September 2023 ALM & Funding Strategies for the Current Environment

Well, hello everyone, and thank you for joining us here today for our ALM & Funding Strategies Webinar as we head into the last couple of days of the third quarter of 2023.

So I’m Andrew. This is Sean, and you may or may not notice that we are in a different setup here.

So just this week, in fact, we moved into some new offices, only down three floors in our office building here in Boston, and so, familiar territory in some regard, but we have some settling in to do, but we’re all, we’re all very excited across the bank about this new modern space. And we’re coming to you live here from our dedicated media room, where we have, you know, we’re very excited about that. Hopefully, we can up the production quality a little bit. And we’ll be able to do these types of webinars and also do some new and exciting things, hopefully, that you’ll be able to get some benefit from. So you can see the overview. Here. This is the plan for what you know we’re going to talk about today. We have a good amount of ground to cover. Some things at least we find interesting.

And then we’ll reserve some time for questions and answers at the end.

So if you have anything that you see during the course of the presentation, or even if it’s something that we didn’t cover, feel free to submit it in the chat in the GoTo Webinar.

I will not be answering the questions of how many times I went to the wrong floor in the elevator banks. You know you can, you can guess – we will do a poll question next time about what your guess is there. So, before we jump into some of those topics that we looked at, a couple of things are happening around the bank non-office related are here. You may have recalled an e-mail about a month or so ago from Ana Dyer our Chief Business Officer about a change in our pricing policies. So, just to walk you through an example here. So if we look at three different scenarios, so one, the old pricing, where we’re assuming a hypothetical 5% cost of funds, and at that time, the term really doesn’t matter here, we would apply a 25 basis point spread.

So assuming we’re talking about the same point of the yield curve and unchanged rates, now, if you were to borrow at that same term and product, it would be two basis points lower if it were to be in the afternoon.

On top of that, we’re also offering a time of day discount that, if you do borrow before noon, on any given day, assuming all else equal in these examples, the spread would be 20 basis points. So, compared to the old version versus borrowing in the morning today, you’re five basis points tighter than we were, so we’re excited to be able to sharpen our pricing in that regard.

And if you combine that with, we still offer further discount opportunities, whether it’s the Tuesday, Thursday, short-term, markdowns, or the Advanced Renewal Discount program, that gives you an opportunity to shave a few more basis points off the rate.

And then we can then we can never forget about the dividend! Last quarter, paid north of 8%. So, when you, when you, when you factor that in, you’re getting somewhere in the neighborhood of — 25 basis points — 25 basis points for that all-in rate.

On the event calendar, we have some, again, some exciting things that we’re looking forward to.

You should, within the next week or so, see an e-mail come out where we’re excited to be hosting representatives from Colliers, a commercial real estate firm, and they’re going to provide us an update about what’s happening in that market.

And certainly, there’s a lot of eyeballs and attention there.

And there’s a lot of relevance, obviously, to the depository balance sheet world. So we’re very excited for them to come in and give us an update about what’s happening there.

In the beginning of November, we’ll be having our very popular CEO/CFO Roundtable event at the Newton Marriott in Newton, Massachusetts. So, check your e-mails there. That is a great opportunity to get together with peers and share some ideas and network.

And then, in the middle of November, you’re stuck with Sean and I, again, for another webinar, where, where we’ll have the data from third quarter Call Reports.

And, as we usually do, we take a deep dive into what’s happening there and some trends that we can suss out, and some, some ideas to navigate going forward.

So, let’s dive in. You know, we’ll talk about economic considerations very briefly.

Really, but it all comes down to talking about the Fed and, you know, a couple of weeks ago, the Fed paused, it did not raise rates. And so they’ve been on this pause-hike-pause cadence.

And, but they did update their dot plot, their forward expectations for where they see rates going forward. And what’s interesting, the end of 2023 number did not change, but we did see changes in the ’24 and ’25 forecast, increases at 50 basis points. And I’m sure many of you are sick of hearing, “higher for longer” really come into the lexicon over the last few months.

So, just generally speaking, the market — so, whether it’s the yield curve and the bond market, tends to be glad to see the world in a “glass half-empty” lens, and tends to be more bearish than the Fed in terms of where they see future rates.

But that presents challenges because the steeper the expected decline, the more potential pain that there may be for the economy if and when things shift, but the yield curve has been inverted for a good period of time now.

And, we said this before, it’s been awfully painful to be early on that call about, “well the Fed isn’t going to raise rates.” I was working on a separate presentation the other day where I was dug into a webinar that we did a year ago and when rates were at 2% or 3% there, there, there wasn’t the expectations that we’re going to be in the mid-5s on short-term rates.

So, not really a component or a proponent of making bets, in terms of interest rates.

I think it’s good to have a conviction when, you know, you’re charged with managing a balance sheet.

But it’s less about, you know, what you think will happen, but you really have to factor in where are the pain points for our balance sheet and for our income statement going forward. And it’s, it’s not necessarily the ideas and the strategies that, that maximize the upside, but it’s really the ones that, that minimize the downside and that, that outsized exposure, like we said, the pain points may be.

So, when we think about, you know, economic indicators, inflation, as we talked about, you know, is continues to be front and center. As we talked about things that are sick of hearing of, it reminds me of “transitory” right, remember, that was the buzzword going back a year and a half or so ago? This was one of my soap bucket, uh, soapbox issues, so grant me, please, 30 or 60 seconds to rant a little bit about this.

