The TINA Effect - Episode 5

posted on Tuesday, August 11, 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.

After a 40-year hiatus, the acronym, TINA is in the financial vernacular once more. A phrase modernized by Margaret Thatcher, she used the term “There is No Alternative” as a rallying call to further the economic policies of that time.

While Tina may not one be of the top-ten names of newborns in 2020, the phrase increasingly describes the perceived lack of investable alternatives for financial institutions.

The TINA effect much describes the dilemma that many portfolios face today. In spite of a disparaging drop in Q2 GDP and other symptoms of the ongoing pandemic economic fallback, the S&P 500 Index is up 0.3%, while the NASDAQ is up 17.4% year-to-date from the end of July.

With the Fed now owning more Treasuries than all foreign central banks combined, when faced with minuscule yields and diminished spreads throughout the fixed income curve, it’s a real strain to deploy your liquidity. There is still an excess amount of liquidity from retaining PPP balances, loan pre-payments, sluggish loan demand and flights to safety.

On the surface, with the Fed sweeping up Treasuries, along with certain types of corporate bonds and mortgage-backed securities, it would seem that there are few alternative to investing liquidity. Hence, the TINA Effect appears to be alive and well, or is it?

So, what to do in this zero interest rate, or ZIRP environment. Let’s look at a smattering of strategies and consider some action, or as the comedienne, Tina Fay, once was quoted, “You can’t be that kid standing at the top of the waterslide, over-thinking it. You have to go down the chute.” Although there are unprecedented headwinds, there are ways to circumvent the TINA effect.

“ZIRP” or zero interest rate policy is nothing new. Remember that 12 years ago, the Federal Reserve established a targeted fed funds rate close to zero that lasted for seven straight years, from 2008 to 2015. Then, as now, low rate levels were backed-up by aggressive purchases of bonds, treasuries, agencies and mortgage-backed securities.

On the monetary side, we’ve thus far skirted the shoals of negative interest rates in favor of massive expansion of the Fed’s balance sheet. For most of us, it’s tough to maintain net interest margins in a low-rate environment, without increasing credit risk or interest rate risk. As many lenders face this inhospitable environment, lets’ explore some actions you can take while navigating your way through today’s labyrinth of zero interest rate policy (“ZIRP”) and excessive liquidity.

First, at some point, your financial institution will need find a path back toward growth. Here are some strategies that could rejuvenate your liquidity and capital redeployment prospects:

  • Hold some of the mortgages you’ve been originating. We talked about the issue of sustainable earnings via holding mortgages, as opposed to taking the gain on sale in Episode 3, “Vanity, Sanity and Reality.” Look at those break-even levels of selling vs. holding against multiple yield curve and rate scenarios.
  • You might consider purchasing some 15-year mortgage-backed securities, or seasoned mortgages with historically low prepayment speeds, in lieu of originating mortgages. Or better still, you might want to evaluate categories that the Fed may not be buying such as jumbo’s, premium 20-year mortgages or low-duration sequential CMO’s. Tightening spreads in these sectors have not been as profoundly impacted as other “on-the-run” alternatives.
  • You might try and intensify potential pockets of demand in your local market (For instance, would commercial mini-perm loans be a good fit with your customer base?) How about creating a new 10-year amortizing, on-balance sheet mortgage product? You may ask, “why ten years?” Why not market this sort of mortgage product as a forced savings mechanism aimed at the 50-somethings in your market? It’s likely that you have customers or potential customers that have existing mortgages that are ripe for re-financing and who also have liquid assets that your customers are tired of getting single-digit basis points returns on. Why not offer a product that increases a customer’s monthly payment, yet builds them a path toward a debt-free retirement in ten years? It’s a disciplined way for a customer to save.
  • On the funding side, to mitigate the extension risk associated with these growth strategies, consider a medium and long-term funding structures with a Symmetrical Prepayment Feature. In exchange for a modest-rate premium, fixed-rate funding can be prepaid in advance of its maturity with a monetary gain that can offset any losses that an asset might sustain in a rising-rate environment. Think about your forecasts. Do any of them incorporate rising credit losses? How about unrealized or realized losses on your securities portfolio should rates rise? It might make sense to build a funding hedge on the liability side of the balance sheet and offset potential losses down the line. In concert with your Relationship Manager, our Member Strategies team can help you simulate balance sheet growth strategies that could be funded using symmetrical advances that could be monetized in a rising rate environment.

An Old Nemesis?

Many financial institutions are pondering the potential impact of an old cyclical nemesis. You know, the one that keeps you up at night; where credit issues surface, allowances build, charge-offs accelerate, capital erodes and liquidity, shall we say, is no longer excess. Under this not-so-cheery backdrop, where the natural human reaction is to hunker down, again, you still can’t lose sight of the importance of growing your business.

