A Paradox of Thrift - Episode 1

last updated on Wednesday, June 17, 2020 in General

Hello and welcome to the inaugural episode of the FHLB Des Moines Podcast Series. This is your host, John Biestman, senior relationship manager.

As you, our members, are working diligently with your customers and communities during these changing times, we wanted to introduce a new communications channel through which we can reach out and update you and help you find ways to adapt to the changing environment.

So, we’re looking forward to producing two podcast tracks.

The first being a semi-monthly short synopsis that will focus on news and observations from FHLB Des Moines. We are calling these podcast sessions “The Insider.” We’ll talk about relevant funding strategies, market conditions, collateral and credit items and other timely announcements.

Second, each month, we’re planning to produce insightful interviews with industry experts, both from within the bank and outside. We’re planning topics that will include capital markets discussions, our new eNote collateral rollout, best practices in liquidity and credit stress testing and much more. We’re calling this monthly podcast track, “On the Record.”

FHLB Des Moines consistently get its best ideas from its members, so always feel free to engage and let me or your relationship manager know what you’d like us to cover.

Along with the rapid pace of change, we too have made some changes ranging from updating our collateral guidance to helping you find new sources for liquidity. I’ll spend some time today talking about how we can help with your liquidity availability stress testing efforts and some of related initiatives that we’ve recently and are in the process of putting in place.

Since sports analogies, thankfully, remain in short supply these days, I’ve heard the current environment best described as “flying on an airplane that’s in the process of being built.” Suffice to say, we’ll continue to keep you apprised of further developments at FHLB Des Moines.

So here we all are in the middle of 2020. Even the best of visionaries would never have predicted it. By and large, our members entered the year with ample capital, lots of liquidity and sound credits. Now, many of us are working from home with reduced retail capacity and closely watching our loan portfolios.

We’ve played the role of good community citizens by offering forbearance where needed and have served as stalwart stewards for distributing funds to communities by way of the Paycheck Protection Program (PPP) and other channels. I also might add that we are doing all of this at the same time low rates and a continued flat yield curve are punishing our net interest margins.

While economic statistics these days may seem about as useful as the “g” in lasagna, it’s interesting that during the month of April, the U.S. personal savings rate hit 33.0% of disposable income, a record high. The increase occurred amid a backdrop of a personal spending rate decline of 13.6%. Some money center banks are reporting that their transaction account balances have increased by between 30% and 40% in just the past three months. There’s little doubt that COVID fears have altered savings and consumption patterns. To give you a sense of the scale of current savings levels, during 2008, the savings rate grew to just below 7% of disposable income.

The question now on many people’s minds: Are we looking at a structural change in spending and a protracted period of excess liquidity in the financial system or simply an aberration until “shopportunities” resume?

A Paradox of Thrift

What’s going on right now with liquidity? Absurdly high growth in savings takes us back to our first class in economics when we learned about John Maynard Keynes theory on the “paradox of thrift.” The theory postulates that left unchecked, increases in personal savings will hamper economic growth. In short, current spending needs to feed future spending. The more people save, the less they spend - all resulting in an infinite loop of no economic growth.

Increases in consumer spending can break this loop, but how and when? The “how” would ideally be addressed by pent-up consumer demand. As far as the “when” is concerned, that’s more complicated: timing of a widespread vaccine, restoration of consumer confidence, et al.

In these abnormal times, one thing seems certain, overall spending from the consumer will drop as a share of overall GDP, with government spending taking up the slack. Liquidity, for now, appears plentiful. So what are the most important things we can do now?

First, liquidity needs to be deployed and in times such as these, it needs to be deployed carefully, being mindful of interest rate and credit risk. Excess liquidity can have a way of being more dangerous than normal liquidity levels. Watch your spreads, pricing and your underwriting. Do you really want to waive or limit prepayment penalties, abandon rate floors and match a competitor’s rates?

Second, it’s important to assess potential changes in your interest rate risk position. Will your deposits become longer-term or transitory? Has your asset sensitivity increased? Will NPA’s disrupt the assumed cash flows that are currently embedded in your interest rate risk (IRR) model? What of IRR time horizons? The difference between one year and threeyear time horizon output might surprise you.

