Everything you ever wanted to know about bank Wholesale Funding options (But were afraid to ask) Presented at: FHLB Systemwide Marketing Conference February 27, 2017 Presented By: Raymond E. Chandonnet Managing Principal (908) 206-4581 [email protected] 1 Goals of this presentation • Review 9 situations in which wholesale funding is useful for banks, and where things stand in TODAY’S market • Provide a primer on the different wholesale funding options banks have at their disposal today • Review each product’s strengths and weaknesses • Provide perspective on how each competing product is “sold” and/or “bought”, including against FHLB advances • Differentiate between approaches to wholesale funding at small, mid-sized and large banks • Get through all this in one hour! Yikes…. 2 They call me the “funding whisperer”…. • I’ve bought or sold pretty much every wholesale funding product there is, either directly or indirectly: Company Time Period Direct Indirect Malden Trust 1987-1992 • Issued brokered CD’s FHLB Boston 1993-1997 • Sold advances on Funding Desk • Designed funding strategies for members • Sold short-term repo to banks First Union 1997-2000 • Created mechanism for transferring FHLB • Designed leverage strategies that incorporated FHLB advances Securities advances from member to member • Designed leverage strategies that incorporated FHLB advances Lehman Bros 2001-2005 • Referred banks to CD brokers to issue callable CD’s we swapped • Sold structured repo to banks JPMorgan 2005-2007 • Helped derivative desk work with FHLB’s to create new structured advance products • Created “funding desk” which advised banks on all sources of wholesale funding and developed strategy for them • Sold structured repo to banks • Designed leverage strategies that incorporated FHLB advances • Launched brokered CD desk Sandler O'Neill 2007-2014 • Introduced banks to “sweep” deposit products in order to sell swaps • Created mechanism for transferring against them brokered deposits from bank to bank • Launched FHLB restructuring advisory service • I’ve been on the leading edge of driving new funding strategies / product design for 20 years (e.g. embedding derivatives, debt modification under EITF 96-19, symmetrical prepayment, use of rate locks) • I serve on the board (and chair the board ALCO committee) of a large community bank that uses every available wholesale funding source (and lots of it!) 3 When do banks use wholesale funding? • Funding loan growth in excess of deposit growth (when cash is less than 5% of assets) • Managing deposit costs and impact on net interest margin: • Funding deposit outflows without having to “pay up” excessively • Controlling marginal cost of funds by minimizing use of CD “specials” • Funding temporary cash shortfalls • Funding seasonal liquidity needs (e.g. tied to agricultural calendar) • Funding fixed rate lending initiatives, both residential and commercial • Managing overall interest rate risk, particularly to reduce liability sensitivity (exposure to rising rates) • Funding wholesale leverage strategies especially involving securities • Hedging potential future deposit runoff if interest rates rise • Using caps or floors without doing a derivative 4 Relative importance of each strategy today Use of Funding Importance Comments • Many parts of the country seeing loan growth outstrip deposit growth Funding excess loan growth and may resort to deposit “specials” or increasing MMDA rates • Little evidence of deposit outflows (yet), but upward pressure on Managing deposit costs pricing in some markets leads to CD specials, price wars, and need to manage marginal cost of funds Temporary cash shortfalls • Always a possibility Seasonal liquidity needs • Always a possibility • Increasing emphasis on fixed rate lending as borrowers worry about Fixed rate lending initiatives rising rates; • Increased retention of fixed rate mortgages at asset-hungry banks • More focus on rising rate risk now that rates are actually rising; Managing interest rate risk • Many banks though are asset-sensitive and seeing margin expansion • Still a lot of excess capital raised during the financial crisis needing to Leverage strategies be levered, but banks more cautious about adding bonds in a rising rate environment Hedging future deposit • Banks with “surge deposit” balances SHOULD be doing this, but most runoff are not • Embedded caps starting to work again with higher rates to play with, Embedding caps or floors but need to restart bank education process 5 What did we learn from the last Fed tightening cycle? Borrowings as % of Deposits • After the Fed started raising rates in mid-2004, (By Asset Size) borrowed money (predominantly FHLB advances) 10.0% approached 6%-10% of assets by the end of 2006, 8.0% • And, banks further supplemented their funding by nearly 6.0% doubling their use of brokered deposits between mid- 4.0% 2004 and late 2006 2.0% • Today, borrowing levels are MUCH lower than they 0.0% <$500MM $500MM-$2B $2B-$10B $10B-$50B were then…. 