​You know, you’ve seen a lot of things about the headline number coming down into the, you know, back into the 4% range, even despite last month, was a little bit higher than expectations. You know, that the year-over-year change works great when things move in a normalized fashion. But when we see that big jump as outlined by the green line, here was the CPI index, not the change, the pure index, we see that big, big jump in 2022. So the year-over-year changes are being judged off of an elevated level.

So even if we do, over the next months and quarters, get back to a 2% target level, well we’re still off that long-term trend line. And, and there’s two ways that we can get back to the trend line.

And they’re not really great options. One of them is, we’d have to be negative for a period of time. Well, then, that’s where we’re talking about recessionary type situations. And, and ironically, it’s almost kind of what we’re seeing in a way with deposits, right? Deposits grew so so much in 2020 and 2021, and now we’re seeing declines, really, that we haven’t seen — forget a generation – really, really, ever, right? So that’s one way that we can get normalized — I don’t think anybody wants to see us be, you know, consecutive quarters of negative CPI changes. The other way is that it takes time, right? We’d have to see 1%, 1.5% for a sustained period of time in order for that trend line to catch up to where the index may be. So, to that big – to that big green question in the letters up top – is the fight against inflation almost over, you know, put me in the camp of saying, “No, it’s probably not.”

So, you know, that’s going to segue into you know, Sean’s going to give us some big picture thoughts on the depository balance sheet landscape.

Yeah, thanks, Andrew. So you mentioned, obviously, you know, the sort of historically unprecedented level of deposit changes that we’ve seen over the past couple of years.

Here’s a slide identifying just over this two-year timeframe, what has happened to deposits. And you can see in late 2021 and early 2022, we still had some of that deposit growth.

And then pretty much right after the first Fed hike happened, way back in March 2022, you started to see declines, and there’s two periods of really very significant declines — last fall, September/October kinda timeframe, and then in the spring bank run period, back in March and April, where we really saw steep declines. I guess the good news is, on some of the deposit front here is that, in the last five plus months, deposits haven’t actually gone down quite as aggressively.

It’s really those kinda those two big timeframes where we saw the big changes.

And the, you know, what’s behind that? If you notice, you know, these two curves — this is the Fed Balance Sheet, on this page — prior slide, this is just bank deposits – boy those curves look a lot alike, actually, don’t you think? With one notable exception here, it’s that peak, going up in March in the spring bank runs. And what’s happening there was the BTFP, the introduction of the BTFP, the Bank Term Funding Program, that I know some folks out there are using, and, you know, that is up to about $110 billion right now.

So, that was a big part of that, that chunk on the sudden increase of the Fed balance sheet. Since that time, however, the, the declines in the Fed balance sheet have resumed. It’s kind of interesting about what’s really driving that and the biggest single driver on that is the reverse repo facility.

What the heck is the reverse repo facility? GSEs, like us at the FHLB and Fannie and Freddie, don’t actually get paid interest on their Federal Reserve accounts and actually aren’t allowed to go negative during the day.

And so, there’s this mechanism that the Fed’s created called the reverse repo facility, where it allows you to, to put funds into that, and then earn interest on that through, through this other mechanism different from what other depositories experience with IORB.

At any rate, that, those balances have been running out.

The other big user of that reverse repo are money market mutual funds, also put money into that.

And so, as they’ve been able to invest more in, as they’ve gotten more funds and as GSEs found other alternatives as well, you’ve seen those balances run out.

And so, the Fed balance sheet has really started to decline.

This chart says, “Let’s take that noise out around the reverse repo. Let’s just take a look at what, sort of, the overall, balance sheet of the Fed has relative to bank deposits again, over this sort of tightening timeframe.”

And what you see here is it’s pretty tight correlation between the two.

And in fact, if you do the math on the correlation here, the R-squared is basically 55. So, more than half of the balances on one of these metrics can be explained by the other statistically, so you could reasonably argue that more than half of the change in bank deposits is really being affected by the quantitative tightening that the Fed has pursued.

And then, again, if you look at this last, this most recent five months or so, the quantitative tightening has slowed.

It isn’t what it was back in 2022.

And I think that’s the primary reason that we’ve seen this, this bank deposit outflow kind of…pause.

It’s not, it’s not as bad as it was.

We’re still not seeing growth, but it’s not that same level of mid-to-upper single digit deposit declines that we’ve seen prior to that.

All right. So how have our members fared?

Here’s a take, a look at what the range of outcomes has been for both banks and credit unions who are members here at FHLB Boston.

And these histograms are taking a look at bucketing by five percentage points buckets.

So that top bucket, on the left-hand side, the member banks, 0% to -5%, we’ve had 50 different banks, member banks, that have had deposit growth year-over-year of 0% to -5%. And you can see the ranges for everything else. If you are to the left of that sort of green line in the middle, that’s a negative.

Credit unions, similar story, if it’s, we’ve seen also an even 50 members who had 0% to -5% deposit growth over this timeframe. And again, what you’ve seen a lot of our metrics is that banks are a little bit “more than” on all of these. Whatever, whatever the number is, the bank has a bigger variance than the credit union world.

And so we’ve seen over 60% of member banks have year-over-year declines, 55% of member credit unions. On a mean basis, actually, credit unions are slightly up.

