ALM & Funding Strategies for the Current Environment
September 26, 2024

0:08
Hi, everyone.
0:09
Thank you for joining us today for our webinar as we approach the end of the third quarter here. So, my name is Andrew. With me today is Derek Hamilton. Derek joined us recently.
0:22
He made his debut in August for our peer analytics webinar. He's back for the sequel here.
0:29
So he's got some good stuff prepared.
0:31
So it's probably going to be more Empire Strikes Back as opposed to Godfather III in terms of movie sequels.
0:40
But so today, what we have planned, if you're new to joining us here, is we'll talk just a little more broadly about some ideas that are top of mind for many folks.
0:54
We'll kick it off by talking about some big-picture topics related to the start of the cutting cycle.
1:02
If you haven't heard, interest rates went down recently.
1:06
And then Derek's going to take a historical look at some past interest rate risk cycles and about what the yield curve tells us in terms of where we should position our funding.
1:23
And then lastly, we'll go through a list of, given all the movements that are happening, what we can consider on the funding side of things.
1:33
So, we'll kick things off with a poll question here.
1:36
I always like to get everyone out there as a perspective on what's happening and where we think the wind is blowing.
1:44
So, you can see here, and we'll launch the poll in just a moment here, and it's going to be related to where we think Fed funds are going to be at the end of 2025.
1:59
So, if we remember, we asked in August where we thought that they were going to be at the end of 2024, and so here's the poll going up, and we'll wait a second as the answers start to come in.
2:17
But, you know, a little anecdote while things were coming in, driving back from a concert with my wife about two weeks ago, we were talking about all the normal things that we talked about. And then, out of the blue, she said, you know, what do you think the Fed is going to do on Wednesday? And, you know, without the context of knowing my wife, I'll just tell you that this was pretty out of character and not quite to the level of when Grandpa asked at the Thanksgiving table, you know, what's up with this Bitcoin thing? But it was pretty interesting.
2:48
And I think it tells us, you know, one or two things that the outside of our little sphere of the banking industry, the financial industry, that you know the Fed rate decisions is on the radar, and then the other thing is that my wife and I ran out of things to talk about on that 45-minute drive home so both of those things can be true but you know it was an interesting observation nonetheless.
3:18
Yeah, in parallel, my dad asked me about Fed rates as well but quickly realized that Bloomberg switched over to 929 and just never changed the channel, but it shows how people get involved with this once they start listening. So it's been interesting.
3:33
Yeah, that radio station here in greater Boston threw me for a loop too, you know, thinking I was going to hear some music, but it was. So I think we can end the poll now and see where the results are.
3:47
And rather interesting that most folks, 73%, believe that option C, an upper limit between three and a quarter to 4% is where ultimately the Fed will end up in just a little more than a year.
4:04
And that's interesting. That's good context as we go through.
4:07
We're going to talk about some of the scenarios, the hard landing, the soft landing, and everywhere in between.
4:13
So, you know, let's move on from the poll and jump right into our first section here.
4:29
So, you know, let's talk about what happened at the FOMC decision last week.
4:35
So, full disclosure: I was personally in the camp that we were going to see a 25-basis point cut, and the tone and the commentary were going to skew toward the dovish.
4:49
So, implying that we're going to see more cuts coming soon.
4:54
So that was potentially to strike a balance between it was a crawl, walk, run perspective, right?
5:03
Where you come out of the gate with 25 and then you can build up a little bit further.
5:08
Now, if we think back to the most recent hiking cycle, which was historic in many ways, it was a 25-basis point hike, but it was a 50-basis point hike.
5:17
From there, we had four consecutive 75 basis point hikes, then a 50, and then 25 until we got all the way to the 500.
5:26
So it was interesting to see the 50 basis points right out of the gate.
5:32
And then the commentary, well, before we get into the commentary, I will note that I was with a bank CFO who was on the, whom I think is on the call right now.
5:40
And he had asked me before the announcement what was going to happen, and then ultimately, when he came out, he reminded me of how wrong I was on the cut.
5:51
So it's always good to have people to keep you in check.
5:55
But in terms of the tone of the comments, Derek had compiled these immediate reactions from the press conference, and we highlighted whether it seemed to have a hawkish tilt or a dovish tilt.
6:11
And it's interesting that, as you can see by the color coding there, it was pretty split down the middle.
6:20
So for every comment that, you know, would imply that there isn't an overwhelming need to be aggressive on rate cuts, like the first bullet there, the economy is strong.
