Maximizing FHLBank Membership for Insurance Companies

Maximizing FHLBank Membership for Insurance Companies
February 2, 2021

0:02
Good morning and welcome to the FHLBank Boston Insurance Company webinar. We're so pleased that you were able to join us, and hope all is well. So let's get going.
0:39 
My name is Matt Stewart and I am the Director of Sales at the FHLBank Boston and I spent many years in the insurance industry at both Prudential Financial and Liberty Mutual.
0:51 
It's been a pleasure and rewarding experience bringing the FHLB bank to many of the insurance companies and look forward to continuing the support of your financial strategies. And I am joined by Andrew. Andrew, if you want to just give a quick introduction.
1:08 
Good morning everybody. I am the Director of Member Strategies and Solutions here at the Bank. And what I do is I work with our relationship managers and our members developing funding strategies and understanding our products a little bit better. And previously, I came from the fixed-income asset management world, so now we’ve switched over and talking about liability side of the balance sheet
1:35 
Andrew, before we jump right into the funding part of this webinar, let me just spend a few minutes updating folks on the FHLBanks and working with insurance companies, especially in this past year.
1:49 
Andrew, let's take a look first at membership for insurance companies in the Federal Home Loan Bank System, and as you can see from this chart, the growth continues. And just this past year of 2020, we saw over 60 insurance companies join, and this is as more and more insurance companies learn the benefits of having membership.
2:10 
In the last slide, we saw the annual increase of FHLB membership for insurance companies.
2:15 
​This slide, we're seeing what proportion of the segment the insurance companies make up, so if you look at the red, you see that there were 514 members
2:25 
at the end of third quarter, which made up a higher proportion of advances at 126 billion.
2:32 
So that represents 8% of membership and almost 27% of advances.
2:41 
Let's take a closer look at the 514 insurance companies that are members.
2:46 
So ranked by admitted assets you'll see on the left side, the life insurance sector. 
2:52 
And of the top 15, every single one of them has a FHLB membership at one of the 11 banks. And on the right side, you'll see the property and casualty.
3:02 
And so that number is getting closer and closer to 100% as well.
3:07 
As of the end of third quarter, there were 245 P&C companies, while there were 219 life companies.
3:15 
Additionally, we're seeing the health insurance sector grow as well.
3:20 
As of the end of the third quarter, there were 41 health companies that had a membership.
3:26 
So we just saw countrywide the largest insurance companies. Here on this slide,
3:32 
we're looking at members that are a part of the Boston FHLB.
3:36 
And it's broken down by life companies, health, depository insurance, and P&C companies.
3:42 
The percentage breakdown is 60% P&C companies, 26% life companies, 10% health, and then 4% for the miscellaneous.
3:52 
At this point, there are 70 members, and if you go back just 10 years ago, there were only 17, so, we've seen a significant increase in that amount of time.
4:04 
So, we've been talking about membership growth for the last couple of slides. Let's take a look at actual advances.
4:11 
Here, you can see a very similar, but on a more significant manner, the advance growth over the last 20 years.
4:19 
I think a couple of things definitely stand out. Andrew, do you want to just talk about how the Banks did during the two crises during this period?
4:28 
Sure. So, the, Home Loan Banks exist to provide liquidity to their members. Access to liquidity is no more important in times of market volatility and market crisis. So, when we look back over recent history, certainly, the two periods that would jump out would be the great financial crisis back in ’07 to ‘09, but also more recently, the COVID-19 related crisis from the beginning of 2020. 
4:58 
If we look just at the insurance company advances, we can see that mission holding true that the providing of liquidity to the members at the times when they needed liquidity the most, occurred exactly when it was supposed to. Back in ’07 and ‘08 where we can see the near doubling of insurance company advances.
5:22 
And then more recently in 2020, we can see the jump from about $91 billion of outstanding advances to over $100 billion dollars in advances just to insurance companies. 
5:34 
And if we were to look at depositories or total advances extended during those periods, we’d see similar patterns of increased growth during those periods of heightened volatility.5:49 Thank you, Andrew.