So we’ve seen outsized on some of the bigger ones, and on the bank basis, it’s most people are experiencing declines, and very few have particularly strong performance in this timeframe.

And so the other thing to think about here that, you know, Andrew was alluding to is what’s going on macroeconomically.

How are things faring in the world generally? We see deposits declining — is that causing effects in the world of credit and lending?

So we have seen, as a little bit of a surprise to me, still a lot of lending out there.

But most recently, we came out with the SLOS, the senior loan officer survey that came out a month ago or so, and that particular survey shows…it asks senior lenders, at mostly larger institutions, “What are you thinking about credit standards? Are you tightening credit, are you extending loans? What are you doing?”

And so this top graph takes a look at the world of C&I.

Are credit standards tightening for C&I loans and what you see here is we’re approaching levels that are very similar to past recessions.

The bottom slide is taking a look at CRE & Construction, and there’s not as long a data horizon on that one, but again, you can see that that’s probably approaching levels that are likely to be recessionary.

The vast majority of respondents to the survey are saying, “yeah,” they’re tightening credit standards and are being a lot more selective on the lending side.

And so, that’s something else to kind of think about as we go forward here, is, when does lending really slow as an industry?

Well, thank you, Sean. So let’s talk about what’s happening for deposits, you know, the type of deposits that are actually making their way onto the balance sheet.

And it should be no surprise to anyone here on this call, given the conversations that we have all day long, that deposits — the ones that are sticking around — are flowing from non-maturity deposits into, into certificates of deposits. So, there’s two things to consider. That, one, the CD book in-and-of itself is shortening. And so, here we’re looking at the distribution — there are slight differences in terms of how the bank and the call reports break these things out — there’s a little more granularity for the banks in terms of looking at less than three months, and then 3 to 12 months, where the credit unions just call it less than one year.

So, we have seen, generally speaking, a shortening of the CD book. And that makes sense, and we’ll talk a little bit about the types of offerings that we, that we see folks using out there.

Frankly, when I was when I was pulling this data, surprising to see, about 30% longer than one year for both banks and credit unions, especially, you know, one, the multi-decade shift away from CDs that is occurring. You know, there’s the entire joke that most young people don’t right now don’t even know what CDs are.

Whether it’s deposits or, you know, listening to music. But, especially, it’s, it stood out a little bit.

Because of where we have been in terms of the path of interest rates, right? Rates were so low in 2020 and ’21, that, you know, a three-year CD at 50 basis points probably wasn’t moving the needle for many depositors.

​So, you know, the impact of the shortening within the CD book, but also the transition from non-maturity deposits into CDs, it’s become an asset/liability management, interest rate risk story.

Your non-maturity deposits somewhere between 3 to 7 years in average life, generally speaking. And then, if they’re flowing into CDs with less than a year, well your duration is that much shorter.

And combine that with the, the asset extension from rising rates that has contributed, you know, we’ve heard from many, many folks, that said, “We used to be comfortably asset-sensitive, now we’re neutral. We used to be neutral now we’re liability-sensitive.” And, you know, we’ve seen that with our activity levels. And then we have seen more and more longer-term borrowings from folks who, maybe historically, that hasn’t been the case. Because they have the need not just on the liquidity side, but also the, the, the motivation to mitigate interest rate risk.

So when we look at the shape of the yield curve, we talked a little bit before about the inversion in the belly. But, you know, when we look at posted CD rates that we have across the district here, it’s very clear to see when we break it out by the percentiles, the quartiles that the common strategies are not leaning on the posted rates, using more odd-term special that don’t necessarily flow into the clean data collection.

And then also playing more defense than offense in terms of waiting to respond to customers who come in and say, “I need a higher rate or else I’m going to the institution across the street.”

So the 75th percentile CD rate for all our members at these various terms is somewhere between, you know, around 200 basis points less than advances. I wonder if you’re, you’re bringing funds in at those levels. If you are, congratulations, you’re…from what we hear and can tell, you’re probably not the case. when we look at the max, maximum CD rate at these various terms, they’re, they’re right on top or even a north of advance rates in many cases.

And I think when you think about the fact that combined factor and the dividend factor, in the fact that maybe, the customer who is that rate-sensitive, is probably not, you know, it’s not the stickiest funds around, that, you know, you really have to have a pretty good set of reasons to justify, especially in this, in this environment, of, of margin pressure, to paying above wholesale, readily available wholesale rates to, to bring in deposits.

So, you know, as a good rule of thumb, we tend to see that 50 to 100 basis points below advance rates is a good target rate for CD offerings. Now, the follow-up question to that is, “Andrew, I can’t raise deposits at 4.50%,” which would be that, you know, 50 to 70, 100 basis points. Well, then, I think there’s your answer there, right, because you want some interest rate risk mitigation, you want some ability to earn NIM as you go out and deploy that funding on the asset side.

It may be better, you know, especially as we get into cannibalization and marginal cost of funds, to hold the line and then just look to, you know, strategically backfill with advances. So, you know, what can we practically, this is all well and good, but what can we practically do? So, you know, I’ve been a proponent for a little bit, that, you know, it might be a time, a better time than it has been really in a generation to test the waters on longer CDs.

Now, I know most customers, you know, they’re going to gravitate towards the short-end but you haven’t been able to get 4% or 5% rates in a bank deposit or credit union deposit product in a long, long time. And then there’s also the potential for differentiation because we, you know, we see and hear a lot of those 4.75% for only five months.

