The Federal Home Loan Bank System: Lender of Next-to-Last Resort

"The FDIC recently has observed instances of liquidity stress at a small number of insured banks." So opened the Summer 2017 FDIC Supervisory Insights issue. And so went your exams.

At a recent banking conference an industry consultant said, matter of factly, that in times of stress your Federal Home Loan Bank (FHLB) borrowing capacity would dry up. Nobody challenged him, including me, by the way. But when I mentioned the comment to the attending FHLB rep, she was not particularly happy.

This has happened before. Regulators and consultants promulgate this untruth. And having heard it so much, bankers are beginning to believe it. 

This week I sat in a bank CEO's office where he complained, ranted really, about his latest exam and the regulators' perception of liquidity risk, driven by the aforementioned Supervisory Insights. He was confident in his bank's liquidity position, but felt regulators could artificially create a liquidity problem.

Their conversation goes something like this: pretend that your non-core and wholesale funding dries up, and you are unable to attract local funds via rate promotion because of our restrictions on rates paid above the national rate cap. What would you do? Prepare for that.

I recently wrote that I thought bankers would have to prepare to offer rates more in line with the market. I noted that there was a greater than 100 basis points difference between what a customer could earn on an FDIC-insured Goldman Sachs Marcus account than what they could earn in your bank's money market account. And that bankers are going to have to build the infrastructure that allows them to be closer to market.

The national average rate for a money market account at the end of last year was 0.09%. The Fed Funds Rate was 1.25%-1.50%. So, according to the FDIC rate cap "guidance", you could not exceed 84 basis points on your money market accounts at December 31, 2017 if you were under regulatory scrutiny. Sixty six basis points less than the Fed Funds rate at that time.

I monitor trends. I know loan/deposit ratios are going up, and liquidity ratios are going down (see charts). But what are the chances that your liquidity position plummets, you lose access to your

correspondent line(s), you can't attract local deposits, your municipalities withdraw, and your FHLB line "dries up", all at once? As the FHLB rep mused to me, it could happen if say, an extreme black swan event much worse than the 2007-08 financial crisis happened.

More to the point, she directed me to her FHLB's president's message on their website where he wrote: "As long as markets remain open, and a member has pledged sufficient qualifying collateral and is willing to purchase the requisite amount of capital stock, the Home Loan Bank will always continue to lend to our members to help you meet your community's needs." 

We need a smarter discussion on liquidity. Before we create an artificial liquidity crunch.

The consultant at the above mentioned conference did have some solid recommendations that I would like to share, even though he is a competitor. Pretty magnanimous of me, right?

1. Create detailed funding concentration risk analytics, that includes:

     -  Stratify funding using a liquidity matrix

     -  A deposit loyalty study (to classify what regulators consider non-core as core)

     -  Determine a local rate cap (to use vs. the federal rate cap)

2. Conduct forward looking stress tests that include realistic contingency funding strategies

3. Train board members

4. Update liquidity policy and contingency funding plan to be consistent with the above process

Are you feeling pressure internally or from regulators on liquidity?

~ Jeff

A Time of Reckoning for Your Bank's Core Deposits?

Bye-bye municipal deposits. 

So worries New Jersey Banker's Association CEO John McWeeney since state-owned bank advocate Phil Murphy was elected governor. The state's municipal deposits approximate $20 billion, $13 billion of which are in community banks. A significant source of liquidity.

I got news for you John. We might lose municipal deposits regardless.

And we might lose a lot more than municipal deposits.

According to the Investment Company Institute, money market funds stood at $2.8 trillion this week. And as the chart below shows, these funds are typically paying more than double the community bank money market account rate. 

These rates were at March 29, 2018. I used Wells Fargo because it is a money market fund that I use. By default. When they bought Strong Asset Management. Marcus is Goldman Sachs online bank. FDIC insured. And Mid Penn Bank is a $1.2 billion in assets financial institution based near Harrisburg, Pennsylvania. I had to call Mid Penn for their rate. It is a tiered money market, and the 0.55% is their top tier for accounts greater than $50,000. The next lower tier is 0.35%. 

Mid Penn boasted about their cost of deposits and funds in their 2016 annual meeting investor presentation (pages 21-22). They currently have a 0.58% cost of funds. Can they maintain it? Will their ALCO model betas prove true? Or will customers demand they bridge the rate gap, so vividly portrayed above?

My colleague recently sent me a link for meetbeam.com, a soon to be released banking app that boasts a 2%-4% rate for your cash, FDIC insured (they are partnering with a bank). They haven't launched. But they have over 76,000 customers that signed up already. Could some be your customers?