2006Y 2016Y • …while brokered deposit levels are close to where they were BEFORE the Fed started raising rates in 2004 Brokered Deposits as % of Deposits (By Asset Size) • Given this, and the regulatory bias against brokered 6.0% deposits, a strong argument can be made for ramping 5.0% up borrowings back to these levels BEFORE increasing 4.0% brokered deposits 3.0% 2.0% 1.0% Source: Regulatory filings, all banks 0.0% <$500MM $500MM-$2B $2B-$10B $10B-$50B below $10 billion in assets 2004Q2 2006Y 2016Y Major sources of Wholesale Funding • Federal Home Loan Bank advances • Brokered CD’s • Listing Service CD’s • Corporate sweep deposits • Broker/clearing company sweep deposits • Reciprocal CD’s (One-way buy) • Short-term repo • Structured / term repo • Fed funds Note: I am ignoring the Fed Discount Window intentionally since it’s use is STILL viewed by most Feds and banks as a sign of weakness, despite new guidance to the contrary issued by the Fed during the financial crisis 7 Pricing Comparison Product 3 Months 1 Year 2 Years 3 Years 5 Years 10 Years FHLB advances1 0.85% 1.20% 1.57% 1.80% 2.30% 3.15% Brokered CDs2 0.80% 1.15% 1.55% 1.85% 2.25% 3.15% Listing Service CDs3 0.95% 1.30% 1.55% 1.75% 2.25% 2.56% Corporate Sweep4 0.90% N/A N/A N/A N/A N/A Broker Sweep5 0.95% 1.25% 1.50% 1.75% 2.05% N/A Repo6 1.10%% 1.35% 1.80% 2.05% 2.40% 2.90% Fed Funds7 0.75% N/A N/A N/A N/A N/A Libor / Swap 1.05% 1.30% 1.55% 1.73% 2.00% 2.37% Benchmark All pricing as of 2/23/2017. Comments: 1) “Regular” advance rates 2) High end of quoted range; rates lower for small amounts or new issuers 3) Highest offered rate for each maturity 4) MMDA account, no long-term commitments, no index so not swappable 5) “90 day” rate = nominal floating rate, unswapped; 1-5 year rates assumes funding is swapped to fixed although fixed rate agreements are sometimes available at the same pricing 6) Assumes Agency Passthrough collateral – Rate will be lower using “Type 1”securities (GNMA / UST), Higher 8 using less liquidity securities 7) Source: Federal Reserve Basic Product Information: FHLB Advances Basic Form: • Secured borrowing Collateralized: • Yes – Qualifying loans and securities Collateral Delivery: • Sometimes, depending on product type and bank credit Margin Calls: • Generally not Brokered? • No Deposit? • No • Fixed terms across most maturities, amortizing, putable, callable, structured with embedded Terms / Structures derivatives, spot and (limited) forward starts Prepayment • Any time, subject to prepayment penalty Symmetrical • Depends on the FHLB and product type; Prepayment? • Generally limited to no more than 10% gain when offered Can be • Some FHLB’s offer limited “blend and extend” Restructured? • Can be ‘cash settle’ restructured subject to debt modification accounting • Borrowers are “members” (cooperative) Other Notable • Borrowing requires investment in capital stock, which pays healthy dividend Features: • Array of lower cost products to fund affordable housing / community development 9 Basic Product Information: Brokered CD’s Basic Form: • Certificate of deposits Collateralized: • No Collateral Delivery: • No Margin Calls: • No Brokered? • Yes Deposit? • Yes Terms / Structures • Fixed terms across most maturities, plus callables (which are typically swapped to floating) Prepayment • No Symmetrical • N/A Prepayment? Can be • No Restructured? • Underwritten deals are funded immediately (broker takes the risk of not selling it) Other Notable • “Best efforts” deals have no commited issuance amount, but are typically 5-10bp cheaper Features: • “Death Put”: Terminates early upon death of depositor 10 Basic Product Information: Listing Service CD’s Basic Form: • CD Collateralized: • No Collateral Delivery: • No Margin Calls: • No Brokered? • No Deposit? • Yes Terms / Structures • Fixed terms across most maturities Prepayment • None Symmetrical • No Prepayment? Can be • No Restructured? Other Notable • Both issuers and buyers pay a flat fee to access an online marketplace Features: 11 Basic Product Information: Corporate Sweep Deposits Basic Form: • MMDA / DDA from corporate cash managers and syndicated out to banks in $250k blocks Collateralized: • No Collateral Delivery: • No Margin Calls: • No Brokered? • Maybe – grey area – empirically, 50/50 split on how banks characterize them Deposit? • Yes Terms / Structures • Terms up to 5-7 years, “floating” rate but not always pegged to an index Prepayment • None Symmetrical • No Prepayment? Can be • No Restructured? • In some products, bank must bid