So, if you’re going out there and saying, you know, “Well, we’re willing to give you a higher rate for a longer period of time,” maybe that resonates. And, you know, like we showed two slides before, there are folks out there who have appetite for longer CDs, right?

30% of the CD book, but, you know, so the, you know, when you think about, “Well, I don’t want to get stuck with paying 4% for two years.”

Well, funding exists to be able to do things on the asset side of the balance sheet.

So, if you’re able to bring in 18 to 24 month CDs, well maybe that affords you the ability to go a little bit longer and take advantage of some of those higher yields in the lending book or in the investment world. And maybe even some term premium that you can extract in in terms of wider spreads. So, you know, naturally extending your funding gives you more capacity to take some of that incremental interest rate risk.

We won’t belabor the point on marginal cost of funds and cannibalization. I’m sure everybody at this point in the cycle knows all about it. But I would just re-iterate that you should be tracking it and knowing exactly what the true cost of that money may be.

think this is the environment for non-traditional features, right? We all strive to not have customers who’re solely looking and being 100% rate-sensitive.

So whatever, you know, whatever features that you think may move the needle with your client base, to get the conversation solely away from just the rate.

Now, now, especially given as Sean showed that even with a plateauing, just a lack of growth, in the liquidity metrics, that now’s the time to really look at all the options on the table.

And then the last bullet point here on the, on the deposit side is, you know, leaning more into CDs creates a situation that we haven’t had to deal with it for a long time. It creates some some chunking and some choppiness in the, in the cash flows of the, of the liability side.

So, if you had a CD campaign that that, you know, aggregates all the, the, the activity into one particular month, for example, you know, say seven months from now, well, then that creates a potential, you know, liquidity, not “situation,” but just something that you need to address because you don’t normally get those, those chunky cash flows from a, a non-maturity deposit reliant deposit base. So, one thing that we’ve had a lot of conversation with folks, and we’ve seen people put, you know, put into practice, is a forward-starting advance, where, you know, rather than say, “OK, well, if I have $100 million of a CD campaign coming due in six months from now,” rather than wait, and take that interest rate risk, and then get into a food fight for, you know, versus the every institution in our geography, about where we’d have to pay market rates to keep that money, maybe take advantage of the inverted yield curve right now, and look to, I don’t know if there’s a word, but pre-replace some of that funding with the advances, right? And maybe do a portion of it, because they say, you have $50 million coming off, and you do $20 million of a forward-starting advance. Well, then, now, that $50 million of the CDs coming due, you know, you’ve replaced $20 [million], you only have to fill the bucket on $30 [million], you can be that much more aggressive on the pricing.

And maybe you’ll get surprised, right? And then, you know, now you’re in a better position, cost of funding wise.

Thanks. So, you know, a lot of different opportunities out there, obviously, as Andrew is talking about with deposit sizes.

But I think of a…kind of a big, fundamental question for a lot of folks out there to answer in this environment, that is so tough where you’re, you’re pulling all the levers are, trying to think about all the different ideas for raising funds, and growth is such a challenge is, “Is this an environment to shrink? Is this an environment to actually just kinda hold, hold serve?” And so, it makes me think of Alice in Wonderland here where, I think, when she drinks this potion, she shrinks and I think if she eats a cake, she grows — something like that.

Andrew said we weren’t going to do cute little stories here, so I’ll limit this to just this cartoon. But I do think it’s an honest question that I think a lot of folks might be thinking of themselves as Alice on those questions saying, “Should I drink this potion or not?”

And so I would offer kind of an idea of, or a rubric to try to think about, “How do I make that assessment?”

How would, how would I, if I were back at a depository thinking about just that question. We’re entering budget season right now.

Where should you grow? How should you think about it? What should we think about?

And I would, I would start the question with capital and say, you know, how do we look with respect to different capital ratios, and then move that into saying, how do we feel about liquidity?

And none of these are one metric. They’re all a combination of metrics, and we’ll talk about that in a second.

And then finally, kinda think about, you know, how profitable is different activity?

If we do have capital, if we do feel good about liquidity, are the actual activities that we’re pursuing, more profitable, for instance, deposits, my gosh.

They probably never look more profitable in the industry, or certainly not, in a very, very long time, especially DDA accounts extremely, extremely profitable right now.

So how do we think about putting all these things together?

And so one thing that I would really want to highlight is this idea around excess capital, and sort of, you have a variety of different capital measures that everyone has to hit.

And one or the other of the capital ratios is going to prove to be limiting to your institution.

Alright, so in bank space, there’s Tier 1 Leverage, Tier 1 Risk, CET1 (the common equity tier one), Total Risk, or you could just elect a kind of opt-out and go to the CBLR, the community bank leverage one.

So which one of these is going to prove to be limiting to you? So if you do elect to use the CBLR, that’s going to be the limiting ratio to you.

But if you don’t, then there’s these other ratios that could all limit you.

And so what this chart takes a look at is whichever one of these is the most limiting ratio to you — what’s the variance between that number and the well-capitalized minimum?

And then, you see the breakdown in the numbers before, below it to say, which ratio has the most number of members that are limited by that ratio.

And so, what you find in bank, the bank world is, Total Capital is actually most likely to be the single most limiting ratio for banks. Kind of makes sense because banks are going to do a lot more commercial loans at a 100% risk-weighted asset levels versus the 50% for mortgage or 20% for most investments.