On that theme, we are putting together a webinar on Managing Liquidity and Profitability in Today’s Environment. We’ll be addressing such questions as:

  1. How do we grow profitably in a flat yield curve, low-rate backdrop?
  2. Are your asset/liability measures adequately portraying the risks?
  3. With your customers demanding long-term fixed-rate loans, do you originate them, or simply pass?
  4. How do we balance net interest margin stability against opportunities for non-interest income?

Look for the registration link on our website.

In other news of the fortnight

We’re imminently releasing our Q2 economic analysis whose details may be found on the Educational Resources section of our website. Let’s review a few highlights.

Remember that the backdrop seems to be the gravitational pull of central banks, not just the Federal Reserve, but literally all of the world’s central banks. To-date, the degree of monetary intervention has been awe-inspiring.

When one thinks about the scale of Fed balance sheet holdings (since March, it’s increased by over $3 trillion), that makes us hearken back to the halcyon days of QE 2008-10, when the balance sheet expanded by a mere $1.2 trillion.

Not only have we sustained massive quantitative ease, but M2 has grown by 24% over the last 12 months. With GDP continuing to drop well within double-digits, as of now monetary velocity is non-existent.

The printing presses, however, seem to be on overdrive while the banking system is flush with reserves. At some point, these reserves would hopefully be deployed back into demand-driven credit and lending activity. When that happens, and it might take some time, many market observers are reminded of the classic definition of inflation: too much money chasing not enough goods and services.

At present, we seem only to be meeting one of those criteria, unless we’re referring to a product manufactured by either Lysol or Clorox.

Perhaps the consequences of warranted aggressive monetary actions will manifest themselves in the form of currency erosion (which has actually accelerated in recent weeks), or inflation, are to be discussed another day.

The US Dollar Index is now at its lowest level in two years. We’re not sure whether the declining currency value is due to improving indicators in Europe and Asia, or if longer-term monetary or fiscal policy risk in the U.S is being recognized.

In the meantime, the priority is now all about promoting financial stability in the here-and now. Traditional fiscal and monetary policies are sitting in the bleachers. Even prior to the pandemic economy, deposit growth started eclipsing loan growth in the second half of last year.

It’s interesting to see where most of these deposits have been applied. The answer has been cash, securities, reverse repos and Fed funds purchased, rather than loans.

In fact, over the past six months, of the $2.4 trillion in deposit growth, only 22% of these funds were applied to making loans. Per the Fed H.8 reports, over the last six months, bank deposits have grown by 17.7%, while loans have grown by only 5.2%.

Were it not for the PPP program, you can bet that that the loan growth figure would have been significantly lower. One item that’s generating some buzz is the relationship between small business bankruptcies and second mortgages.

How so? Small business owners frequently tap into their home equity to finance operations. Recent COVID relief packages including the CARES Act and 2019 Congressional bankruptcy code changes are increasingly facilitating second mortgage loan modifications.

FHLB Des Moines News

We recently announced a capital tweak in our standby and confirming Letter of Credit (LOC) products. Effective, October 1, 2020, we will be requiring the purchase of a de minimus activity stock of 10 basis points of the LOC amount. This requirement will apply to any new, renewed or modified LOC’s after October 1. Remember that on July 24, the Bank’s board of directors approved an annualized second quarter dividend at an annualized rate of 5.50% on activity-based stock.

FHLB Des Moines letter of credit balances have actually increased, year-over-year, with many of our members working with us on strategies to build on-balance sheet liquidity through having us issues LOC’s in favor of public depositors, rather than posting securities as collateral.

Speaking of tweaking, for those of you with Blanket ASPA agreements who pledge or report collateral on a Borrowing Base Certificate, we’ve streamlined the online filing process. There’s a new “quick-start” guide that we now have on the collateral section of our website that can help you walk through it. There’s also a link to the quick-start guide in our latest Collateral Quarterly publication that was released just last week.

Finally, a major announcement on our Virtual Leadership Summit on October 21 from 1:00 – 5:00 PM Central. Even though the world looks a bit different this year, our 5th annual summit will include as top speakers. There will also be plenty of networking opportunities and information on how you can optimally tap into your partnership with FHLB Des Moines. Again, block out the afternoon of October 21 and look for registration for the complimentary event on our website.

We’ll see you next time on the FHLB Des Moines Insider Podcast. Stay well, safe, liquid and remember, as we at the FHLB Des Moines work with our members, there ARE alternatives when it comes to developing your own customized balance sheet and funding strategies. Thanks for tuning in.


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