03/12/24 09:04 AM EDT

Bank Term Funding Program Shuts Down

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 March 11th, the Bank Term Funding Program (BTFP) has ceased operations and is no longer issuing new loans. This program was instrumental in providing liquidity to the banking system and supporting bank deposits during the collapse of Silicon Valley Bank. We're highlighting this update today not only because it's significant news but also because it prompts several questions.

Initially, the BTFP served its purpose effectively. However, as interest rates began to decline, it turned into an arbitrage opportunity. Banks could borrow at a rate of 12-month OIS (Overnight Index Swap) plus 10 basis points through the BTFP, then deposit these funds with the Federal Reserve to earn interest on reserves (IOR), netting a risk-free 50 basis points. This arbitrage became more appealing than issuing new loans in the current "supercharged economy," leading to scrutiny and the Federal Reserve adjusting BTFP loan rates above the IOR to halt this practice. This change obscured the distinction between banks seeking essential liquidity and those engaging in arbitrage.

The BTFP's recent growth of $548 million just last week—though seemingly minor in today's financial landscape—raises questions about the ongoing need for liquidity with declining forward-looking rates. It's now crucial to discern how much of the BTFP's activity from December to January was driven by genuine liquidity needs versus arbitrage. In its initial months, the BTFP issued $79 billion in loans, a sum that is now approaching repayment. The mechanisms for repayment, whether through the discount window, reserves, private markets, or the Federal Home Loan Banks (FHLB), remain to be seen, especially since accessing these options often requires collateral. The challenge of mobilizing eligible collateral, highlighted by the failures of banks like Signature Bank's attempts to use certain bridge loans and subscription loans as collateral, brings us to the looming issue in commercial real estate (CRE). With potential declines in CRE values, the need for treasuries as collateral for borrowing becomes more acute due to uncertainty around the eligibility of CRE loans as collateral. This situation leaves us with more questions than answers as we face the impending maturity wall in commercial real estate.

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