So I’m not surprised to see that most, most banks, or the Total Capital ratio is the sort of mode capital ratio, that’s, that’s most likely to limit folks. But there are 53 banks out there of our members, who are using CBLR and then everyone else is on Tier 1 Leverage.

So and this also kind of highlights, you know, where is, where’s the bucket, how much capital is too much? There’s kind of a Goldilocks level of capital, right?

If you’re too thinly capitalized, you’re probably running risk really hot.

And if you have a situation where there’s credit problems some day, or lack of profitability combined with credit problems, combined with liquidity problems, you run a risk of a, an adverse event, for sure.

On the other hand, if you have a lot, a lot of capital, probably, it’s not as profitable as it could be, and there’s an opportunity to do something with that capital that could enhance your institution one way or another.

So, where do folk shake out?

And what you see here is that most folk shake out in this sort of 2% to 4% bucket, and 4% to 6%, because those are the two biggest ones on, on where people actually have as much excess capital.

The mean number is 4.3%, so little over 4%, on average, and the median is 3.5%

Meaning, there are some places that are really, you know, really prize capital and keep a lot of capital.

So, a bit of a difference between the mean and median, only a couple of people, right now below 0%. It’s CBLR folks who are just below the CBLR limit right now. And there’s a sort of grace period.

Just a note there.

And then, on the credit union side, what is the limiting ratio? A lot of credit unions are using CCULR, the credit union leverage ratio of, basically, the community credit union leverage ratio similar to the CBLR at the 9% level.

In fact, the lion’s share of our credit unions are using that designation and only two are limited by Total Capital, and everyone else is limited by that Net Worth, which is comparable to the Tier 1 Leverage on the bank side.

One note of housekeeping here is that credit unions are actually — on the Net Worth ratio — have a 7% well-capitalized minimum versus banks have a 5% on Tier 1 Leverage.

So, it’s a little bit of a higher standard.

And what that means is that, again, if you kinda think about the way these work, banks have a generally higher level of excess compared to credit unions.

So, you can kinda see how that chart shifts, the center of gravity shifts towards the left.29:24And a lot of that is because a lot of the credit unions are electing the CCULR which has a very high standard and the Net Worth, which has an inherently higher standard than banks.

The excess here is 2% and 1 5%.

So, if you add back the two points, it’s actually very, very similar, in credit unions to banks in terms of the absolute level of rates, where the excess in credit unions isn’t quite as strong.29:46So, how might this be really useful to you?

Well, I would think, especially if I were a bank, I would think about which one of these ratios is limiting, and then how does it compare to the other ratios?

So, if you were in a situation where your Total Capital were, say, 11%, so that’s not very, that’s not a huge buffer above the well-capitalized minimum at 10% and the 10.5%, for the sort of, the place where compensation or restrictions start to come in for folks.

If you’re at that place where there’s a thinner level of capital, marginally, a lower risk-weight, an asset actually adds more profitability to the institution, not on a nominal basis, but on a risk-adjusted basis, on a capital use basis because you’re not using, you’re not stretching that risk-based capital, you’re, you’re taking advantage of the differences between the leverage ratio and the Total Capital ratio.

So, in that case, an investment at a widespread, very wide spreads these days or a mortgage also has a very wide spread these days — that might be the better bet if you’re, if you’re kind of constrained on that Total Capital. And it’s just the reverse if just the reverse.

​If you’re more limited by the leverage ratio on a significant way, versus the Total Capital ratio, then there might be an opportunity to go out on the risk spectrum in the credit world, where you get higher nominal rates and higher risk-adjusted rates.

So understanding which one of these governs your institution and which one has better variance versus well-capitalized could be a real potential value unlock for folks out there.

So we said we’d take a look first at capital. And what we think about there is to say, “How much excess capital do we have? And do we feel good about what that level of capital is relative to the risks that we might see in this environment?”

And then the second piece, as we said, “Hey, let’s take a look at what the policy guidelines, what are risk guidelines, particularly, liquidity risk guidelines that are being, that are happening at our institution?”

And, like, a lot of these things, it’s not one metric, no one metric is telling the whole story. It’s a combination of metrics together that work together that start to tell the story.

I’m not going to go into too much depth on this particular slide around this topic, because in March, I did go into a lot of depth on this.

So, I’d encourage folks to dig up, that, that old webinar from March, that really goes into how I would try to think about putting all these different metrics together, and how you might holistically consider the value of different metrics.

But what I’ll quickly identify is, as you start to assert targets or minimums on certain ratios, you are necessarily crowding into other targets or minimums on other ratios.

So you’ve got to kind of be a little bit more global in the thinking around the balance sheet and how your institution is structured.

And especially with your clientele type, whatever your client verticals are doing. So if you’re a very commercial heavy institution, a lot of C&I, there’s probably strains on borrowing capacity, because that’s not as pledge-able here or in other places.

Right? And vice versa.

If there’s a lot of real estate, maybe you can take advantage of wholesale funding a little bit more, because that’s really freely available to you. And that’s the type of thinking that I would think about here on liquidity ratios. I’d also highlight on this, too, things like, you know, loans/deposits ratio, wholesale funding ratios, we see where our members are here, banks, again, on the left and credit unions on the right.

This is again to give kind of an idea about where are your peers, where are other folks on these measures?

