There was a collective sigh of relief in the banking industry on the evening of March 12 after the release of the joint statement from the Treasury, Federal Reserve and the Federal Deposit Insurance Corp., which in part introduced the Bank Term Funding Program (BTFP). The statement was a show of resolve and an important step in strengthening public confidence in the banking system in the wake of the bank failures that weekend.
The BTFP appears to be a potentially very effective panacea to eliminate the “need” for an institution to sell bonds at losses to generate liquidity, which is a critical feature after 450 basis points of Fed tightening within the last year.
What is the Bank Term Funding Program?
The BTFP is a lending facility through the Federal Reserve Discount Window that was established to make additional funding available to depository institutions. The goal of the program is to ensure that banks and credit unions can meet depositor needs without having to adversely impact capital by realizing bond losses.
- Term loans up to one-year.
- Banks, savings associations and credit unions are eligible.
- Collateralized by Treasury, agency and government-backed mortgage securities.
- Collateral valued at par.
- Market rate floats daily at the one-year overnight swap rate plus 10 basis points.
- Loans are fixed and rate is locked at the prevailing market rate on the day of borrowing.
- Advances can be prepaid at no extra cost at any time.
- No limit on amount of borrowing if required collateral is pledged.
- The program ends March 11, 2024.
- The Fed will disclose who borrowed, and how much, one year after the program ends.
Reframing the BTFP Decision by ‘Thinking Backwards’
Darling Consulting Group has spoken with hundreds of clients about the potential merits of the BTFP since the program was announced. In these conversations, I’ve found it helpful to take the advice of Charlie Munger, business partner of Warren Buffet and vice chairman of Berkshire Hathaway, and “invert.” Inversion is generally defined as looking at a question backwards, or upside down, and focusing not necessarily on what could go well, but what could go wrong.
Thus, instead of asking whether you should use the program, ask yourself: Why would we not use this program?
I offer this decision framework because, by all accounts, the economics of the program appear favorable. For instance, funding can be locked in for a year to protect against further rate hikes; funding can be paid back at no cost if rates fall and/or the funding is not needed; and the rate, depending on the day, could be less expensive than other wholesale alternatives.
The main reasons we have come across for not using the program come back to optics. Will my regulator be okay with it? Will my board, biggest stakeholders, etc., be okay with it? Will the press and/or The Street be okay with it?
In essence, do economics outweigh optics?
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Key Decision: How Would You Use This Funding?
At the very least, ask your ALCO the following question: Is it prudent risk management to consider pledging the appropriate bonds (if available) and making sure the paperwork is completed, as an insurance policy?
From there, if you decide to use the program, conversations generally fall into four categories:
- Use the program immediately to cover real-time deposit outflow.
- Use it to preemptively boost current cash buffers.
- Use it to retire other more expensive wholesale funds and diversify the funding mix.
- Use it to continue funding loan growth or new investment purchases.
If, like some of the bigger regional banks, your institution had or has funds fleeing, the first option is a necessity and effectively why the program was created. Sure, you may be able to achieve the same goal borrowing from the Federal Home Loan Bank System or using brokered funds, so this invariably harkens back to the economics versus optics discussion.
Two overall points of advice:
• If your goal is to boost current on-balance-sheet cash, pay down expensive wholesale funds, and/or diversify your funding mix, the economics of this program are generally favorable.
• However, if your goal is to continue to fund loan growth or make new investment purchases — essentially leveraging your balance sheet — be careful. Not only is this not what the program was intended for, but unhinged growth with potential late cycle credit and capital dynamics is not prudent for most institutions today.
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Ultimately Proper Risk Management Reigns
It remains to be seen how much actual usage will materialize for this special temporary program. To date, utilization of the traditional discount window has been more popular than the BTFP. This could be due to the size of the institutions involved (i.e. larger regionals tapping more so than community banks), familiarity with the discount window, or perhaps availability of collateral. Anecdotally, we know of a lot of community institutions who are setting up their lines and strategizing whether to draw. The jury is still out.
Overall, the framework for how your group considers the questions of whether to participate is more important than the actual answer, as you will need to be prepared to defend your ultimate decision.
Given this, I think Charlie Munger’s advice to invert, and understand the downside, is prescient.