Bumbai - Episode 13

last updated on Tuesday, December 22, 2020 in General

Hello and thank you for joining us for another episode of The Insider, a bi-weekly podcast production of the Federal Home Loan Bank of Des Moines and your source for industry news, strategies and key information about the bank. This is your host, John Biestman, Senior Relationship Manager.

Time for a trivia question. Geography for $500. As you know, the FHLB Des Moines district literally spans the globe. In fact, its membership extends the farthest north, east, south and west of the entire FHLBank System. Name the locations of each of those four reaches. No Googling. We’ll give you the answer at the end of this podcast, so stay tuned.

We’ll now turn to Hawaii, the home of 24 FHLB Des Moines members. (Is that a hint? Maybe.) The Urban Dictionary defines the pidgin’ term “Bumbai” as “in due time” or “Lay-tah.”

Which brings us to the Bumbai file, that being the ICE and Federal Reserve’s recent directive on Libor’s long-heralded, albeit slow-motion demise. As we know, the Libor benchmark was scheduled to expire on 12/31/21, a mere 12 months from now. In tacit recognition that many financial institutions have not yet become operationally ready for adoption of SOFR and perhaps other emerging standards, the ICE Benchmark Administration Limited in concurrence with U.S. regulators, including the Federal Reserve, announced a plan to extend the date when most Libor benchmarks would stop being published, from the end of 2021 to June 30, 2023 – effectively an 18-month reprieve. 

Five U.S. Libor maturities (overnight, and one, three, six-month and one-year maturities) would expire in June of 2023, while one-week and two-month tenors would expire, as scheduled on January 31, 2021. All of this means a little more breathing room for institutions to update systems, insert fallback language and allow some more time for markets to accept credit differentials between Libor and SOFR and for futures markets to develop term structures beyond SOFR’s daily re-sets.

The proposed delay is welcomed by many in view of Libor-based interest rate swap activity of late still exceeding SOFR-based activity on the order of 25+ times. Hopefully, by mid-2023, most Libor contracts will have expired long before Libor itself vanishes from publication. In the meantime, we at FHLB Des Moines have adopted the Alternative Reference Rate Committee’s (ARRC) recommended fallback language for floating rate notes tied to LIBOR and for all advances with a Libor component.

The FDIC recently released its Quarterly Banking Profile for Q3. In the good news department, the industry’s net income was higher than in Q2 due to much lower loan provision expenses. Additions to the problem bank list were negligible. However, net interest margin fell to a record low, a paltry 2.68%. Blame the usual suspects: a whopping 139 basis points decline in asset yields in the face of a decline in funding costs of “only” 72 basis points.

This begs the question: How are you doing with your deposit pricing and is it time to reconcile with the notion that loans actually dropped slightly over the quarter and were particularly held down by C&I loans.

Here’s another interesting statistic from the quarterly report. The proportion of loans and securities whose maturities were five years and beyond was 27.6% at the end of Q3, an increase from the 26.4% level of the previous quarter. This statistic is in line with some of the anecdotal information that we are hearing from the field along the lines of increasing asset durations, including purchases of longer-duration muni’s and loan purchases.

Indeed, borrowers are reported to also favor taking down longer duration loans. More institutions, as a result may now be less exposed to falling rates. On the flip side, should rates turn, perhaps due to: widespread vaccine adoption tripping pent-up demand in the economy, surging money supply and/or continued currency depreciation; many financial institutions may be best off modeling the impact of an inflationary environment of say, three or four percent on their margins and economic value.

Just as a purchasing manager considers locking in supply agreements in the event of potential rising costs, see if it makes sense to pre-fund or fix your cost of money. In any event, it’s best to measure and monitor these sorts of contingencies.

SBA loans and their derivative, PPP loans, are gaining increased attention lately. For one, SBA 7(a) liquidity, as has occasionally been known to occur, is on the wane. So far this year, roughly $23 billion in disbursements have been approved. Nonetheless, funding that permits the SBA to purchase loans under the program has been fully expended due to Congressional budgeting and continuing resolution procedures, effectively halting secondary market activity.

