who may be familiar with our MPF program where we buy mortgage loans from members. And you know, aside from current production flow, that you may look to immediately sell and take a gain on.

We also have the ability to buy season loans, And however we you define season.

It could be something you’ve portfolio for a couple of months, or it’s been on the books for years.

But know, that there’s a couple of different rate environments that we’ve seen in the last couple of years.

So, certainly, there was a high volume at very low rates in 2020 and 2021. Those 3%, you know.

As many had so much excess liquidity that they were putting these on the books and now they’re underwater, so, you know, to think about selling these.
I
t’s almost like the investment loss trade that this is not something that happens in the silo of the mortgage group or Treasury, for example. This is, you got to get everybody on board. This is ALCO.

This is the board you got to look at, you know, your capital and earnings position and your ability to absorb the income statement noise.

So that’s, you know, as you looked at ways to bolster your liquidity, that’s certainly an option.

But aside from that, you know, those selling loans at deep discounts, You know, there could be an opportunity as well, in more recent production, right you know, a lot of that, we mentioned before, a lot of activity has as flowed towards adjustable-rate products, but to the extent that there were a fixed-rate loans being portfolioed in 22 and 2023, if you have something that maybe you got your top tip, where rates were. So, it’s something mid to high sevens, possibly. Maybe there’s a little bit of a gain on more of a gain on sale than you would with the current flow pricing.

And the other thing is, maybe it’s slightly underwater where, you know, you may target to gain on sale of 102, you know, based off of where rates are. But let’s just say you know the going market rate is 7% today; you have a 6.25 loan that may be at par; said, well, why would I sell a loan at par and make no money?

Well, you’ve earned the carry for the period that you’ve held it on the books, but it’s not just about the sale on that loan; it’s about the use of the precious capital and liquidity that you have. So, to the extent that you have other things and other initiatives that may be better uses of that, that capital liquidity, whether it’s shrinking the balance sheet, other lending opportunities at wider spreads in different buckets.

That now, that situation where you can sell that loan and not take an income statement loss and redeploy into more targeted areas, that may be an opportunity and an idea. So, you know, this is that, you know, this is one of my favorite idea, is that there’s more nuanced and more things to talk about more than we can get into right here, but if you have any questions, you know, reach out to myself, or your relationship manager. You’re Or one of our … representatives. We’d be happy to walk you through and discuss. No, although we may need to do it there.

So, you know, that brings us to the end. You know, thank you, everybody again. For your participation, hopefully, you found something of value here and, you know, and if you’re in that, that group with 60% in negative deposit growth, hopefully, you found some took some solace in that you’re not alone, and we’re all rolling up our sleeves. And not doing what we can to manage our way through this challenging environment for banks and credit unions. So, with that, we’ll sign off, and you know. Thank you very much, everyone. Thank you.