5:52 
So we saw the growth of advances. Let's see how the actual pricing compared to Treasuries over that time. You can see a very tight correlation obviously indicating 
6:49 
the high quality of the FHLB. Andrew, do you want to expand a little bit more on this information? Sure. So the home loan banks are government-sponsored enterprises and we’re able to extend advances or borrowings to members by issuing debt into the capital markets. We’re a regular participant and a large issuer of debt securities and that as Matt eluded to, leads to the tight spreads and tight correlation to the interest rate-related movements and the Treasury. So, when you look back at the five-year tenor going all the way back to 2003, you can see that they track pretty closely, 
7:31 
and in the next section, we'll get into some more, a more nuanced look at what happens to advance rates during different parts of the interest-rate cycle.
7:44 
So, Andrew, speaking of rates, I think the hottest topic right now
7:47 
is the transition away from LIBOR, and it's been pretty obvious that the Federal Home Loan Bank along with the other GSEs are leading the way towards the new SOFR rate.
7:58 
Would you take a couple of minutes and expand on that?
8:02 
Sure.
8:02 
So, you're absolutely right that this is front and center for many types of financial institutions right now. Again, we're happy to say that the system is leading the charge on the transition,
8:16 
the benchmark transition away from LIBOR to alternative indices, including SOFR, the Secured Overnight Financing Rate, which is the preferred benchmark.
8:27 
So on the chart on the top, you can see it's a collection of volume in different SOFR products whether it's the futures market, interest-rate swaps, or cash issuance.
8:39 
And so adoption of SOFR has been continually growing and increasing as this multi-year transition is ongoing. And in the bottom chart, table rathe,r is cash bond issuance.
8:54 
As we had mentioned previously, the Home Loan Bank System is a regular large issuer of debt and nowhere more certain is that [thank] in the SOFR issuance that we've seen thus far.
9:08 
So the Home Loan Bank System has issued over $350 billion worth of SOFR debt as a percentage share of total debt issued, that is, far and away, the largest global issuer and double even the other GSEs and some of the corporate issuers out there right now. So the Home Loan Bank is adding to liquidity and the transparency and the adoption of SOFR as an alternative benchmark index.
9:41 
And Andrew will talk about SOFR and other floating-rate products that we offer in a couple slides forward. 
9:50 
​Let's move on to the funding portion of the webinar.
9:56 
Andrew, one of the most common questions I receive is: How are insurance companies using FHLB funding?
10:01 
And the answer is really a wide spectrum, and there's people who are using it for cash management, 
10:07 
so think of short-term liquidity as you're waiting for either a reinsurance check, or you had a large outflow for either paying agents, or just something you didn't expect.
10:18 
And then on the other side, you have members that are using it from a spread management.
10:24 
So you're borrowing at a low rate and turning it around and investing in an asset with a higher return, so members are making a nice spread with the use of FHLB.
10:35 
And, of course, there's the miscellaneous category that I call, and we've seen members use it for a variety of reasons, whether it's funding a pension or M&A activity.
10:50 
So, as far as funding is concerned, the first thing you need to think about is what type of collateral you'll be pledging.
10:56 
And so as you can see on this slide, there's a variety of asset types that are eligible between Treasuries or other US-backed securities along with agencies and commercial mortgage-backed securities, municipal securities, and any type of residential commercial loans.
11:14 
And the beauty is that we are flexible in what you pledge. So there obviously is a haircut based on the credit risk,
11:22 
but it's you who determines what you're going to pledge, and you are able to swap in and out at your convenience.
11:30 
Andrew, I've heard of many members who utilize the funding to purchase assets that they turn around. Can you expand on that a little bit?
11:39 
Sure.
11:40 
So, when you look at the available types of collateral, as you move from left to right, you can see there's, there's really a shift in the liquidity profile.
11:51 
So, one of the appeals from the member perspective, is to be able to take an asset that is not as liquid and be able to create liquidity from it.