6:32
There was language to soften that a little bit, talking about how the labor market has cooled, how, you know, the efforts to battle inflation and the hyperfocus that had been on inflation, and that really a lot of success has been made
6:48
And, you know, I'll call your attention to the two bullet points down at the end, which I think are very informative in terms of looking forward as to, you know, where do we go from here?
7:03
And, you know, the bullet point of look at today's cut as the new pace. You know, Powell is very pragmatic and very transparent.
7:13
And I think that was kind of the elephant in the room that had to be addressed because, and again, that was my sentiment going in, you know, could you see a path where they go 50 in September and then 25 in November or December or any point thereafter, and then go back up to a 50, right?
7:33
That's that yo-yo in terms of the size of the cuts.
7:38
Again, in contrast to the hiking cycle where they built up each of the increments and then they gradually slowed it down as we got to the end of that particular cycle.
7:48
So, that type of sentiment has a hawkish tilt to it.
7:53
Now, you could argue that my first instinct was, don't look at today's cut as a new pace means that, like, they want to be able to signal to the market that we could go 25.
8:05
You could say it's the other direction.8:08It's 70, 75, right?
8:09
Like, don't think that we're just talking about 25s and 50s that, you know, again, that goes to the ones that aren't denoted in blue and green, that are kind of neutral ish to say, hey, you know, we could accelerate.
8:24
And it says there, continue making decisions, meeting to meeting, no preset path.
8:30So that's one thing that can go either way.
8:33
But, you know, as we mentioned, the last bullet point really is fascinating.
8:37
And there's a whole cottage industry meant to tear apart, you know, which way the Fed is thinking.
8:44
I think there's really mixed messaging there in terms of, you know, we don't think we're behind on rate cuts.
8:49
But the 50 basis point shows that we're committed to not fall behind.
8:53
And, you know, one of our relationship managers, I think, astutely pointed out that, well, you know, if you come out and you say we're not behind, then you're kind of admitting and telling yourself that, you know, maybe kind of sort of you think you may be behind.
9:09
So, let's talk about the dot-plot progression.
9:11
Every quarter, the Fed updates their projections.
9:14
All the governors vote on where they think rates, the Fed funds rate will be at the end the year, as well as a handful of economic data as well.
9:24
So, when we look at where the forecast was for the end of 2024, we can see that there was a big drop going from June to, most recently in September.
9:33
And, you know, when you think in June that we were still, we still had the remnants of the higher for longer regime in place.
9:41
​The intermediate part of the curve really turned around.

9:43
The fulcrum point was in just about the, towards the end of May is when intermediate rates started to come down.
9:51
So, you know, for the June meeting, it was kind of in a wait-and-see mode and really the expectations didn't change.9:57But now in September, after the really vigorous rally that we've seen in the belly of the curve, we'll get to that in a little bit, that the Fed has accordingly adapted.
10:08
And so you can see the general trend in terms of the year-end 24, 25, and 26 expectations.
10:15
But I think really one of the most interesting things that we observe here is look all the way to the right-hand side at the longer run expectation.
10:25
So that has been gradually ticking up.
10:27
So it used to be two, two and a half, and now it is approaching three percent.
10:32
And I think, you know, we can talk about two things. There is one, the conviction in the potential soft landing, right, that we don't need to go back down to zero rates like we have in the two cutting cycles.
10:45
But the other part here is, and it's one of my soapbox issues, I'm not going to elaborate on it, it's this idea of the compounded built-in inflation that isn't necessarily recognized by the year-over-year metrics.
11:01
So, with the terminal rate, the rate that the Fed needs and wants to get to doesn't have to be 2% that it could be closer to 3%.
11:13
So this is all well and good about where the rate is projected to be.
11:19
But what are the types of things that the Fed are watching? So we talked a little bit about inflation.
11:23
We can see that on the bottom.
11:25
So, the core PCE, it's widely known to be the Fed's favorite metric for assessing inflation.
11:35
And it strips out food and energy, so it tends to be less volatile, doesn't spike as high as other versions of inflation, and it has been steadily coming down. But when we look at what the forward path here again in contrast to that, you know 2.9% terminal rate the expectation is that it's really a really a slow taper from the current 2.6 down towards 2% at the end of 2027 more importantly than inflation.
12:04
I think the conversation really has flipped from talking about and fighting inflation to the unemployment rate.
12:13
So we had done a webinar a year or two ago, closer to two years ago, because it was the onset of the cycle.
12:23
And Powell was pretty blunt and direct in his comments in saying, the pain of not fighting inflation aggressively enough will pale in comparison to the pain felt, the temporary pain felt by raising rates at an aggressive clip.
12:40
So, you know, if you were with us for one of those webinars, you noted I highlighted the word pain that he had mentioned a handful of times.