And these box and whisker charts show the bottom of the box is the 25th percentile, the top of the box is the 75th percentile, the whiskers, sort of the, the lines above it are sort of a full range. And then any dots are outliers in a dataset.

And what you see is that banks are around usually 90% on loans to deposits.

And quite a number of banks are above 100%. And then in credit union world, that number is usually in the low 80s, not quite as high as banks again.

And all these measures, when we take a look at everything, banks have a bigger, a bigger range of variance, often, than credit unions.

And then on wholesale funding use, you know wholesale funding use is significantly up in the past year and no surprise, as we’ve seen deposits kind of struggle. And in banks, what we see is that the mean is in sort of a low teens.

A lot of folks are up to about 20%, some folks significantly higher, and in credit union world, it’s sort of upper single digits.

Alright, so, we said we’re going to take a look at capital then when we think about liquidity and then the final question about how profitable, how profitable or different assets and liabilities as we think about assessing growth?

And so, you know, on the investment side, I think what we know is that a lot of investments are, have historically wide spreads right now.

Mortgage-backeds and mortgages themselves up at kind of historically wide spreads, what might that translate into ROE, taking a swing at actually trying to estimate the profitability here?

So on the left-hand side, I tried to take a quick estimate on, “What are residential mortgages worth right now? What’s the profitability?”

And so what that’s saying is, let’s take a rate.

Let’s back out the option costs, the interest rate cost, liquidity costs, get to a spread.

Assume something around operating, and then, divide by a series of buildups on how much capital you might need against that and I get to an ROE of about 11%.

Your mileage may vary on how you do this, and what assumptions you’re using for that, but pretty profitable for a traditional mortgage compared to what you might otherwise see.

And then on the commercial side, very similar numbers, kinda came to some, some similar numbers there again, on the ROE side, and thinking about how you might build up capital, and how you might add value.

So pretty profitable numbers here if you’re booking, you know, things in this kind of ballpark and, and thinking about what kind of risk you’re assuming on that.

One thing that I’ll again highlight that we talked about in past webinars is managing prepayment penalties on the commercial side is a really great way to add value right now.

​Just settling for a 5-4-3-2-1 when rates are elevated like this is a really tough kind of value proposition right now, I think.

And if rates do decline at some point in the future, it’s not gonna look as profitable as you might think.

Um, so, something to think about there. Sean’s favorite word, “convexity.” “Convexity” — always talking about that positive convexity.

So, you know, what are the final questions that we might ask ourselves here to assess growth?

And it’s sort of going down this list here, and saying, you know, “Should we build capital? Should we deploy capital, should we kind of hold serve?”

And if you do get to a place where you say, “Geez, my Total is at 11%, I really want to build that up.

I looked at the peer metrics.

I did some math internally and said, geez, I need to get to 12% something, maybe 13%.

Where should we be?” Well, your capital ratios can grow by ROA.

So if you’re ROA is 80 basis points than an 11% Total Capital ratio all else equal could probably go to about 11.80% in a single year if you didn’t grow.

So, that’s another way to think about that is capital, again, it’s like turning around a battleship.

It’s really tough to move overnight, unless you do something in the secondary market.

Are we approaching risk limits? How are we looking on some risk limits, and how do we compare to some other folks out there?

And are there things we could do to enhance borrowing capacity? I know a lot of folks out there have done so in the past year, we’ve seen a lot of activity on, on people pledging more, trying to find different asset classes. We think there’s a lot more out there, too.

There’s, there are still, still some opportunities out there for a lot of members to pledge more assets and to enhance that borrowing capacity.

So, something else to think about.

And does lending profitability justify using all of this?

You know, in this environment, maybe — if you feel good about the credit. Always sort of the big, the big caveat at the end.
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And then, finally, another, another point to think about is the non-interest items.

You know, we talked here extensively about the ALM-related issues and considerations, which again, is sort of our world, but maybe it’s non-interest items like offices, maybe it’s head count, maybe it’s things like that that you have to think about as we go forward.

How do we fit into these strategies? Well, if you are thinking about shrinking, one thing that we’ve highlighted a few times and has become really popular in this environment — even though the world of mortgages is not quite what it was in the past — is the MPF program. This is where you sell loans directly to us. Instead of pledging them, you sell them directly to us.

And you get paid income for actually assuming a portion of risks still along the way. We think that this program is more attractive than it’s been in a very long time.

A lot of folks, I think, agree with us on that, because we’ve seen a lot of sign-ups and a lot more people using it.

And so it’s something to consider if you are thinking about shrinking and you’re thinking about, “How do I find a room in the balance sheet?”

Think about the MPF Program here.

And then if you’re thinking about growth, if you’re looking at it and saying, “You know, my capital is fine.

My liquidity’s fine.

You’re right. I think loans are pretty profitable.”

Um, maybe you can augment with wholesale funding through us and then think about sort of the interest rate risks. And think about what advance sort of complements the risks.

And that’s a nice segue as we think about, too, you know, what type of advance would complement your risks, is to think about should you float, should you extend, what should you use, bullets? What type of products should be, should be available if you think about using?

And so, something I wanted to think about here was to say, “If you were going out for a few months, or you thought you might go out for a few months, which product might be better for you?”

Would it be doing bullets, would it be thinking about a floating rate advance?

We’re at a point of major uncertainty. We’ve talked about it several times today.