12:04 
So, you'll be able to pledge a residential or commercial real estate loan and have that serve as eligible collateral in order to purchase another asset
12:16 
that Matt alluded to before with the funding usage applications that is either going to be supportive of your overall asset liability management and your stress management opportunities or even just the short-term liquidity aspect of things.
12:38 
So, let's look at an example where a spread lending strategy may be impactful.
12:44 
So, when you think about corporate bonds being the predominant asset class on many insurance companies’ balance sheets, you have the slope of the yield curve, the compensation for interest-rate risk, and you have the credit spread component.
12:58 
So this is what we're looking at in this graph here, so it’s the relationship between the steepness of the curve
13:03 
and the credit spreads. 2016 through 2019 in green was the relatively normal period.
13:11 
So we saw that the curve was sometimes steep, sometimes flat and spreads … moved up and down. 2020 was a very atypical year where we saw a sharp widening of spreads and then a collapse in rates.
13:25 
And then, here we are, in the beginning of 2021.
13:29 
So, when you think about … let's consider, if you had bought a longer-term corporate bond coming out of the spike of the crisis in March of 2020. Credit spreads have tightened
13:43 
so there's been some benefit to having bought risk assets then,
13:49 
but long-term Treasury rates have backed up in that period, as well,
13:53 
so you may have gotten the spread tightening, correct
13:57 
but you may have lost from the total return perspective on the duration.
14:00 
So, where the spread blending really comes into play as an attractive lever to be pulled is that it strips out the interest-rate risk component of the transaction, and also the liquidity risk.
14:14 
You have the ability to, you and your asset managers, do what you do best and identify where there are attractive spread opportunities
14:22 
on the asset side of the balance sheet
14:25 
without having to factor in the additional components of the interest-rate risk moods.
14:32 
So, when you think about how that gets treated from the leverage in the ratings agency perspective, there may be some benefits to the spread lending program as well. Matt, do you want to elaborate on that? Yeah, that's a good point
14:45 
Andrew. I think most members are aware of how this is treated, whether it's operating or financial
14:53 
and I think what you'll find is all of the rating agencies, whether you're a life company using a funding agreement or a non-life company just matching an asset to this funding, you're going to have it treated as operating leverage as long as you identify the program and have it match fairly close.
15:14 
So, obviously, the operating leverage is a better, better outcome for the insurance company.
15:26 
Thanks, Matt.
15:27 
So, let's look at it, something similar, but in a slightly different way here.
15:32 
So, we had mentioned earlier that because of the Home Loan Bank System’s ability and prevalence in the debt issuance markets, that our cost of funds as a spread to Treasurys tends to hold up better than other participants in the debt markets.
15:46 
And, and ultimately, that flows through to what members are able to receive in terms of advance rates. So this is no more obvious than in periods of extreme volatility.
15:59 
And March, as everybody here knows, March of 2020, was a perfect example of market volatility.
16:08 
So, what we're looking at here is the blue line is the yield on a three to five year corporate bond index, and in green, that is the spread that would have been able to be captured by buying the yield of the index and funding it with the
16:26 
match funded
16:28 
Home Loan Bank Boston advance rate at the time.
16:30 
So, going into a crisis, that spread was about 58 basis points.
16:36 
That was owed to very narrow asset spreads at the time
16:40 
but also very narrow debt spreads. But then as volatility erupted into the market, as we all know, credit spreads widened out very sharply.
16:52 
But advance spreads did widen out a little bit, but they held considerately compared to what was happening in the debt markets. So, I think back to some of the conversations that I've had
17:08 
at that time where we were watching corporate bond issuance and seeing some of the best of breed, double A and up issuers, issue bonds
17:16 
at incredibly wide spreads, but also flat credit curves, because that was the only way that they were able to capture the liquidity that they need.
17:26 
But the takeaway here is, you can see where that green line peaked in March of 2020 that to put on a spread lending program
17:37 
funded by advances, you were able to capture nearly 300 basis points of spread versus just that index yield.
17:45 
And certainly, if you were to look at individual sectors or names, there were opportunities where you could have match funded a double A plus, or, even AAA name at spreads more commonplace for triple B and below.