12:47
And it's kind of, you know, takes you back a little bit to say, you know, good.
12:51
Here's the Fed chairman talking about pain that's coming down the road in the economy.
12:56
So, all eyes were on inflation.
12:58
But now things are turning to unemployment.
13:00
So here is 35 years' worth of inflation data.
13:04
And we've annotated the cutting cycle, the start of the cutting cycle, which is instructive for where we are today, in terms of what the unemployment rate was doing at the time of the first cut.
13:17
And I think the big takeaway here is that it doesn't take much of a move in unemployment for the Fed to feel motivated to act and begin a cutting cycle.
13:31
So you can see in 91, skip over 94 for a second, we'll get back to that, 2001, 2007, and then 2020, really a modest if that rise in unemployment rate when rates started to get cut.
13:51
But it's a slow-moving cycle in that in all those instances, or most of those instances, unemployment gradually went up by two to 5% over the course of two to three years.
14:02
So it takes a while for the impacts of short-term interest rate cuts really to alleviate the unemployment pressure.
14:11
And when we talk about where we are right now, that unemployment rate has been ticking up for a longer period of time relative to what we have seen historically.
14:21
And I think that the things that jump out there is, one, we're starting from a very, very low point.
14:27
These are the national numbers, But here locally in New England, I think that the six New England states have been in the top 10 for lowest unemployment rate, or at least the majority of New England states have been.
14:42
So locally, regionally, the economy is doing very well.
14:46
So it's coming off of very, very low levels.
14:48
But also, the reason why the Fed maybe felt inclined to let unemployment run a little hotter was the fact that there was still work to be done on making sure inflation and making sure that pain, you know, the medicine wasn't worse than the disease.
15:06
So I mentioned the 94-95 cycle.
15:09
So we saw a very tiny, you know, tick up in unemployment, but we ultimately, back then, avoided a technical recession.
15:18
So, you know, that's something to keep an eye on in terms of, what's going to happen here, and that would be consistent with the soft-landing expectations.
15:29
So a lot of focus on the short end of the yield curve, but most of us know, all of us know, how the yield curve works and that the long end and the intermediate end tends to move ahead of the short end and starts to build in and price in expectations.
15:46
And this is going to tee up some of the things that Derek is going to talk about in a little bit.
15:52
But again, here's an awful lot of data.
15:54
Here's 25 years' worth of data of the steepness in the yield curve, one to three year and left in blue, Fed funds versus five years on the right.
16:04

And then on the x-axis, we have the level of the Fed funds rate.
16:07
Now, it's intuitive that we would see the trend here, and you can kind of eyeball it, that there'd be some northwest to southeast directionality here because the higher Fed funds are, the more room you have for the curve to be able to invert.
16:24
But I would invite your attention to the bottom right there in green, the big X marks the spot where the Fed funds five-year steepness or lack of steepness, the inversion is as high or as high, as low, the magnitude is as wide as really as ever been.
16:45
And that's going to be a common theme as we go through the presentation here, in that the yield curve may have made into that belly has already made the bulk of the move that we think it's going to make.
16:57
So, if we're putting eggs in the basket, we think we're going to see that part of the curve continue to ratchet down in lockstep with the short end of the curve, you know, it may be a little challenging.
17:12
So, you know, what does that mean for the core parts of the balance sheet aside from wholesale funding, which is not the core part of the balance sheet? So deposits really are the big thing.
17:24
We've seen a transformation of the deposit portfolio over the last year or two.
17:30
So you know some of the questions to ask is our deposit growth, core deposit Is it going to come back because of the lower level of rates?
17:41
And one of the good things that we're able to see in our position talking to and dealing with a lot of members across the district is that really to the last person, everyone was rooting for the relief going to be offered from these potential rate cuts.

18:01
But I'll ask this question and say, is it the absolute level of rates, or is it the relative level of rates that ultimately is going to serve us well?
18:10
So, is it going to get any easier to bring in core deposits at an advantageous spread than it was six months ago when rates were at its peak?
18:20
So let me clear that up.
18:22
So, if we're talking about non-maturity deposits, what is the clearing rate to bring in a money market account? Is it SOFR minus 25 or now can you bring in SOFR minus 100?
18:32
When we think about the CD book, can we get Home Loan Bank 6-month rates minus 100 instead of minus 25?
18:44
Because those economics, if you're still getting that narrow spread to where readily available wholesale funding is, you're probably not in any greater of a position because that's only going to tighten your potential spread on the asset side.
18:58
So, you know, on the lending side, this is really that area where the high-quality lending franchises really start to shine.
19:10
When if we do see an economic slowdown and things kind of tapering off a little bit, growth is not as robust as it had been.