Recent developments at FHLB Des Moines

I mentioned earlier the importance of stress testing in today’s environment and the role that we can play in helping you assess the impact of various economic and credit related scenarios on your scenario forecasts for liquidity availability.

You definitely need to assess potential sensitivities of changing economic conditions on credit and collateral availability. At FHLB Des Moines, we assign LTV’s that have a degree of “pre-stress” and are based upon our assumptions of our liquidating an asset class in a very short time frame. If there were changes that we would make to LTV’s, we would telegraph them to members and allow a reasonable amount of notification time. We typically review the validity of these LTV’s on a semi-annual to an annual basis.

While members tend to focus on collateral LTV’s, which again are prestressed, but are still subject to change; the highest potential variable impacting eligible collateral is just that: eligibility. Collateral must be eligible in the first place in order to be assigned an LTV (i.e. not non-performing, et al).

A member’s collateral eligibility in a stressed situation is one of the strongest variables that impact liquidity availability. We want to make sure that our members are familiar with FHLB Des Moines credit and collateral underwriting criteria.

So, take a look at credit capacity, term limit and collateral pledging type dynamics that we have on our website. You can see that we post median ratios of our members showing select credit indicators each quarter. You can position scenarios against these medians and project credit status. Going into the downturn, 81% of our member banks were accorded 45%-of-asset credit ratios.

On collateral, look at all categories that would be eligible for you to pledge. As an example, members over the past few weeks have looked at posted loan participations as collateral. They do need to be reported via loan-level listing and a few other parameters. We can help run a collateral
optimization analysis.

Taking (e)Note

Next month, FHLB Des Moines will launch the ability to accept electronic promissory notes as eligible collateral. Alongside other banks in the FHLB system, we have developed a solution that will allow members to pledge single-family residential mortgage eNotes as eligible
collateral.

The protocol will include a MERS® eRegistry. In the interim, there is a link to resources you can use to initiate an eNote pledging process, including a readiness checklist and webinars.

A More Powerful CIA

During the pandemic situation, we are temporarily expanding our Community Advance (CIA) program to encompass all loans our members are making to PPP-eligible entities, whether or not they have received PPP funding. We have created a new CIA application specific to PPP loans for members to submit funding requests.

If you are looking for $10 million-or-below in advance funding beyond one year, the CIA program could represent a valuable funding tool. Today’s CIA advance rates range between 16 and 19 basis points below posted levels. Click here to view current rates. 

Here are more details on the “how-to’s” as well as a link to an application.  

“Other Matters”

We are expecting to distribute updated collateral loan-to-value rates within the next several weeks. As always, feel free to let me know if I can give you a detailed walk-through on our credit and collateral methodologies and how they can relate to your liquidity availability stress-testing process.

Remember that we continue to offer three and six-month advance levels at a substantial discount from posted levels. Program availability expires on October 15. Remember that the program has been expanded to $60 million outstanding per institution.

Speaking of other expiration dates, we extended the annual deadline for the Competitive Affordable Housing Program to June 15, rather than May 31. AHP is a great way to team up with innovative housing developments and non-profit programs. We’ll keep you posted on the selection results late in the fourth quarter. Thanks to all members that applied.

Happy Anniversary

This week marks the fifth anniversary of the new FHLB Des Moines, representing the first voluntary merger in the 80- year old history of the FHLBank System.

From depressions to pandemics. Whether rates go up or down; yield curves steepen, flatten or invert; loan demand increases or wanes; or if the supply or demand for deposits expands or contracts; we’re here for you during all economic cycles and conditions.

Again, look for further versions of our podcasts from FHLB Des Moines and always, always, always ask us questions, provide us feedback, as again, the best ideas come from our members. Thanks for tuning in and for your tremendous support of your cooperative. Don’t forget to subscribe to “FHLB Des Moines Insider” via our website or other channels.

Stay well, safe, strategic and liquid.

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1. Insider
2. Podcast Series