18:02 
And that is a testament to, as we said, the spread stability that you tend to see from Home Loan Bank advances in periods of considerable volatility.
18:14 
So Matt, I'll pose this question to you that when markets were volatile back then or even other bouts of volatility, were there any issues with execution or timing in terms of advances getting put into place? Yeah, good question. Andrew. I would say the answer is no. It was a very seamless and smooth operation.
18:36 
We saw quite a few insurance companies come in for the first time and/or get ready to come in for the first time.
18:43 
The best part about the FHLB is it's a turnkey, quick borrowing process,
18:50 
so once the collateral is in place, it's a matter of a click on our website or calling our 800 number.
18:56 
So, I think most people have found that it’s quite easy to borrow.
19:05 
So, thinking about the match funding, there are some options when you have a fixed-rate asset and you want to put the liability against it that mitigates the interest-rate risk. So, you know, there's three different advance products that come to mind when considering a strategy such as this.
19:21 
The first one on the left-hand side would be the Classic Advance. 
19:25 
As the name implies, it is a traditional bullet structure. 
19:29 
So, if we have a scenario where we're looking at a five-year asset.
19:34 
the liability would be a five-year bullet structure as well. So, in an example where we were putting on an asset at a plus 200 spread -- approximately 245 -- the five-year bullet rate at 89 basis points would produce a spread of 156 basis points.
19:53 
No interest-rate risk, no liquidity mismatch there as well. So, there are some other options that have very similar structures, but provide some flexibility to the member, depending on your outlook and your needs. So that the next one would be the Symmetrical Prepayment Advance. Similar to the Classic Advance, it’s a five-year bullet, 
20:12 
but it has some added features in that it provides a benefit that if you were to return the funding in a higher-rate environment, then you'd be able to capture the market value of that advance.
20:25 
So just like on a bond, … fixed-rate bond in a higher-rate environment, the market value would go down, which is not a good thing,
20:36 
but that's an asset, so think about a liability,
20:40 
a decreased market value is a positive.
20:42 
So, if, for whatever reason, you do not need the funding from the Home Loan Bank advance in order to fund the assets, you can collapse that advance and realize a gain.
20:54 
And this comes just at a cost of just two basis points on top of the Classic Advance.
21:01 
And then the third option is called the Member-Option Advance.
21:06 
So again, it's a fixed-rate, final maturity borrowing,
21:11 
but the member has the option to return the funding after a specified lockout date, which is highly customizable.
21:20 
So, one indicative structure would be a five-year maturity with a three-year lockout period.
21:26 
So if you get to a scenario where you're in the last two years of that asset’s average life, but you have the term or liquidity to be able to fund that asset, well, then you can return that advance that was priced at just 98 basis points, just nine basis points above the comparable Classic maturity 
21:47 
and then, hopefully, expand some of your spread.
21:50 
So those are the three main options for funding fixed-rate assets.
21:56 
And we do have a program that enables some additional cost savings.22:01 Matt, you want to give some background on that? Yeah,
22:03 
so, we're always happy to provide a discount to our members wherever possible. And so, besides the regular emails that we send out based on member feedback, and also our Tuesday, Thursday, short-term specials, we also have the Automatic Renewal Discount Program that's in place.
22:24 
As long as you have maturity that's at least two days, you're able to have a discount anywhere up to eight basis points
22:33 
as long as you renew it into at least a one-year term, and if you go two years that discount is even higher.
22:42 
So based on the term and the amount compared to the last maturity, you are able to receive a discount from us.
22:55 
So, we covered fixed-rate spreads on the program.
22:58 
So, what about when we're looking at floating rate assets?
23:03 
So, there's, again, multiple options available for members. So the one option is to roll short-term advances, which is good for aligning the reset in the interest rate component of the asset, but it does create a liquidity mismatch because you have a longer asset, and a shorter-term liability. Alternatively, the Bank has floating-rate advance products that can help for a better alignment of not just the duration of the asset, but also the average life. So, there's two primary products that come to mind here, and they are listed on the table on the right-hand side. Those would be the SOFR-Indexed Advance and the Discount Note Auction-Floater Advance.
