12/21/23 09:09 AM EST

Regulation Changes Exposing Regional Banks

Below is a chart and brief excerpt from today’s Market Situation Report written by Tier 1 Alpha. If you’re interested in learning more about the Hedgeye-Tier 1 Alpha partnership, there’s more information here.

As of the week of December 13, 2023, the usage of the Fed's Bank Term Funding Program (BTFP) tool surged by an additional $2.06 billion. The accumulated size of BTFP is $123.764 billion, reaching a record high. The $20 billion acceleration in using the program since July is notable.

A temporary government program is now permanent. It's not what you would call surprising.

The surge in BTFP usage since July is more a product of regulation changes at the FHLB, historically a lender of second resort, rather than additional stress at the regional bank level. (Yet)

The Federal Housing Finance Agency (FHFA) is setting a course to re-orient the Federal Home Loan Banks (FHLBs) toward their original housing finance mandate, moving them away from their expanded role as a safety net for struggling banks. The FHFA's report from November 7, 2023, "System at 100: Focusing on the Future," signals an end to the FHLBs' function as a lender of first resort for financial entities in distress, encouraging these institutions to utilize the Federal Reserve's more visible discount window in dire situations.

The FHLBs, established during the depths of the Great Depression to stimulate mortgage lending, have gradually evolved into a fallback option for the banking sector, even as their role in housing finance has waned amidst the rise of nonbank mortgage lenders. The report suggests that these changes, stricter FHLB regulations, and the burgeoning use of the BTFP could expose regional banks more.

This shift could prompt banks to explore alternative financing avenues, like the commercial paper market, potentially driving up their borrowing costs. Moreover, the reduced access to lower-cost funding could affect banks' liquidity coverage ratios, possibly triggering a recalibration of their reserve strategies. This move by the FHFA may increase the minimum reserve requirements across the banking industry as financial institutions bolster their holdings to cushion against funding disruptions.

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