Georgia On My Mind - Episode 12

posted on Tuesday, November 17, 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.

Now that the election is over, well sort of, fixed income markets are trying to assess the impact on rates and the shape of the yield curve. With two outstanding Senate races to be decided upon, we’re likely to have Georgia on our minds at least until early into the New Year. Nonetheless, prospects for no single political party controlling the collective legislative and executive branches continues to be a good probability.

With that scenario, sentiment on the degree of impending fiscal stimulus has shifted just a bit. Before November 3rd, we started seeing glimpses of a so-called reflation trade that steepened the yield curve to levels not seen since mid-2018. The steepening was said to be in line with prevalent predictions of single party control of both branches and therefore being able to effectuate fiscal stimulus on a larger scale, leaving trillions of U.S treasuries needing to find a home.

Not surprisingly, medium and long-term rates declined post-election with the more likely scenario of divided government and perhaps a skinnier version of fiscal stimulus that will soon be generated out of the lame duck session, perhaps “only” in a range centering somewhere around $800 billion. The “on-again-off-again” trend toward steepening again tilted toward higher longer-term rates in the wake of positive news on the vaccine front.

As an example, yields on the 10-year treasury recently recorded their highest levels since March. With stronger-than-expected vaccine efficacy rate projections, we’ll soon see how that could translate into releasing pent-up consumer and capital spending, and with that, the viability of the reflation trade as far as rates are concerned.

The post-election employment situation report generated some positive elements. The October report registered a decline of one-percent to 6.9% of the workforce, representing the sixth straight month of improvement. Still, most of the employment gains represented furloughed workers who came back to the job, as the labor market remains down from its high of the first quarter of the year by roughly 10 million jobs.

Displaced workers in the service sector such as hospitality and transportation caused a full-one-third of those unemployed to be out of work for six months or longer. By reference, during the last recession, 45% of those unemployed were jobless for over six months. This development is one of the key reasons that the Federal Reserve is urging meaningful fiscal stimulus to be undertaken.

Conventional wisdom dictates that a surfeit of government debt and rising money supply leads to rising rates, assuming growing demand. We’ll check both of those boxes, but will do so with a caveat. We haven’t commented in a while about the monetary side. Year-over-year, M2 has increased by 24.1% on a seasonally-adjusted basis. The Federal Reserve Bank of St. Louis’ Velocity of M2 Money Stock finally showed some signs of stability after and lengthy decline over the past few years, or for that matter, cycles.

Monetary velocity represents the frequency that a unit of money is used to purchase gross domestically-produced products, essentially the ratio of GDP-to-money supply. The gauge is a good indicator of recessionary conditions as of now when consumers shift from a consuming mode to a saving mode. Velocity in Q3 increased slightly by 3.4% over Q2, although the index is down by almost 21% from a year ago. Interestingly, current velocity is only slightly above half of levels sustained in 2008 during the Great Recession.

Last month, the Congressional Budget Office updated its forecast of federal deficits, debt and spending. For 2020, the budget deficit is expected to triple that of 2019, not surprisingly due to the fiscal stimulus required to confront the effects of the pandemic. At a level of 16% of GDP, that’s the highest since 1945.

For 2021, the projected deficit is 8.6% of GDP, still far in excess of the ratio over the past 50 years of 3.0%. At the current projected rate, we’re not forecast to return the deficit to just above 5% until 2030. Key to how interest rates react will be to what extent the Fed is willing to purchase the burgeoning supply of debt. The spotlight will increasingly be focused on that very question.

So, what are we hearing from many of our members over the past few weeks? On the credit front, Q3 loan loss provisions appeared to have dropped across the board due to large increases in loan loss reserves that have been taking place since the onset of the pandemic.

Loan deferrals also showed consistent declines. Deposit activity continues to rise, with higher shares being originated electronically, perhaps due to the pandemic. It will be interesting to see how these deposits behave after balances have leveled off. Many are asking if these deposits will be among the first to leave.

Mortgage banking activities remain strong but uneven, especially the refi market. A recent National Association of Realtors report asserts that most mortgage demand has been sourced from higher-value homes where prices have risen. Sales of million dollar homes, in fact, have doubled year-over-year, although sales of single family homes are starting to level out.

Overall loan growth has remained sluggish, ex-PPP and mortgages, especially C&I loans. We find that most members are focusing on appropriate levels of ALLL, capital and liquidity. The recently released Federal Reserve quarterly senior loan officer survey noted tightening underwriting standards including credit scores and collateralization standards.

Last episode, we talked about, members in some regions that remain saddled with high-cost term CD’s, many of which were one-year CD’s that were originated and priced just before COVID. Even on newly-posted CD’s, it’s not terribly unusual to see rates above one-percent, even in the current ZIRP environment! With CD’s starting to mature, it’s all the more important to evaluate their prospective renewal rates and compare them to other sources of funding.

When CD’s mature, you’ll face multiple options. You can roll them over, let them mature and deploy balance sheet cash, re-deploy into other deposit categories, or replace the funding with FHLB Des Moines advances.

In comparing the alternatives, you’ll want to go through a three-stage assessment process:

  1. Scanning the pricing environment of specific deposit types and geographies (Your Relationship Manager can help you with a competitive analysis at multiple levels);
  2. Ascertaining the degree to which existing lower-rate depositors are attracted to the term deposit program; and
  3. Projecting the prospective sources of deposit category cannibalization. Let’s consider a scenario in which a low-rate, one-year bullet Community Investment Advance (“CIA”) could be used as a marginal cost of funding benchmark. Why a CIA advance? Quite simply, it’s the lowest dividend-adjusted source of wholesale funding that’s offered by FHLB Des Moines anywhere on the curve, about five or six basis points. Don’t forget that FHLB Des Moines members are eligible to access CIA advances up to $10 million which may be used for a Commercial Lending or Residential Advance. When I mention dividend-adjusted, I’m referring to the net impact of the activity stock cash dividend on a member’s assumed cost of capital. Under most capital assumptions, a dividend-adjusted Community Investment Advance is well into the middle single-digits. Even if an institution were to price a term deposit in the teens, its marginal cost could very well be much higher than its actual rate. So, engage with us and give your deposit pricing strategies a marginal cost of funds reality check. We can help walk you through the process.

Some PSA’s:

Would you like to know how we’re doing with LIBOR transition, what we’re thinking about the rate markets and how the Federal Home Loan Bank System is ensuring that it is fulfilling its mission to provide liquidity into the financial system?

Then tune into a podcast that we’ll be releasing next week, featuring Bill Bemis, our Chief Capital Markets Officer.

This week, we released the Q3 2020 Quarterly Economic Overview. This edition introduces an new feature: economic summaries for each state in the FHLB Des Moines district in terms of economic indicators, housing GDP and employment. Check into our website or let your Relationship Manager know if you’d like to access a copy. If you’re looking for an ideal economic summary to include in your ALCO or board discussions or handouts, the Economic Overview is an ideal deliverable.

Finally, throughout the district, with the notable exceptions of Hawaii, Guam, American Samoa and the Marianas Islands; we know that November is the time of year when the weather can change by the minute, so it’s always best to check the radar on your cell phone. It reminds me of the time I called a friend to warn him of an impending ice storm. I cautioned, “Did you hear they have ice in Spokane?” He replied, “Already?” To which I replied, “Yup it’s $2.29 a bag.”

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

Stay well, safe, liquid and weather the weather, whatever the weather, whether you like it or not! Thanks for tuning in.


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