Doing More with Your Balance Sheet

Transcription

1 Doing More with Your Balance Sheet John P. Biestman, CFA - VP/Senior Relationship Manager Brett L.A. Manning, CFA - VP/Director, Member Strategies October 27, 2015

2 Who is FHLB Des Moines? Current Balance Sheet Issues Discovering Solutions and Strategies 2

3 Who is FHLB Des Moines? FHLB DES MOINES 3

4 WHO IS FHLB DES MOINES? The FHLBank System FHLB DES MOINES 4

5 WHO IS FHLB DES MOINES? FHLB Des Moines Congressionallychartered, privatelyowned, wholesale bank a cooperative Regulated by the Federal Housing Finance Agency Membership composed of commercial banks, savings institutions, credit unions, insurance companies and CDFIs 5

6 WHO IS FHLB DES MOINES? The Vision of The Bank The vision of the Federal Home Loan Bank of Des Moines is to be the preferred financial provider of our members in meeting the housing and economic development needs of the communities we serve together. FHLB DES MOINES 6

7 WHO IS FHLB DES MOINES? FHLB Des Moines Member-owned cooperative Provides funding solutions and liquidity to around 1,500 members Members include banks, credit unions, insurance companies, thrifts and community development financial institutions Supports mortgage lending, economic development and affordable housing FHLB DES MOINES 7

8 WHO IS FHLB DES MOINES? FHLB Des Moines Results Type Quarter Ending 6/30/15 ($ Millions) Assets 118,758 Advances 68,181 Mortgages (net) 7,029 Investments 42,754 Retained Earnings 726 Total Capital 4,985 Net Income 21.0 NIM 0.30% 8

9 WHO IS FHLB DES MOINES? FHLB Des Moines Dividend Rate As of June 30, % 4.00% 3.50% 3.00% 4.00% 3.50% 3.50% 3.50% 3.50% 3.50% 3.50% 3.50% 3.50% 3.50% 3.50% 3.50% 3.50% 3.50% 2.50% 2.00% 1.50% Ac#vity Stock Dividend Membership Stock Dividend 1.00% 0.50% 0.50% 0.50% 0.50% 0.50% 0.50% 0.50% 0.50% 0.50% 0.50% 0.50% 0.50% 0.50% 0.50% 0.50% 0.00% 1Q Q Q Q Q Q Q Q Q Q Q Q Q Q 2015 Ac#vity Stock Div Membership Stock Div Avg 3 Mth LIBOR Avg Fed Funds Rate 9

10 WHO IS FHLB DES MOINES? How The Money Flows FHLB DES MOINES 10

11 WHO IS FHLB DES MOINES? Partnership Retail Institution You work with your local customers Community is most important part of community financial institutions Cornerstone of strong local community Vital to health of nations economy Consultant, optimist and sounding board You have gained trust of your customers Wholesale Cooperative FHLB Des Moines works with our members Partner to help with your asset/liability mix Respond to your needs for liquidity Preserve community institutions by providing access to global markets We are always working hard to retain your trust and confidence

12 WHO IS FHLB DES MOINES? How? Advances are FHLBank s core business Issue Letters of Credit (LOC) Purchase single-family mortgage loans from members Provide subsidies for affordable housing Offer low-cost funding for community development and affordable housing FHLB DES MOINES 12

13 WHO IS FHLB DES MOINES? Access to FHLB Des Moines is Critical Local economies need a stable source of credit to support job creation and enable stable housing markets Community institutions are financing engines for local economies FHLB Des Moines advances were a critical component of member bank funding for new loans during the credit crunch FHLB DES MOINES 13

14 Current Balance Sheet Issues FHLB DES MOINES 14

15 CURRENT BALANCE SHEET ISSUES 15

16 CURRENT BALANCE SHEET ISSUES Common Balance Sheet Issues Safeguard against deposit/share rate increases Fund the duration of a pre-payable asset Differentiate loan products from competitors Accommodate a front-end construction period Protect a portfolio in a rising rate environment Using the balance sheet to optimize NIM Pricing assets for risk 16