23:51 
So in both cases
23:54 
the way they work are that a spread is priced at the initiation and that spread is fixed for the duration of the asset.
24:04 
The ultimate rate that the member pays will adjust, depending on the particular index.
24:10 
So, we had talked a little bit before about what SOFR is and how that is part of the LIBOR transition process, and that is a daily overnight rate.
24:22 
So, the change in the rate will happen on a daily basis, but in terms of the payment of interest that occurs either annually or at maturity.
24:35 
You know, we do have available SOFR-Indexed Advances that are shorter than one year. Alternatively, there's the Discount Note Auction-Floater Advance. What is the Discount Note Auction? 
24:47 
Essentially, it is the Home Loan Bank cost of funds. So, think of it almost like a Home Loan Bank T-Bill. And there's two versions of that -- there's a four week and a 13-week version. They can often line up against one- and three-month LIBOR,
25:03 
and with the insurance companies the 13-week, the three-month version tends to be more popular because you have the asset world tends to price assets off of three-month LIBOR, so there's a natural match there.
25:23 
So now, let's walk through an actual example of where one of these floating-rate advances really provided significant value in a spread lending program. So, we're going to take a look at the DNA Floater.
25:38 
So, let's rewind to October of 2019, and, let's say a member put on a one-year final maturity with a three-month reset DNA Floater, and this was back when short-term interest rates were the high ones, 
25:55 
low 2% seems like 100 years ago, but that was actually where things were. So, when you look at the all-in rate for that 
26:04 
DNA Floater at that time, it worked out to be three-month LIBOR plus 12 basis points.
26:11 
So, pretty cheap funding relative to, if you think about, if you are looking at a CLO for example priced at three -month LIBOR plus 150 or something like that. So, you know, a significant amount of that is flowing directly through to spread.
26:28 
So, we fast-forward three months.
26:31 
That first reset occurs. LIBOR comes down, DN comes down as well, and because, we had a Fed rate cut during that time,
26:40 
so, what we saw was that the DN rate went down a little bit more than LIBOR so that the all-in rate now works out to a spread of about three-month LIBOR plus four basis points.
26:53 
So, very nearly LIBOR flat.
26:55 
So, [it’s] an improvement in the spread received for the member.
27:00 
We go forward another 3 months, and now we're in April of 2020, and we're in a market in the world that no one has ever seen before where short-term rates have plummeted.
27:12 
But because of the credit component in LIBOR, there was some stress in the funding markets, and LIBOR was significantly elevated.
27:22 
Now, there's two opportunities where members were able to benefit, not just at the, as you can see, by the green bar, that the DN rate came down significantly with Fed Funds and all-in short-term rates, but the recovery for a Home Loan Bank advance spreads, was much quicker and spreads tightened much more sharply
27:46 
than anything else out there, such that the rate on a new one-year, three-month DNA Floater was at plus 25 versus the original plus 38.
27:59 
One of the key features of this product is that the member is able to call the funding with no prepayment fee at every reset interval.
28:09 
So, in this example, the member was able to get rid of the old advance and plus 38 and re-institute it with a new plus 25 spread.
28:19 
And, again, when we convert that to a spread to LIBOR, this is where the value really comes shining through.
28:26 
And you can see that all-in rate at the time, now is equivalent to three-month LIBOR less 99 basis points.
28:33 
So, think about that in terms of, if you had that asset on plus 150, that the spread that you're receiving through this program now far exceeded just what you're receiving on the asset side
28:48 
because your funding was at such lower levels as compared to LIBOR.
28:54 
So, a pretty exceptional time and an opportunity presented by those markets.
29:02 
And then as we look at what happened over the next three-month period, we can see that conditions started to normalize and as LIBOR reset, so did the DN and the funding continued on the DN Floater reprice at around approximately LIBOR plus 10 basis points or so.
