BEWARE THE PERFECT STORM - FHLBank Topeka

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MESSAGE FROM THE PRESIDENT DOING WHAT WE DO BEST: MEETING THE LIQUIDITY NEEDS OF HOUSING INVESTORS MESSAGE FROM THE PRESIDENT Andy Jetter President and CEO FHLBank Topeka A severe lack of confidence in the fixedincome markets causes many housing lenders to pull back. Typical channels for raising funds for home financing are blocked. Funds, if available at all, are at much higher rates. People trying to finance homes are facing significant hurdles. Sound familiar No, I’m not talking about the recent liquidity crisis. I’m describing the state of the economy in the early 1930s that led President Hoover to propose a system of 12 Federal Home Loan Banks dedicated to providing liquidity to housing lenders. President Hoover and the Congress recognized the importance of ensuring a stable supply of funds for housing lenders. Because the need for liquidity would change depending on the markets, the FHLBanks needed to expand and contract easily. Therefore, the FHLBanks were created as cooperatives whose capital would adjust in proportion to the demand for liquidity by housing lenders. When liquidity needs were large, the FHLBanks grew to meet those needs. When liquidity needs fell, the FHLBanks dropped in size. The role taken by the FHLBanks in addressing the liquidity needs of housing lenders during the recent liquidity crisis was exactly what was contemplated when the THE FHLBANKS ARE CONSERVATIVE COLLATERALIZED LENDERS. BECAUSE OF OUR CONSERVATIVE PRACTICES, NO FEDERAL HOME LOAN BANK HAS EVER HAD A CREDIT LOSS ON AN ADVANCE. THAT INCLUDES A PERIOD OF MARKET DISRUPTION IN THE LATE 80S THAT MAKES OUR RECENT EXPERIENCE LOOK LIKE A WALK IN THE PARK. FHLBanks were created in 1932. And the FHLBanks met the additional need for liquidity in a virtually seamless manner, just as anticipated in 1932. One big difference between 1932 and today - this time around the FHLBanks supplied needed liquidity immediately. The suffering in the 30s took much longer to resolve itself. But not everyone seems to be in agreement. I read with some satisfaction a Bloomberg article published on October 30. The overall tone of the article was intended to be critical, but I think most readers probably reached the opposite conclusion. In brief, the article noted that the foremost housing lenders in the country turned to the FHLBanks for liquidity when the normal channels of housing finance dried up. A quote from the article is an excellent case in point: “The cost of asset-backed commercial paper, when it was available, shot up. The home loan banks were the only game in town for a lot of borrowers. Even AAA-rated credits were having a tough time issuing paper. It took everyone back to the Federal Home Loan Banks.” The article raised concerns about the risk of growth in FHLBank borrowings needed to close the liquidity hole. I don’t share the concern. The FHLBanks are conservative, collateralized lenders. Because of our conservative practices, no Federal Home Loan Bank has ever had a credit loss on an advance. That includes a period of market disruption in the late 80s that makes our recent experience look like a walk in the park. I’m proud to be a part of the FHLBank System as we continue doing what we do best: providing liquidity to housing lenders to ensure that the supply of funds for residential mortgage lending is not disrupted. Sincerely, President and CEO 2 FHLBank Focus | Winter 2007
THE PERFECT STORM CONTINUED FROM COVER A GOOD ALM PROCESS SHOULD SERVE AS THE COMPASS THAT GUIDES THE BANK- ING SHIP AND EMERGENCY ALERT SYSTEM. REACHING OUTSIDE YOUR ALM GUIDELINES AND BRANCHING OUT INTO UNKNOWN TERRITORIES CAN BE DANGEROUS TO YOUR INSTITUTION’S HEALTH. becoming increasingly irrational in their product offerings on both sides of the balance sheet. It seemed there was no relief in sight as the Fed was expected to keep the pressure on. OUR ADVICE: NEVER LET GREED OVERCOME YOUR FEARS! A good ALM process should serve as the compass that guides the banking ship and emergency alert system. Reaching outside your ALM guidelines and branching into unknown territories can be dangerous to your institution’s health. STRATEGY At the August FHLBank regional fall meeting in Colorado, I discussed the inverted curve and its implications for banks. First and foremost I reminded folks that an ALCO’s role is not to forecast rates. However, historically, the inverted yield curve has been a precursor to recession; long rates have generally peaked by the time the curve inverts, and the next move in rates is generally down. Given the fact that most banks were expected to benefit if the curve steepened yet couldn’t afford the pain of higher rates, we spent a good deal of time reviewing the benefits of caps embedded in advances. The cost of insurance against rising rates was very inexpensive and that continues to be true today. We also discussed strategies for banks exposed to falling rates, which included pre-investing 2008 investment cashflows; leveraging to offset declining loan volumes due to a slowdown in the economy; using embedded floors in advances to protect against falling rates; and booking more fixed rate assets at lower rates than floating rates for commercial loans. FED LOWERS RATES - WHAT NOW The Fed has lowered rates by 100 basis points since September, and rates across the yield curve spectrum have followed suit. Bankers, on the other hand, have been reluctant to lower their deposit rates for a variety of reasons. For some, they may not recognize the impact these lower rates have on their bottom line. For others, it’s a matter of who blinks first in their market by lowering rates ahead of the crowd. Meanwhile, loan yields and investment yields are screaming down, causing further margin erosion for bankers. Additionally, this lower rate environment may cause a whole new refinancing boom, causing the roof to cave in on asset yields and flooding bankers with unwanted cash flow at a time when they’ll want it least. 9 SIMPLE STEPS YOU CAN TAKE RIGHT NOW: 1. IMMEDIATELY LOWER CD RATES IN LINE WITH WHOLESALE FUNDING COSTS. Depending on a bank’s need for funding and liquidity position, most CDs should be at, or a quarter point below, FHLBank comparable maturities. Wholesale funds should be utilized for any funding needs beyond 12 months -- period! Currently, you can borrow 3-year money at 3.77% and 5-year money at 4.06%. I still see 5% handles on CDs! My advice: Don’t be the village fool. Lower your rates and reap the immediate rewards. You’ll be surprised just how much your margins will widen while your deposit levels remain relatively stable. Any outflow can be replaced by wholesale funds at a considerably lower cost. One of my clients took this approach. Everyone in his market followed suit, and the five handles disappeared. 2. MMDAS SHOULD BE DROPPED TO REFLECT MONEY MARKET RATES, NOT CD RATES. The Fed lowered rates in December, so be prepared to lower rates again on these accounts. Some banks have acted already, as the 91-day Treasury bill is now 2.83%. continued on page 4 www.fhlbtopeka.com 3 ASSET\LIABILITY STRATEGIES
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Page 7 and 8: THE MPF PROGRAM IS BEST UNDERSTOOD
Page 9 and 10: BACK TO COMMON SENSE LENDING If you
Page 11 and 12: MORE ON THE VILLAGES AND FHLBANK TO
Page 13 and 14: FHLBANK PRODUCT NEWS AT A GLANCE M
Page 15 and 16: her new home, “I feel good, I sle
Page 17 and 18: BANKERS ATTEND MEETING IN OKLAHOMA,
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BEWARE THE PERFECT STORM - FHLBank Topeka

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