17 CURRENT BALANCE SHEET ISSUES Key Issues Facing Members Liquidity Management Just-in-time funding Re-allocate lower yielding assets Interest Rate Risk Management Control asset/liability mismatches Balance sheet (macro) funding Transaction (match) funding Maintain Profitability and Safety Capital Management Increase capital efficiency Allow capital to determine assets size, not deposits Increase net income/return to ownership (dividends) 17

18 CURRENT BALANCE SHEET ISSUES Microtrends No more NIM squeezable from deposits/shares Markets believe that falling rates = further earnings risk Asset duration drifting lower, as a rate rise has been expected = yield curve fatigue Growing competition on loan terms and pressure to take on optionality What would happen to deposit/share rates in a deflationary environment? Defending Margins - Stagger AFS maturities - Pressure to extend asset duration - Charge for prepayment penalty withdrawals and manage duration variances to well within one year 18

19 CURRENT BALANCE SHEET ISSUES Microtrends Holding excess liquidity overnight can result in a negative spread O/N rate=0.25% Average IBD COF =0.33% (Des Moines District 2Q 2015) This results in a negative spread of 8 basis points (bp) guaranteed For a 3.5% loan to produce this kind of negative spread, your IBD COF level would have to increase to 3.58% 19

20 CURRENT BALANCE SHEET ISSUES Microtrends Loans refinancing? Bonds being called? - Customers desiring long-term fixed rate loans? - Natural reluctance to redeploy funds at these low rates Pass on new loans or sell them to secondary market? Hold Cash? Guaranteed loss today (to avoid future loss) This has been going on for six years and counting 20

21 CURRENT BALANCE SHEET ISSUES The Mortgage Portfolio - Duration extends - NIM can contract Rates - Duration declines - Loans pre-pay - Under stable decline, NIM preserved via low-cost deposits - NIM declines if you are wrong on funding duration / need to invest in assets of declining yield 21

22 CURRENT BALANCE SHEET ISSUES 1) How Many Loans Actually go to Maturity? 2) Where is Half the Original Principal Repaid on a 15yr Mtg Loan Pool? 0% PSA 9.3 yrs 100% PSA 6.5 yrs 200% PSA 4.8 yrs 300% PSA 3.8 yrs 400% PSA 3.3 yrs 500% PSA 2.9 yrs 600% PSA 2.7 yrs 700% PSA 2.4 yrs 800% PSA 2.3 yrs 900% PSA 2.2 yrs 1000% PSA 2 yrs 1,000, ,000 Prepayment speeds usually fluctuate over the life of a loan pool 600, , , Higher Coupon Loans Typically Have More Volatile Prepayment Activity FHLB DES MOINES 22

23 CURRENT BALANCE SHEET ISSUES FHLB DES MOINES 23

24 CURRENT BALANCE SHEET ISSUES Symmetrical Prepayment Blended Funding Strategies Laddered Fixedrate and Callable Advances 24

25 CURRENT BALANCE SHEET ISSUES The Investment Portfolio Pressure to extend duration with compressing NIM and excess liquidity Falling rates increase capital, rising rates decrease capital Solutions - Stagger investment maturities - Complement liability structure with duration certainty - Can you monetize the value of a liability in a rising rate environment and offset declining AFS? 25

26 CURRENT BALANCE SHEET ISSUES 26

27 CURRENT BALANCE SHEET ISSUES Shrinkage? Merger? Rates Rise Rapidly, Beta s Increase Regulator Scrutiny, Cannot Meet Loan Demand Deposit Run-Off, Portfolio Losses, Investment Sales 27

28 CURRENT BALANCE SHEET ISSUES Managing Risk: The FDIC on IRR Traditionally stable deposit categories may have higher rate sensitivity than historical behavior may indicate In general, mitigation strategies could include shifting the asset and funding mix; diversifying income sources; ensuring capital is adequate to absorb losses should depreciated securities have to be sold. - FDIC Supervisory Insights, 12/13 The agencies believe that a diversification of funding sources strengthens an institution s ability to withstand idiosyncratic and market-wide liquidity shocks The most common way to control IRR is through the balance sheet mix of assets and liabilities Financial institutions have a number of approaches that can be used to mitigate risks associated with outsized exposure to interest rate risk. These approaches can include rebalancing asset and liability durations - FIL Managing Sensitivity to Market Risk in a Challenging Interest Rate Environment, 10/13 28