19:18
Maybe the credit profile of perspective and existing exposures aren't getting you too excited.
19:26
Well, really, this is where you want to have the things, the people and the processes in play and the balance sheet capacity in place to make the good high-quality loans that really differentiate you.
19:38
And with investments, it comes down to two things that are always butting heads.
19:44
And it's this motivation to have an unnormalized liquidity condition that we've been so stretched in over liquidity over the last couple of years.
19:52
So, we don't want to reinvest back into the bond portfolio because we're trying to supplement the lack of deposit growth and meet that loan growth.
20:02
But given where rates and spreads are and given where rates and spreads are on the existing portfolio and the existing asset base, frankly, that right now to reinvesting back in, there's some interesting opportunities, and it's going to be that much more accretive to margin if you have the ability to be reinvesting back into the portfolio.
20:26
Great.
20:27
So, what I want to do now is take a look at what happened during our last cutting cycle in 2019 and see if that can give us any insight into where we should be going in the future.
20:38
So, looking at market rates in 2019, they obviously started coming down before the Fed cut rates.
20:47
So, market sentiment was pushing down the rates.
20:50
We saw that downward pressure, and we got some variation between what the longer-term one year and beyond was doing compared to the short-term daily three-month rates So from what we see here, you have the short-term rates declining over a hundred basis points in about eight months Which is fairly quick The movement was quick there and then once rate cuts were announced the downward movement came even quicker.
21:21
So you can see, towards the middle to end of 2019, the very short-term rates quickly caught back up with where the longer-term rates were benefiting members who are trying to stay short there.
21:35
I think the rule of thumb that people were going with was rates going down, let's stay short, let's not get caught out with this.
21:43
And what I to do is take a look into a scenario of did that actually make sense?
21:50
Was it worth staying that short, riding the curve down?
21:53
Or would you have been better off trying to lock in a little bit and go out on the curve? So what I did was I took three different cases here.
22:04
One was kind of our short case, and it's rolling short overnight funding.
22:10
For my market rate here I used our DCM product, Daily Cash Manager, and you're essentially getting the rate every day, repricing every day and riding the curve, whichever way it goes.
22:22
In this case, 2019, we were moving down pretty rapidly.
22:26
So our other cases here was the three-month.
22:30
So if you rolled three-month funding, how would that work in comparison and perform to rolling overnight?
22:39
And in the beginning of the year, it actually worked out pretty flat.
22:44
DCM stayed flat with the three month.
22:47
So there wasn't much of a savings there, but as the curve steepened and as rates started dropping more rapidly, that's where the rate variance began to show itself and members would have been losing kind of funding cost if they kept rolling on the three-month rates.
23:05
Definitely would have been more beneficial to stay short there.
23:08
So, over the year, if you continue to roll three-month rates, would have incurred roughly on average 42 basis points more, so not a huge amount, but definitely makes a difference at the end of the day, especially if margins start tightening and there's more pressure on members trying to get funding along with the other movements within the market.
23:32
So the other case we wanted to look at too was six months. Maybe it averages out a little bit more, but as you can see in the same case, because rates moved so quickly and the curve was fairly flat in terms of the yield curve, the longer rates weren't as drastically lower.
23:48
There was a loss there as well.
23:50
So not as drastic as the three month, it ended up being 33 base points on average.
23:56
But still, you would feel that pain going down the curve and it almost taught a lesson saying, okay, staying short actually makes sense here.
24:04
Let's keep it rolling.
24:06
Maybe this is what we do in down rate environment But it's not necessarily the full story.
24:13
So Our next step is okay. We're in a new down rate environment.
24:16
We feel the downward pressure the Fed just cut rates. Where do we go from here?
24:23
And What we wanted to do was take a look at is This environment actually the same as our last down rate So we're coming off of 2023, where rates steadily increased, moved fairly quickly, about 100 points throughout the year.
24:40
And then things started to change.
24:43
We started having that downward pressure.
24:45
People were considering the Fed cutting rates, waiting for the announcement to come.
24:50
And our yield curve started to steep in more on the inverse side.
24:57
So, our longer-term rates had a much wider spread to the short-term rates.
25:01
And you can see that on this chart.
25:03
So the one-year market rate was much lower at times throughout 2024 than the daily rolling rate was, which essentially stayed flat throughout24.
25:17
One of the more interesting points to me on this chart, too is that in the beginning, or sorry, the end of 23, we started seeing the longer-term rates start declining while market rates on a daily basis and overnight funding stayed flat and then they started to recover a bit so and that arbitrage opportunity kind of diminished the spreads came in a little bit more but once June hit and once more talks of the Fed starting to ease and cut rates the bottom kind of dropped out and went into overdrive and the curve became even steeper and you can see that impact here.