You know, we don’t know, nobody’s completely sure — I don’t think the Fed is completely sure — whether the next, the next move is a hike, if that hike is coming in November, or December, or next year.

Or if the next move is another hawkish pause, or the next move is a cut at some point.

And so one of the questions to ask yourself here is, which, which structure should work work best for you?

And so the way you might want to evaluate that is to sort of set the SOFR float and the bullet in like-kinded SOFR terms. So, you’re putting it both in SOFR terms, not just looking at it nominally.

So in that upper box, we’re taking a look at what the bullet is in SOFR terms and what we find is the bullet’s cheaper than the floater by a few basis points apples-to-apples.

But then if we do turn the tables around and say, “OK, what does it look like on an absolute value basis?” well, it’s a little different on that three-month piece, where the SOFR Index advance at 5.51% is cheaper than the bullet.

And so the point there is, the market is baking in the possibility, but not the certainty, of potential Fed hikes.

And so if you think there is no hike coming — there’s not going to be a hike –then the floater’s a really interesting option for folks out there right now compared to bullets, because even though the market is not fully baking in a hike, it is baking in a portion of it.

And so if you want to bet against that, the floater is an option. And vice versa.

If you think, my gosh, there is going to be another high, coming up, then the market is not fully pricing that in. And taking a bullet and extending a little bit is probably going to turn out to be the better bet on these sort of intermediate horizons, shorter/intermediate horizons, precisely because the market’s not baking it in.

And so, just like, our last kind of questions, we said, “Hey, what are the questions to decide how you might act?”

And what I would, I would offer here is, the first question is, “How long are you gonna go out?

Um, in this example, if it’s very short-term.

You know, the bullet wins in both cases, both on an absolute and relative basis.

But if you are going out longer-term, then, the key question is, “What do you think’s going to happen with the FOMC?”

So, if you do think that the FOMC’s going to hike, then bullets are probably better. And if you don’t, then it’s probably the floaters.

​And another thing to think about with floaters relative to bullets is that the floater allows you to sort of constantly keep that advance without having to do all the homework and all the administrative work.

And so if you just want to set it and forget it, like an old ’90s infomercial I remember, then you might want to think about the floater if you’re used to rolling bullets because you might you might miss that rollover one day.

And then finally, you know, the SOFR-indexed advance is a really great opportunity if you have hedge strategy in place, it probably really significantly reduces the chances of hedge ineffectiveness.

Because it is indexed to SOFR right there.

So, things to think about, as you think about funding options.

Well, thank you, Sean.

So let’s, let’s talk about a couple advance ideas.

So, you know, one of the great things about, you know, our role in the in the universe here is that we get a chance to talk to a lot of folks in banks, credit unions, all across New England. And so we get a pretty good qualitative feel for you, know, what’s going on, which way the wind is blowing.

And, we’ve, one of the things that we’ve observed over the last, call it month or two, is that we’ve gotten more questions and inquiries about, uh, what should, what kind of ideas should be on our radar, right? What other products that we’re not thinking about? And I think that’s a function of all the pressures that we’ve been talking about on the funding side. And, as Sean said, budget season, how folks are starting to get a glimpse into what 2024 it looks like. And it’s going to be a challenge.

So I think, you know, we have to, to kick every tire and see what’s out there. So, we’re going to go through four ideas here that I think make sense in this current environment and that present some value. So, you know, the HLB option advance is likely one, if you’ve been paying attention to our webinars, in our daily communications, that’s probably on your radar.

So it’s where you sell the option to the Home Loan Bank in order to lower the rate. And you know, here we’re just outlining some of the ways that the different structures can produce a lower rate. So generally speaking, the more optionality there is, you’re going to get a greater discount.

When you have a shorter lockout period, that period of guarantee before the put/no put decision occurs, that, again, is going to produce more discount.

Generally speaking, a longer stated maturity is going to lead to a higher option value, more of a discount, and then high interest rate volatility contributes as well. So, it’s important to understand, if, if, if, if this is not something that you’re familiar with, the cash flow profile, but more importantly, that the potential change in the cash flow profile, and I would summarize it, is that it’s the liability version and the mirror version of what you’re very familiar with in terms of a mortgage.

So, that contract/expand decision is the opposite of what you see in a mortgage. So, it’s a, it’s a case where if rates go down, generally speaking, the advance would extend if rates go up, generally the advanced would contract.

But remember, by taking that optionality, you’re getting compensated for that cash flow potential variability.

The SOFR flipper is one advance that has been increasing in popularity of late. And as we mentioned up here, it’s a cousin to the HLB Option because it is very similar in terms of selling that optionality, but with the added wrinkle of for the period of the lockout period, it’s it’s a floating rate as opposed to a fixed rate throughout and also the floating rate, it comes with a discount to SOFR that is highly customizable. So, you can select how much of a discount that you would want.

So, we have three examples here: SOFR -150, SOFR -250, and SOFR -500 . And the greater the discount, the, generally speaking, the higher the the backend coupon, coupon would be. So, you know, there’s some dynamics here in terms of the “higher-for-longer” and the impact that if you’re talking about starting advance rates in the 2s, 3s or even in the case of structure C, in the 0s, that depending on the direction of rates and the magnitude of any moves that that that that put decision may increase. And you’d be able to minimize funding cost during that lockout period.