Much like PPP loans that have yet to be reimbursed and forgiven, a funding gap has become a fact of life for many originating institutions. In these cases, the “off the shelf” and customized payment and maturity features of FHLB Des Moines advances are frequently used by SBA originators for funding loans that they intend to sell which may require some additional time in the waiting room.

All eyes are on continuing Congressional discussions on potential extension of the CARES Act. Aside from additional PPP set-asides, related developments include: tax deductibility for expenses that accrue to obtain PPP forgiveness, the possibility of recipients of previous PPP disbursements to tap into the program for a second time, as well as any special carve-outs for industries that have been particularly hard-hit by the pandemic.

As developments unfold in Washington, remember that FHLB Des Moines, under its special pandemic response program, considers PPP loans as eligible collateral for the purpose of funding. To say that PPP forgiveness has been slow is a clear understatement. Once these slow loans are forgiven, since many institutions are subject to amortizing origination fees over the life of a loan, look for some extracurricular fee revenue to be recorded early in 2021.

We’ll need that fee income. The race to fund toward zero percent levels persists. S&P recorded the industry’s third quarter overall cost of funding to be 28 basis points. Expect that number to drop further in Q4. The Federal Reserve’s H-8 report for the first week in December shows essentially flat-lined seasonally-adjusted loan growth year-to-date, along with a significant increase in investments. Indeed, on occasion, we find some financial institutions whose investments comprise over 50% of assets.

It’s no surprise then, that funding costs remain in the spotlight. With banks having added $310 billion in deposits since the fourth quarter began, in theory, at least, it should become clear that the balance of pricing power has shifted from depositors to depositories. In practice, the changing dynamics should bode well for your opportunity to reduce funding costs. While it’s important to focus on interest margins in the here and now, it’s just as important to frequently measure and monitor the impact that uncharacteristically rising deposit levels place on your interest rate risk.

Have these times of excess liquidity made your funding duration less certain? Is it just as important to balance your funding portfolio as it is to balance your investment and loan portfolios. One other thing to watch as the power dynamic of depositors and depositories changes: The declining amount of “free checking” products or an accelerating deployment of deposit fees. One industry metric that could be the subject of more focus is the ratio of deposit fee income-to-deposits.

Among our listening audience, which of you Baby Boomers remember the old adage, “Never trust anyone over 30?” The original source of that phrase was one Jack Weinberg, a student activist who coined it back in 1964. Later in 2000, well after his thirtieth birthday, in a brief moment of self-reflection, he unsurprisingly disavowed the quotation.

On to things you can trust, the Affordable Housing Program (AHP) turned 30 this year. Since the inception of the Affordable Housing Program in 1990, FHLB Des Moines has awarded $700 million to provide affordable housing opportunities to more than 120,000 families and individuals.

As your partner in providing affordable housing opportunities, FHLB Des Moines would like to thank you for your role in the program’s success. Your participation in Competitive AHP, Home$tart or the Native American Homeownership Initiative (NAHI) has had a profound impact on communities across our district.

We’d like to congratulate and thank all 149 program applicants that submitted competitive proposals to the program, resulting in 63 of these applications being approved for $41.3 million in grants in support of the purchase, construction or rehabilitation of affordable housing.

I’ll give you an example of one of 2020’s grant recipients, Covenant House of Alaska. Why Alaska? I’ll tell you in a minute. One of our members, Northrim Bank, successfully sponsored a grant request on behalf of this impactful organization that offers young people who are experiencing homelessness a safe place to stay and get help. The Covenant House shelter provides access to health care, educational service and housing assistance. Congratulations to all involved for fulfilling a key mission of the cooperative.

So, back to our earlier pop quiz. Alaska, the Last Frontier, is 50% of the answer to the question posed at the beginning of the podcast. Alaska extends the farthest north AND west in the FHLB system. Now for the remaining directional extremes of FHLB Des Moines geography, South would be represented by American Samoa and East would be represented by Guam. Yes, we have members in many parts of the globe!

We’ll see you next time on the FHLB Des Moines Insider Podcast.

Stay well, safe, liquid and just like the map, maintain your balance sheet bearings! Thanks for tuning in.

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