25:57
So, as we're in the down rate environment, what should members be doing?
26:01
Is the rule of thumb still actually to stay short on a daily basis?
26:08
So, I took the same approach, wanted to model out what that would possibly look like.
26:15
And in some ways, staying short kind of helped.
26:18
If you look at the rolling three-month term, A member would have taken on probably roughly 23 basis points more throughout the last year, going up to about May, June of this year in terms of our timeframe.
26:36
So early on, walked in some rates for DCM, got their arbitrage there.
26:42
But in the long run, because the short term three month and the overnight rate were so there was no opportunity for savings there.
26:51
And if rolling overnight was your preference, you actually got some better rates just due to the movement there.
27:00

But the real winning aspect here was taking a rate and moving out the curve with it.
27:07
So as you can see by that solid light green line, the one-year advance rate, you would have saved probably 47 basis points over that year.
27:17
And this is starting 23 where rates were still rising, but if you picked any point on the curve Since then up to now It's still the same story those overnight daily rates remained high Well the inverse curve Put that downwards price pressure Provided funding relief if you went up further out on the curve And I'm sure everyone remembers in the spring of 2023 what was happening across the banking industry and so that it's no surprise that the market was pricing in yield cuts as some of the largest banks in the country were experiencing difficulties, but they ultimately never materialized and the fact that the Fed held off on cuts for as long as they did, that drove that significant outperformance that Derek highlighted between the fixed versus the rolling.
28:17
Right, yeah, and that's a really good point.
28:19
And it kind of gets back to the idea that this cutting cycle really isn't the same as the last cutting cycle.
28:25
And what worked then doesn't necessarily work for members today.
28:30
So the question we get to is why?
28:32
What's the mechanics behind this?
28:34
What's actually happening?28:36And to better understand that, we want to look at the yield curves from the time of the last cut to the times where we're cutting today.28:44So what you see here is the difference in 2019 between the very short-term term one-two month to the one-, two- year The spread between those rates is very thin the curve was very flat, So, any incremental movement in daily and overnight rates Would have had a better impact in terms of cost savings rather than lengthening the curve and Having that rate move out into the future Very different today, where you see almost a hundred basis point difference between our very short-term rates in the middle of the curve So what that's doing for members, is it's pricing in future cuts that still haven't fully come, But it's providing a benefit in terms of funding costs if member decides to move out further on the curve and capture that savings so rule of thumb isn't necessarily in the down market to stay short, stay overnight.
29:47
It's more determined by the yield curve and what the yield curve is telling us.
29:52
So it's one of those myths that we want to try to debunk.
29:55
And I think this does a good job of kind of showing that picture and illustrating where the differences are and how each cutting cycle is different based on how the yield curve is priced.
30:07
Well, thank you, Derek.
30:09
And, you know, before we get to the funding ideas, I just want to go back, you know, to this visual because there was something that I had in my notes plan to talk about in that earlier section.
30:19
But this is a, this is a fine place to mention it as well.
30:22
​So, you know, with the poll question, right, most folks in that three to 4%, you know, bucket of where it will be, and then reconcile that with how much movement may see in that two-, three-, five-year bucket where a lot of our assets are going to be priced off of.
30:39
So, let's just do some simple math.
30:41
If the short end of the yield curve comes down to 3%, is there a scenario where the belly of the curve is going to be 50, 100 basis points lower than it is right now?
30:55
Well, as we know, an inverted curve tells us that more cuts are going to happen.
30:59
So, Fed cuts aren't going to stop at 3% if the five-year treasury is at two and a half; more cuts are going to be coming along the way.
31:07
So, if short-term rates come down to 3%, we're at three and a half roughly right now in the five years, we may not see any move.31:16In fact, that's 50 basis points of slope.
31:19
In fact, the direction, the next direction of 50 basis points may be higher.
31:24
So we may see the five-year treasury, you know, closer to four than closer to three unless short-term rates go back down to 0, 1%, then I'm completely wrong, and you can tell me about it the next time you see me.
31:35
But if you're in the camp of 3% plus or minus on short-term rates, then that belly of the curve and the impact it's going to have on investments and fixed-rate mortgages and asset repricing, I wouldn't put all my eggs in the basket.
31:54
We're going to see continued price appreciation in market value support, you know, just because short-term rates are going down.
32:02
So, you know, we have to use that. I don't like using the same adjectives, but I'll say the word reconcile because I want to say it on this slide, but I said it on the prior slide.