29:25 
So, pretty interesting how the DN was able to provide the funding for asset opportunities at those times,
29:33 
and you know, Matt, do you want any input in terms of the conversations that you had with members and asset managers related to this type of strategy?
29:44 
Yeah, definitely add in that the DN Floater has been a very popular product when it comes to matching for a floating asset
29:52 
and as you point out, so well,
29:55 
it's a great product and strongly recommend it.
29:58 
Um, and I want to make sure everyone understands that we are moving away from LIBOR.
30:04
We will only go out through the end of this year for term.
30:08 
So basically, we've got about seven or so months left.
30:14 
And so that's, that's how we're moving.
30:18 
Aside from the … examples we looked at with longer-term assets funded by longer-term liabilities like we looked at earlier,
30:28 
there's also the value in the liquidity management side of things where you're able to meet the day-to-day needs of the balance sheet
30:35 
and the intermittent and uncertain cash flow needs that may arise from time to time.
30:39 
So, you know, here, when we look at three-month LIBOR versus the three-month Classic Advance rate going back to the beginning of 2020, we can see, just like we did with the spread funding analysis,
30:54 
that other metrics widened out much more than where advances had moved during those periods of high volatility and credit stress.
31:04 
So if you had funding needs and liquidity needs that may not have been looking to take advantage of investment dislocations that were occurring in time but were just short-term needs, well then advances were there to be able to allow you to plug the gap and meet that funding need at a highly customizable term depending on what you needed.
31:30 
The other thing to point out is, aside from the long-term spread lending, we do have members that will look to put on longer-term advances
31:41 
because of the low rates and tight spreads that advances afford them. When you think about what your capital structure looks like and how you manage your liquidity,
 31:49 
if you think about something like our one-year Classic Advance rate at 30 basis points, which works out to right now about a spread of 20 basis points over advances,
32:02 
That's a good opportunity to put some debt onto the right side of the balance sheet that is affordable and provide some support to the liquidity planning process. And that's going to be dependent on all the moving pieces that you have on your balance sheet.
32:19 
And, you know, we even have some folks who have used this tool and this strategy, even going out as far as five years and capturing the rates that are currently sub 1%.
32:33 
So, here's an example from a cash management perspective. So, when you think about how low short-term interest rates are right now, cash drag can be pretty painful. So, with money market rates being as low as where they are right now,
32:50 
so, holding excess cash can be expensive from an earnings perspective. So, if you were to look at two different ways where you could rely upon advances to minimize that cash flow.
33:05 
So, if you were to look at an example.
33:08 
So, example one would be instead of holding excess cash and earning money market yield of just one basis points, you stay invested in a more normal investment mix where you'd be able to earn 2%.
33:22 
And in example one, look to borrow at that 12-month term that we had just talked about at 30 basis points.
33:30 
And you can see what the benefits of being fully invested would accrue: that you pay $75,000 in the funding, but you'd be able to capture another half million dollars’ worth of earnings from being fully invested.
33:49 
Alternatively, you can stay invested but rather than borrowing the full $25 million on day one for a one-year term, use the
34:01 
overnight borrowings, and in this example, I'll use it on 100 days throughout the course of the year,
34:07 
whenever a need would happen to arise. And the math works in a very similar way where the earnings from being fully invested, far outpace what the costs of the funding need would be
34:23 
and that all falls right to the bottom line.
34:27 
Yeah, I’ll definitely reinforce, Andrew, to save $425,000 or $470,000 in this example, is well worth the effort. I also want to point out that most of the members benefit by the fact that they can borrow up until 5:00 at night.
34:43 
So, when you think of other sources of short-term funding, you really need to have a decision by 10, 11:00 in the morning, at the latest,
34:51 
and with the FHLB, it's really right up until 5:00,34:54 and you can get the funding with one call pretty quickly and not have to stress out during the day what you're going to do. So definitely, cash management is a great way to use the FHLB.35:07 So, Andrew, that's the end of the webinar, appreciate your help. And certainly, thank everyone for attending. We look forward to helping you as you guide through your financial and investment strategies and utilizing the FHLB as best as possible. Thanks for attending again.