29 CURRENT BALANCE SHEET ISSUES Managing Risk: The FDIC on IRR The most common risk mitigation strategy is slowly repositioning the balance sheet over time to more consistently align an institution s overall re-pricing, maturity and duration profile. For example, an institution exposed to rising interest rates may need to shorten the duration of assets or extend the duration of liabilities. Generally, the rapid sale of illiquid, longduration securities could result in significant losses and may not be an optimal method to reduce risk. The FDIC strongly supports banks efforts to control outsized exposure to interest rate volatility and will not criticize an institution for temporary adverse consequences to earnings resulting from a prudent rebalancing strategy. - FDIC Supervisory Insights, 12/14 29

30 CURRENT BALANCE SHEET ISSUES Tenets of Member Interest Rate Risk Strategy Deposit/Shares are a Key Component of Funding Strategy Advances are Complementary to Core Funding Advances can Enhance Value as Rates Rise Deposits/shares represent the primary source of low-cost funding and franchise value Deposit/shares are inherently duration-uncertain Can deposits/shares be run-off and transferred into duration-certain, long-term funding in the form of advances? Advances add duration certainty to the righthand side of the balance sheet Diversification of funding sources can help reduce overall volatility of balance sheet Advances are capital-efficient, customizable, simple and backed by a strong counterparty As rates rise, the value of an advance can increase Offsets losses to fixed-rate assets in rising rate scenario 30

31 CURRENT BALANCE SHEET ISSUES Assessing the Cost of Waiving a Prepayment Fee Price for It Comparing the rate on a Bullet Advance with that of a Member Option Fixed-rate Advance is a good pricing proxy for assessing the cost of prepayment 1.95% Five-year Member Option Advance Five-year Bullet Advance 1.70% 31

32 CURRENT BALANCE SHEET ISSUES 32

33 Discovering Solutions and Strategies FHLB DES MOINES 33

34 DISCOVERING SOLUTIONS AND STRATEGIES Advance Products Overnight Advances Short-term Fixed-rate Advances Long-term Fixed-rate Advances Amortizing Advances Member Option Fixed-rate Advances (MOFR) Member Option Variable-rate Advances (MOVR) Convertible Advances (FHLB Des Moines Owned Option) LIBOR Indexed Advances Capped LIBOR Advances Prime Rate Advances Forward Starting Fixed-rate Advances Advance Restructuring Symmetrical Prepayment Feature FHLB DES MOINES 34

35 DISCOVERING SOLUTIONS AND STRATEGIES Blended Funding Models Make loans your customers want Evaluate funding scenarios Create funding solutions that meet your risk and return criteria Match fund a single loan or portfolio of loans Discuss scenarios in loan/credit committee meetings 35

36 DISCOVERING SOLUTIONS AND STRATEGIES Blended Funding Steps Develop Asset Parameters Asset Amount, Note/Loan Rate, Amortization Schedule, Term/Balloon, Payment Type, Principal Amortization Delay Estimate Retail Cost Of Funds Rate Can Be Steadily Increased Over the Asset Term Model Advance Structures Term/Amortization Schedule, Fixed/Variable Rate, Type of Ladder, Advance Options, Principal Amortization Delay, Prepayment Options FHLB DES MOINES 36

37 The member institution wanted to portfolio some new production 15-year mortgage loans to improve net interest margin. To match the cash flow characteristics of the mortgage pool, the member constructed a ladder of nonamortizing bullet advances to maximize spread. This strategy involves using nonamortizing bullet advances to match the cash flows of the asset. This strategy does not attempt to match fund the tail due to the small amount of cash flows during the last six years of the loan. This is a $5 million pool of 15-year residential mortgage loans that the member chose to hold on their balance sheet instead of selling into the secondary market. 37