32:13
We have to reconcile and when we think about strategy, you know, this is all well and good.
32:17
We can talk about where rates are going to go and debate and do an analysis.
32:21
But we have to think in terms of, you know, the things that we put on our balance sheet, loans, deposits, bonds, and wholesale funding.
32:30
And really, it comes down to reconciling what we think and have some conviction on the direction of market.
32:37
And you can see in green the types of paths that we may have.
32:42
And it's not about making bets.
32:43
But I think, you know, because we are charged with managing both sides of the balance sheet, that we have to have some type of conviction on the most plausible scenarios, and also identify our weak spots and our pain points.
32:57
And, you know, that leads into the right side, the balance sheet needs, you know, because as we see it, we look at more call report data than really anybody, and we have very substantial qualitative conversations with folks.
33:12
And no institution's needs are exactly the same.
33:15
I'm thinking of a meeting that Derek and I had with a member institution about two months ago or so, talking that they had an acceleration in loan growth, so they were looking to add some funding, and they have some liability-sensitive markers, so our initial thoughts before the conversation was tiptoeing out the curve.
33:32
But then as we got to talking, they said that the construction of the investment portfolio, that it was very low yield, But it was laddered out in 2020 and 2021, and they had some big chunky maturities coming off.
33:46
So that was going to effectively create some funding and the ability to remix the balance sheet.
33:52
So that immediately pivoted to, okay, well, we don't need to go out necessarily as far as we thought we did initially because the dynamics have completely changed.
34:04
So there's no magic bullet, But especially in these periods where market conditions are changing, right?
34:12
This is not 2011 to 2014, where essentially, relatively speaking to now, nothing happened.
34:19
We kind of went short-term rates in a budge, long-term rates went a little bit.
34:22
We had the taper tantrum in 2013, but that's just about it.
34:27
We're kind of at an interesting turning point here in the markets.
34:32
So, when we think about the impact of the deposit portfolio or ALM position, goodness, we've mentioned this, we used to be asset-sensitive, now we're liability-sensitive, was a common refrain.
34:43
We have heard a lot over the last couple of years.
34:46
So, really triangulating your risk position and where you want to be on your return profile, I know it's cliche, it's easy to say, but you really need to be kicking the tires on everything, wholesale and core.
35:02
So, you know, we'll go through a couple ideas on the funding side, but Derek's going to continue with that theme, that existential question of, you know, short versus long, fixed versus floating.
35:13
Sure.
35:14
So, we get back into the whole yield curve situation in terms of is this inverted curve helping our longer-term classic rates or does it still make sense to stay short?
35:26
So, in that vein, what we ended up doing was modeling out a couple different scenarios.
35:32
First case here is kind of our base case, takes the Fed's predictions in terms of what they're forecasting for the next year and a half.
35:41
And we lay out about 150 basis point cuts over the next couple meetings.
35:46
So front loads the first half of 2025, we do two cuts for the rest of the year.
35:51
When we look at what that has as an impact on rolling overnight funding it looks like your 12-month Classic is still going to outperform in terms of cost savings even after 150 basis point cut so our next case here is our super aggressive case. Does the Fed want to take a 50-75 cut rate or are they going to stick with 25, so in this case they're going crazy blowing out what their forecast was and doing 300 basis points worth of cuts in this case yes at the end of the day in about a year the short-term rate falls under what today's 12-month Classic is so I might be saying okay great maybe this way to go but in when you look at the average it's about 435 basis points rather than the 406 that you'd be paying through across the year.
36:57
So again that 12-month rate is more beneficial than trying to roll short really because of the steepness of the curve right now. And lastly, it's a very light cutting cycle.
37:13
So 75 basis points over the next year cut probably 25 over the next every other meeting and again not much impact to rolling short there you're still winning if you go the further out on the curve and take the longer rate.
37:31
So I'll offer up some color from what we've been seeing you know activity wise with members you know, we have seen robust and an increased activity in turning out to that nine- to 18-month window and taking advantage of the price and yield curves, as Derek showed.
37:47
We also have seen increased adoption in terms of those who need or want to stay short with their interest rate risk or their interest rate exposure or liability duration, that gravitating from using the daily cash manager or very, very short-term one-week classics about using the SOFR Index Advance, the floating rate.
38:09
So you do get the benefit of the longer liquidity.
38:11
So but to that end, we want to mention point out the Callable SOFR Indexed Floater, which again has been picking up steam with members. Because if only were as easy as pointing as selecting Derek's scenarios 1, 2 & 3, which one you believe in, and if you believe in that aggressive 300 basis points of cut, well, heck, I want floating rate exposure?
38:33
It's going to reprice down, but the other side of the coin is I may not need wholesale.
