"Aw Shucks" - Insider

last updated on Thursday, November 4, 2021 in General

Hello and thank you for joining us for another episode of The Insider, a monthly podcast production of the Federal Home Loan Bank of Des Moines and your source for industry news, strategies and key information about the bank. This is your host, John Biestman, Senior Relationship Manager.

Ron Howard, the well-known actor and his brother, Clint, recently authored a New York Time bestseller entitled, “The Boys.” The book is an “aw-shucks,” and refreshingly wholesome memoir of growing up as a family during the turbulent 1960’s. Well after Ron Howard played “Opie” on the Andy Griffith Show or “Winthrop Paroo” in “Music Man,” he made a simple, yet timeless observation about life.” “You’re always a little surprised when something takes off.”

So here we are in the final quarter of 2021 and to say that we’re just a little surprised that things are taking off seems to be an understatement. Let’s take stock and start with inflation. The phrases “transitory inflation” may soon join the Federal Reserve’s semantic scrapheap in similar fashion to the classic “irrational exuberance!”

I recall, in another place and time, an assigned text book that was entitled “Inflation Accounting.” While the famous Volcker Recession forced the publisher to cease publication, that book was replete with lessons on how to adjust financial statements according to price indices – all in the name of trying to match current revenues with current costs. That accounting methodology, believe it or not, was not too far from becoming a widely accepted standard. Massive Fed tightening put an end to that. So, from accounting to economics.

As we know the classic definition of inflation has to do with chasing too few goods and services, dubbed “demand,” relative to too much money, dubbed “supply.” Classic macroeconomics teaches that when demand increases amid cheaper money, something’s got to give in order for supply and demand to stay in equilibrium, that being the price of goods and services.

We now find ourselves in a perfect storm. The supply of goods and services has become noticeably constricted by supply chain woes and acute labor shortages. Consumers and business who have taken savings levels to unprecedented heights throughout the pandemic, are exuding pent-up demand.

The supply-demand dynamic tinderbox also faces the added risk of what psychologists would term as consumer attitudes shifting from a state of cognitive dissonance to the ultimate acceptance of inflation. That is, the longer higher prices appear and the more consistently they rise; irrespective of supplies of goods and services getting back into balance, it becomes all the more difficult to squeeze the toothpaste back into the tube.

We know that the CPI has grown by 5.4% over the past 12 months since September. The increase was dominated by energy costs, including a 42% increase in gas prices, not to mention used cars and travel costs. But as we underscored in our last podcast, the Fed’s preferred measure of the personal consumption expenditures benchmark has not been as alarming.

Inflation can manifest itself in ways other than by price increases. Witness what in a 1976 issue of MAD Magazine referred to as “the incredible shrinking candy bar.” The size of the wrapped paper trays stayed the same, but the actual candy bar itself shrunk.

During the repeated inflation cycles of that era, shadow inflation would take hold wherein the quality and quantity of goods and services would drop. The most famous case of shadow inflation took place in 1987, when American Airlines claimed cost savings of $100,000 simply by no longer serving an olive in the salads of first-class passengers for the year.

Where are the signs of shadow inflation today? Well, think about slower mail service as an example. The door can swing in the opposite direction from so-called shadow inflation when thinking about the method of so-called “hedonic” adjustment of prices – for instance when today’s cell phones hold as much computing power as the space shuttle.

With just a couple of months before year’s end, let’s do a quick environmental scan. Some good news in that many institutions are reporting signs of loan growth in certain categories. The Federal Reserve’s H8 data as of the end of Q3 showed CRE sustaining annualized increases of 5.2%, and construction loan increases of 9.2%.

However, C&I loans showed an annualized decline of 13.1%, likely due to being cannibalized by the PPP program. It wouldn’t be out of the question to see the C&I category rise in forthcoming quarters.

In the meantime, the consumer and corporate sectors are flush with savings, with deposits having grown at an annualized rate of 8.5%; although that’s a rate of growth that’s down a bit from recent quarterly readings. Interestingly, the rate of growth in bank holdings of securities is beginning to moderate.

Increased economic demand is running into the obstacle of supply constraints caused by capacity limitations. Production is simply going to need to catch up with savings. Remember that shortages are nothing more than a disequilibrium between supply and demand.

In theory, at least, shortages, whether they’re computer chips or restaurant workers, don’t exist if market prices are allowed to be the true arbiter. Let’s now take stock of several developments at your Federal Home Loan Bank of Des Moines. I’ll give you a shopping list.

Have you looked at the recent levels at which the Bank has been purchasing member-originated mortgages for its Mortgage Partnership Finance (MPF^®) or Mortgage MPF Traditional program compared with such benchmarks as the rate at which Fannie Mae and Freddie Mac are purchasing. And, that’s even without calculating the value of your activity stock dividend and the credit enhancement fee income that you could generate. If we can help you keep an eye on those spreads and get you started with the mortgage sale process into MPF, get ahold of your Relationship Manager.

Next, as we know, deposit balances can take on seasonal fluctuations. Often times, for instance, there are deposit inflows that take place in Q1. If this phenomenon applies to your institution, you can always readily use FHLB Des Moines as a source of liquidity for purchasing securities instead of waiting for deposit cash flows to arrive later. If you see deployment opportunities, you have the ability to immediately deploy funding. Yes, deposit balances remain prolific, but what are your forecasted levels in the event loan demand picks up (which we are seeing in some sectors), interest rates rise and the yield curve steepens? Remember, while deposits are currently abundant, there’s no assurance how long or how much of them might stick around. Diversify your risk and blend the non-duration-certain characteristics of deposits with the duration-certain characteristic of advance funding.

I had an interesting conversation with a member last week on the subject of collateral availability. I ran an analysis that compared their potentially eligible collateral from their call report versus the actual amount of collateral that was posted with us. There was a meaningful variance between these figures. While we often focus on what types of collateral are eligible in the first place, there can be measurable improvements to advance availability if direct efforts within an organization are applied. In this case, the member assigned an individual task master to work with the frontlines and do a document scrub, not just before a Member Collateral Review, but on an ongoing basis. It’s even to the point where this member has developed collateral eligibility as an internal key performance metric. Speak with your Relationship Manager about preparing a collateral eligibility variance analysis.

Finally, it’s Letter of Credit (LOC) Appreciation month! Although many members use the Standby FHLB Des Moines LOC for the purpose of backing uninsured portions of municipal deposits in favor of municipalities, confirming LOC’s may also be used to effectuate performance guarantees on behalf of a member’s customer or the member itself. Also, there are interesting economics associated with members financing projects using their own direct pay letters of credit with the confirmation of FHLB Des Moines. We’ll be digging into letter of credit solutions with a webinar slated for November 9. Look for information on our website or in your email.

One last note. During November, we will have a fireside chat podcast with Don Musso, president and CEO of FinPro for our “On the Record” series. We’ll be discussing such burning questions as whether or not most members are as asset-sensitive as they think they are, where excess liquidity should be deployed in the current market and how to position a balance sheet should inflation become something other than transitory. More information on the date coming soon.

Stay well and we’ll see you next time on the FHLB Des Moines Insider Podcast. Remember that there can be upside when the economic environment is turbulent – an incredibly shrinking candy bar just might be what the doctor ordered!

There’s more to do than simply act surprised when liquidity and interest rate conditions change. Whether it’s via purchasing mortgages, issuing letters of credit, or acting as an immediately accessible source of funding your loans and investments; we at FHLB Des Moines are here to see you through. Thanks for tuning in.

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