In strategy sessions the past couple of months, I'm hearing more bankers talk about pressure from large depositors on rate. The old arguments are starting to play out. Not bringing large deposits with their loan deal because rates are too low. Municipalities hemming and hawing. Will the traditional retail and small business depositor be next?

There is an inflection point where our Rip Van Winkle bread-and-butter depositor will wake up to think "hey, I'm getting screwed by my bank!" What sized rate gap will trigger it? I don't know. I'm no futurist. The above rates are still below the inflation rate. So keeping money in any of those accounts will result in a real decline in value. Do you know where your customer inflection point is?

Because a business model based on the sleepiness of your depositors is unsustainable. 

Are you feeling the pressure yet?

~ Jeff

Earnings Guidance? Buy Side Wall Street Says Think Long-Term. Sell Side Wants Tax Rate.

In February, Larry Fink from Blackrock sent a letter to publicly traded CEOs to think long term and to stop giving earnings guidance. Specifically, he said "Today's culture of quarterly earnings hysteria is totally contrary to the long-term approach we need."

Let's see if bankers are heeding Larry's call on their first quarter earnings call.

Christian Bolu - Credit Suisse to Goldman Sachs CFO Harvey Scwhartz: "Tax rate was a bit lower in the quarter, just curious how we should think about the go-forward tax rate?"

Schwartz - "In terms of the go forward I guess if I was to give the best estimate, I'd say something similar to last year."

Bob Ramsey - FBR & Co. to BofI Holdings CFO Andy Micheletti: "I guess putting it all together, next quarter you'll have less Block [from acquisition of H&R Block portfolio]; sounds like your loan yields are stable-ish; plus you have some lift from the equipment finance; and deposit costs maybe tick up with a little growth. Does that put you somewhere in the ballpark of 4%? Or what is the right range for next quarter?"

Micheletti: "Yes, Bob, I think we're still in that 3.80% to 4% range. I would lean to the higher end of that, given where we're coming out, without the Block impact. But certainly in the 3.90%s would be fair."

Michael Rose - Raymond James & Associates to BB&T CEO Kelly King: "Can you give us your thoughts, in light of the environment, in terms of what we could expect for the efficiency ratio"?

King: "I think we will end up this year with improvement. It may be in the 57ish kind of range. Pretty confident about that."  

Dave Rochester - Deutsche Bank to Great Western Bancorp CFO Peter Chapman: "And then just one last one on the margin. Just trying to get your sense for the trend that we should see from here?"

Chapman: "Not much change really to what guidance we have given in the past. So as we have said, Dave, I think if rates remain low, if it ticks down a point or two a quarter, then we wouldn't be surprised with that." 

Chris McGratty - KBW to UMB Financial Corporation Chairman & CEO Mariner Kemper: "And given the stock movement, should we be assuming that those 2 million shares [stock buyback] will be used kind of consistently through the year?"

Kemper: "You know, all I can really tell you is that we certainly think we are very thoughtful about how we think about how to deploy our capital. I know you want more but that is about all I can give you."

Amen Mariner!

To be fair to these banks and their executives, equity analysts bombard them with questions each quarterly call to help them with their projection models. What are they to do? 

In the spirit of Larry Fink's comments and wishes, as one of the largest investment funds in the world, and to be consistent with my belief that managing for the long-term opens doors to investments that can transform your financial institution for an enduring future, here is a sample analyst question and a proposed answer.

Joe Spreadsheet - Bank Stock Investment Firm, Inc. to Chris Evert, CEO of Schmidlap National Bank: "So, Chris, I have this spreadsheet in front of me and I have to enter in an effective tax rate to spit out net income projections. I don't want to be surprised next quarter when I make my estimates, what number should I put in cell F72?"

Evert: "Joe, our long-term strategy has been to transform our bank into a core funding machine, and away from the asset-driven strategy that resulted in large amounts of wholesale funding. As we make this strategic transition, our loan to deposit ratio will fall and, if successful, will result in greater margin as a result of lower cost of funds, offset somewhat by a lower yield because we are becoming more liquid and more assets will be in our investment portfolio. We'll manage taxes from there. Good luck to you buddy on cell F72."

How do you think we can transition from this "here's what we promised the investment community next quarter" to using the investment community to give us discipline in executing long-term strategy?

I'd like to hear from you.

~ Jeff

Bonus: Lloyd Blankfein, CEO of Goldman Sachs, talks about Fink's letter on CNBC Feb 3rd.

http://www.cnbc.com/2016/02/03/cnbc-exclusive-cnbc-transcript-goldman-sachs-chairman-ceo-lloyd-blankfein-speaks-with-cnbcs-squawk-box-today.html