38:38
I know I also need funding now. I think I may need it for six months or 12 months.
38:43
But what happens if conditions change?
38:45
And, you can see on the table on the bottom, here are some of the things that could change the liquidity profile that everyone here is well aware of.
38:52
The loan pipeline dries up a little bit, deposits start falling out of the sky, prepayments pick up, which I think that's a ways away.
38:59
Or maybe the economics of selling off some of the underwater investments or loans, starts to look a little bit better.
39:07
So, the Callable SOFR version allows you to get the benefits of the long-term maturity.
39:13
You can see here there's a 12-month maturity with a 6-month call and a 3-month in green.
39:21
And this is interesting because there's no prepayment fee at that call date for you to pay off.
39:27
So, a scenario where, hey, it's the aggressive cutting, you're funding, it's 100% beta, it's going to reprice down. Wonderful.
39:35
But hey, maybe at that three-month mark, the deposits really start to pick up.
39:41
And you're only paying $250 on the Advance, but you'd rather pay 1% on a deposit.
39:50
​So you very gladly will pay back the Advance in order to transition into the floating rate asset, excuse me, the deposit.
40:00
Yeah, and this idea is actually picking up steam, too, in terms of restructuring current advances.
40:07
So we're starting to have more calls with our members interested in this piece.
40:12
So over the last several months to a year, rates were a bit higher in this situation.
40:17
A member would have a 539 rate, and as the curve steepens and longer-term rates become dropping more, there's a benefit to switching over and moving out on the curve.
40:30
So in our situation here, 539 was the advance rate. There's six months left on the advance.
40:39
And in order to restructure to capture the new rate, the member would save quite a bit, probably 60 points within that rate.
40:49
But the added benefit of restructuring is that you're extending out on the curve.
40:53
So helps with liability management.40:56You're not taking the one-time hit of doing a prepayment fee.
41:00
It gets bundled into the new rate, so you're not paying the exact longer-term rate.
41:05
It's bundled in with that prepay cost.
41:08
And it lowers your cost of funds providing NIM relief, which is still a big pain point for a lot of members right now.
41:15
So if there are those longer-term advances that are starting to mature, or you want to start moving down through the rate, this is a good way to capture all those benefits without having a big impact on the bottom line.
41:30
So forward starting advances are, we call them, they're like a cousin to the advance restructures because there's a lot of technical similarities in terms of how it works.
41:39
But, you know, we mentioned this before: the inverted yield curve tells us that forward rates and future rates are expected to be lower than where things are right now.
41:50
So, you know, this is consistent with that theme of if you think that the expected number of cuts baked into the yield curve has maybe gotten a little too fast too soon, then a way to take advantage of that is, as Derek said, restructuring the advances to increase your liability duration.
42:09
Or if you're thinking about new funding, you can do that with Forward-Starting Advances as well.

42:14
So, in this example, a six-month delay period, and then it kicks into a 12-month advance, which would be at a 355 base off of yesterday's or the day before's rates.
42:26
And that is, as we mentioned, lower than what the six-month, the 12-month, or the 18-month is.
42:34
So, you know, it's interesting.42:36I ran all different types of combinations of delay periods and maturities, and everything is kind of coalescing around the 3.5% rate.
42:45
So that's interesting, and that's telling because short-term rates are projected to where the terminal rate is going to be.
42:56
And that's projecting a flat curve going into the future.
43:02
So, we talked about the callable sulfur index.43:04That's where you, the member, has the control over paying back the advance.
43:09
Well, what about puttable advances, which have been very popular as a NIM relief solution over the last couple of years.
43:16
So those rates have ratcheted down and really have, you know, there continues to be opportunity because, if you remember, the things that create value here on these advances are inverted curve and high volatility, high uncertainty in the markets.
43:32
And those two things are at present are still prevalent.
43:36
So the way we would analyze these is to, that wasn't a movie reference, coming back to what we said in the beginning, is look at a stress test of two scenarios.
43:52
We take out the advance, and it extends fully to maturity.
43:55
So, in this example, a five-year non-put six-month advance.
44:00
So let's just say we stress it, and it extends fully.44:04We contrast that to what if we take a six-month borrowing and then replace it with shorter replacement funding, which we don't know what that rate would be today because we're subject to market rates.
44:19
Well, we can figure out what that breakeven rate would need to be to outperform the 298 on the portable today.
44:26
So, that 280 is where a given rate for this structure, things would have to be.
44:32
So, that creates a margin of cushion for rates to go down.
44:36
Now, if we're talking about, hey, this is going to be a portion of our balance sheet that we forecast that we expect to be in wholesale funding, then that makes sense.