38 This advance has an option that allows the member to pay any or all of the advance off without a prepayment fee for a fiveyear period. The length of the prepayment window utilized is at the member s discretion. The member used a 10-year monthly amortizing advance with a 15-year amortization schedule and a 5-year prepayment option to match the cash flows characteristics of a pool of 15-year mortgages. The member chose to portfolio some customer mortgage loans and used FHLB Des Moines advances to assist them in building margin and mitigating interest rate risk. This strategy does not attempt to match fund the tail due to the small amount of cash flow during the last five years of the loan. This is a $5 million pool of 15- year residential mortgage loans that the member chose to hold on their balance sheet instead of selling into the secondary market

39 DISCOVERING SOLUTIONS AND STRATEGIES Symmetrical Prepayment Feature Protect the value of a portfolio of long-term assets in a rising rate environment Hedge a mortgage-backed security or other optionable securities Offset losses on securities Achieve potential liability gains in certain rate environments Potentially no prepayment fee if rates rise to a certain level from origination Negligible premium increase over standard advances 39

40 DISCOVERING SOLUTIONS AND STRATEGIES 40

41 DISCOVERING SOLUTIONS AND STRATEGIES Market Value of Equity Impact ($000) 2,500 2,000 1,500 1, (1,000) (1,500) (2,000) Example of MVE Changes Resulting From Symmetrical Funding as a Hedging Tool Hedging and Funding Newly Originated 15-year Mortgages (Assuming Average Life of Five Years on a Hypothetical $15 million Portfolio) Gain on Liability as Rates Rise (500) Hedging the decline in value of the mortgage position (2,500) 15YR MTGE FIXED-RATE FUNDING COMBINED PORTFOLIO 41

42 DISCOVERING SOLUTIONS AND STRATEGIES Forward Starting Fixed-Rate Advance Protect against rising rates without adding immediate liquidity Fund loans with delayed disbursements - I.e., construction loans No stock or collateral required until the advance settles Manage deposit runoff or uncertainty Replace future maturing FHLB Des Moines advances, brokered CDs or maturing term CDs FHLB DES MOINES 42

43 DISCOVERING SOLUTIONS AND STRATEGIES Forward Starting Fixed-Rate Advance The rate on a seven-year bullet advance, starting one year forward is 2.73 percent. The final maturity is eight years as of Thursday, March 12, In the graph below you can see the comparison of the FSFRA commitment to projected seven-year bullet advance rates. 43 Based on projected forward swap curve

44 DISCOVERING SOLUTIONS AND STRATEGIES Advance Restructuring Embed the advance prepayment fee into the interest rate of a replacement advance Receive favorable accounting treatment if debt modification criterion met Take advantage of prevailing low interest rates Lengthen duration of liabilities without increasing balance sheet size Enjoy no upfront cash expense or fees 44

45 DISCOVERING SOLUTIONS AND STRATEGIES Since the introduction of the Advance Restructuring Program, a number of members, with the approval and certification of their external auditing firms, have used the program and seen the following benefits: Extended liability base duration without increasing the overall size of their balance sheet Decreased cost on advances Added duration to funding mix to mitigate interest rate risk on longer-term loans Example: In this transaction, a member was able to restructure $77.5 million in advances. Original Advance Amount Original Interest Rate Maturity Date of Original Advance Years to Maturity $15,000, % 9/15/ $32,500, % 1/27/ $15,000, % 6/9/ $15,000, % 9/11/ $77,500, % 1.78 Restructured Advances New (Blended) Interest Rate Maturity Date of New (Restructured) Advance Years to Maturity $15,000, % 2/8/ $16,250, % 2/7/ $16,250, % 2/8/ $15,000, % 2/8/ $15,000, % 2/8/ $77,500, % 5.32 Result: This member was able to accomplish their well-defined goals by restructuring several existing advances. The member lowered their cost on advances by 76 basis points and extended their liability maturities by over 3.5 years. As the chart shows, this decrease in the cost on advances should result in a yearly interest savings of $589,000. Ultimately, this restructuring strategy allowed the member to hold some of their 15-year mortgage production on balance sheet without increasing advance balances. Decreased cost of advance: 0.76% Increase in liability base duration: 3.54 years Net interest savings for 2013: $589,000 FHLB DES MOINES 45

46 Q&A Session 46

47 THANKS John P. Biestman, CFA VP/Senior Relationship Manager Brett L.A. Manning, CFA VP/Director, Member Strategies