So, this is the advance – so switching to, from selling options, to buying options — that, I think, is, is really the idea that, I think, has a lot of merit in this environment.

As the Member Option name tells us, that you own the option, you have the ability to shorten it. So here we’re looking at a 10-year/1-year structure. So, 10-year maturity, 1-year lockout with a one-time call option at the one-year mark, and that was recently priced at 6.25% and now you’re saying, “Why would I want 10-year funding? And why would I want to pay 6%?” And we’ll get to that in the next slide here.

So, the reason why it’s a consideration is because you get the value and the duration benefits of the long-term liabilities, so we won’t go through all these numbers. But this is something that we’re really gonna put a lot of work into in the next couple of weeks. You should see some analytics and some articles and case studies to this point. But always feel free to reach out and we can run some numbers for you.

So, here, you’d be looking at at about a 7.5 year duration and that affords you benefits in terms of your interest rate protection, how much it contributes to your EVE or NEV calculations, right?

Now, to get that same level of duration, by taking classic advances, there’s a multiplier effect, you’d have to…for $10 million of a lot of a long-term member option advance, you’d have to take $77 million of a 1-year, or $39 million of a 2-year. And obviously, with the higher principal amounts, that comes at a higher interest cost, and we’re doing some of the comparisons here.

So, the summary down there, at the bottom, for the same duration benefits, less borrowing required, right?

So, less strain on your borrowing capacity, and, ultimately, at a lower total cost.

And, again, because, at the one-year mark, you can prepay the advance, you know, you’re not holding that advance for the long duration, if you don’t want to. So, there’s a lot here to unravel. I think, like we said, that you’re going to be seeing more from us. I think that this: if interest rate risk mitigation is on your radar right now, then there’s merits for this type of strategy.

Symmetrical prepay advance.

Similar to the long-term classic, but the benefits are in a rising rate environment, where the funding is below the the marginal market cost, you can capture the favorable gain, much like a bond, that, well, there’s not many gains in bonds right now, right? But sometimes, when by, when rates move in your favor and you have a bond, you have the ability to sell it and take a gain, similar idea of this is the liability version.

To give you an example, just about a year ago, five-year classics were at 4.03%. Symmetricals were just two basis points higher, which is typically where they are priced even today.

As we went through the last year, as we talked about the Fed…the market underprices the probability of rates continuing to go higher and higher.

Short-term rates went up pretty significantly, and even the intermediate part of the curve reacted to that “higher-for-longer.”

And then, as we sit here today, if you would have taken out a classic, one year ago, you could pay it back.

But there’s zero fee, but there’s also zero credit. On the symmetrical, because you get that market value gain, you have the ability to get a 2.5% gain. So for $10 million, you pay back only $9.75 million, and you realize a $250,000 gain.

Not bad — you can offset that maybe if you have some asset cash flows, large depositor come in and, as Sean showed, deposits have kind of plateaued, so certainly there’s some instances where maybe you have some less of a need for wholesale funding.

So this would be a rather efficient way to do that.

So, taking a look here at the queue and we have a question related to what we talked about in the beginning.

About that, you know, the pricing changes so just, let’s see, “When did the FHLB start having sales and specials and what are all these specials and when are they available and was this…did this occur in August or before?” So, a little history lesson, so we used to have more specials than we typically have right now, so aside from the, the, the tightening of spreads that we saw over the last month, if we rewind about a year and a half ago, we did narrow our spreads considerably as well.

So, know, we’re less reliant on saying, “Hey, we’re having a special on this particular feature, or this particular product,” and any given day, if you look at our rates relative to the Treasury curve or other benchmarks, you’re going to see very, very narrow spreads. So it’s been a concerted effort on our part to have low everyday pricing and not have members need to be calling the desk and saying, “Hey, I would love to see this particular structure. Can you run a special at some point later this week,” that if you see something that you like, you know, that you’re getting a very competitive rate any day of the week. I’ll elaborate on some of the discount offering. We don’t say “specials” anymore, and that’s like, you know, put it in the swear jar. So, but discount opportunities would be on Tuesdays and Thursdays. Short-term, 1, 2, 3, and six month offerings are offered from 10:00 to 10:45, and you’re able to shave a couple basis points off there as well.

But then the advance renewal discount program affords you the ability, when you have a maturing advance, if you replace that as it’s coming due, there’s a grid where you’re able to save an additional few basis points by pre-replacing that. There’s that word again, pre-replacing that advance before it comes due, so you can stack those on top of the, the low, everyday pricing as well as the, the, the, the time of day discounts that we were discussing earlier.

So, you know…I’ll just really quickly add that our pricing has actually sharpened a lot. You know, this is another one of those things — if you do look at it on a basis, compared to other other opportunities and options out there, I do think FHLB Boston’s pricing has sharpened compared to what it was historically, some years ago, for sure.

Yeah. So that, that brings us to the end. Thank you for bearing with us here. You know, as we as we tend to do, we always go over. I think that’s because, you know, in this environment, there’s a lot to talk about. And we wouldn’t wish it upon you, but we could probably go for 2 to 3 hours on this. But, you know, as we always say, we’re easy to find if there’s anything that we can do, and be of assistance to you and your, your organization. You know, we are at the ready, whether it’s analytics, feedback, you know, insights from what we’re seeing and hearing, you know, we’re here to help you the members, so, thank you again. Appreciate your time, and hopefully, we’ll speak and see you all soon.