44:46
Because at a 280 rate, that's, you know, considering our short-term rates are, you know, very narrow spreads to SOFR and treasuries.
44:57
So call that a two and five eights Fed funds rate with the nominal spread tacked on top of it, you have some significant opportunity there.
45:09
And when we talk about the different rates scenarios, these are going to succeed wildly in those soft-landing scenarios, right?
45:17
So if Fed funds only get to 4% and you have 298 funding, Well, you started out well, the margin tightened a little bit, but you're still better off to be in 298 than 4% and change.
45:31
In that same vein, keeping with the family tree, here's the silver flipper as a cousin to the HLB option.
45:38
This is interesting because if you subscribe to the benefit or the value, or excuse me, the potential for short-term rates to come down and the belly of the curve to remain flat or move higher, then this is one way that you could express that viewpoint and really benefit.
45:59
So the SOFR Flipper gets its name because it's a floating rate exposure for the first part, and then if not put, it flips to a fixed rate.
46:09
And on that front end, it's at a negative spread to SOFR.
46:14
So, in this example, we're looking at a five-year maturity with a one-year lockout period, and the coupon on the front end is going to be SOFR minus 200.
46:22
So we've modeled and visualized out what happens if the Fed cuts 25 basis points every meeting for the next year.
46:29
So, you can see in green SOFR ratchets down, the rolling cost moves in a smoother fashion.
46:36
We do the same thing for the SOFR flipper rate, and you can see the rolling cost gets you inside of 2%, even though the terminal rate for SOFR gets to 283.
46:50
So you're funding cheaper for that first year.
46:53
And where the interesting thing is that if it flips to that fixed rate, you're comparing it to where that belly of the curve might be.
47:02
And so right now, the back-end coupon versus where the current HLB option is right now very close.
47:10
So, if we do see a decline in interest rate volatility, which is reasonable to expect at the end of a cutting cycle, and or rates in the belly of the curve moving up a little bit, then the extension risk is mitigated, and you will have bank considerable savings on the front end.
47:30
So, another idea that is coming into focus a little bit is the idea of season loan sales.
47:38
And we talked about this a little bit about the rally in intermediate and long rates over the last couple months have been pretty significant in excess of 120 basis points, depending on which point of the curve that you're looking at.
47:51
So when we look at the 30-year fixed rate mortgage, it's been even more than that, about 180 basis points.
47:57
So, depending on the particulars, you may have seen a recovery in your fixed-rate mortgages or your investments of probably in excess of ten points.
48:07
Now, from the low 80s to the low 90s, not quite yet back to par, but the economics of looking to reduce the amount of those low coupon fixed-rate mortgages, which is probably not an ideal asset for your balance sheet, certainly with rates where they are.
48:30
There may be some opportunity, the economics may look better than they have in the past.
48:34
And the other part of that is, OK, it's not selling just for selling sake, but a lot of folks have more wholesale funding on their books right now than maybe they probably need or want.
48:44
So, you know, maybe you compare you if you have some gains and some of the things that you portfolioed in recent months that, you know, instead of if you had sold it immediately as flow at 102.
48:56
Well, maybe, you know, it didn't fully appreciate because of the negative convexity. So maybe it gets to the 103, 104 range.
49:04
And you can pair, and I was talking with some of our MPF folks before this, you can, for every three million of a high coupon mortgage that you sell, you pair it with one million of one of the low coupon ones, and that could get you to an income statement neutral impact.
49:29
So you sell the high coupons at 103, you sell the low coupons at 91, You could be, you know, the gains and losses offset, and you, you know, you've reduced some of that low coupon fixed rate mortgage exposure you have, and then you take those funds, and you pay off the wholesale funding.

49:45
So, I think me throwing in an idea about how to reduce advanced levels is probably an appropriate place to end the presentation, but I see some questions in the queue.
49:59
I don't know if they're technical issues or if they're strategic fund questions.
50:05
So, you know, while I tap dance to get confirmation on that, I will say that we appreciate everyone joining us here.
50:18
And I got the thumbs up that they are technical questions.
50:21
So, you know, that'll bring us to the end.
50:23
Thank you, everyone.
50:25
I'll point out that, you know, a lot of the things that you saw here were pulled right from some of the analytics and calculators and models that we have built to assess a lot of the decision making, short versus long, this product versus this product.
50:39
So if there's anything you need or you want to take a look at, the restructures, the floating versus fixed, we have it all at the ready.
50:48
Just reach out to us, your relationship manager, your MPF contact, and we'll provide you the support that we were able to.
50:55
So thank you again, everybody and have a great rest of your day.