The Federal Reserve’s New Bank Term Funding Program
On Sunday, March 12, in an effort to demonstrate support for the banking system, the Federal Reserve Board created the Bank Term Funding Program (BTFP) to make available additional funding to eligible depository institutions. This new program will provide an additional source of liquidity for financial institutions with an asset-liability duration mismatch relating to high-quality collateral, with the goal of providing banks an alternative to quickly selling off high-quality collateral at current discounted market values to fund liquidity needs.
In its announcement, the Federal Reserve Board stated the BTFP will “bolster the capacity of the banking system to safeguard deposits and ensure the ongoing provision of money and credit to the economy.” The program first became available on March 13, and financial institutions borrowed over $11.9 billion allocated from the BTFP during its first week. During the same week, borrowing at the Federal Reserve discount window increased by over 3,000% to $152.85 billion.
Eligibility for BTFP: Who can borrow?
Any U.S. federally insured depository institution (including banks, savings associations, and credit unions), as well as any U.S. branch or agency of a foreign bank that is eligible for primary credit (see 12 C.F.R. § 201.4(a)), is eligible to borrow under the BTFP.
Financial institutions that already have discount window borrowing documentation under the Federal Reserve Banks’ (FRB) Operating Circular No. 10 (Lending) are able to borrow from the BTFP immediately. Other financial institutions can contact their district FRB to determine the documentation needed to participate in the BTFP.
BTFP Terms: How does it work?
There is no restriction on the number of times an eligible financial institution can access the BTFP. The funds will be available for a term of up to one year, and borrowers may pledge U.S. Treasuries, agency debt, mortgage-backed securities, and certain other high-quality assets as collateral (see Exhibit A for a detailed list of current eligible collateral and 12 C.F.R. § 201.108(b)). The collateral valuation will be 100% of par value regardless of the current market value of the collateral. The loans are made with full recourse to the eligible borrowers beyond the pledged collateral. Borrowers may prepay advances at any time without penalty, and the BTFP is currently scheduled to end on March 11, 2024. The Department of the Treasury has allocated up to $25 billion from the Exchange Stabilization Fund as a backstop for the BTFP in the event of any borrower default, but the Federal Reserve Board stated that it does not anticipate having to make any draws from the backstop funds.
Financing: How much does it cost?
The fixed interest rate for term advances under the BTFP will be the one-year overnight index swap rate plus 10 basis points, as of the date the advance is made. There are no fees for a borrower to participate in the BTFP.
Balance Sheet Implications
A large tenet of the BTFP is swapping bank-owned quality assets for the cash that financial institutions need to support liquidity to protect themselves from becoming victim to a potential run on deposits, which could otherwise force the sale of assets and crystalize current mark-to-market losses on the quality collateral. These assets will become a part of the Federal Reserve’s balance sheet, and depending on the BTFP’s utilization rate, the balance sheet could see significant growth. As of March 15, 2023, the Federal Reserve’s balance sheet expanded by $297 billion to $8.63 trillion, reaching the highest amount since November 2022. As a result, the Federal Reserve’s stated intention to reduce its balance sheet likely will be put on hold.
The financial institutions participating in the BTFP have the potential to change their balance sheets: a bank looking to protect decreasing deposits could effectively be shielded from realizing the mark-to-market losses on its high-quality assets. Additionally, this could act as a price support for those assets. For example, billions of dollars in assets may fail to reach the current market, and in a future market, could potentially result in even larger mark-to-market losses. Also of concern is the fact that the financing costs of the BTFP will be greater than the income from the pledged assets, generating additional current income losses for the participating financial institutions.
Why still utilize the discount window?
The BTFP, with its new offerings and favorable terms, is not replacing the discount window. Financial institutions are still drawing from the discount window, and in record-breaking amounts. Federal Reserve data showed a total of $152.85 billion borrowed from the discount window as of March 15, which is $41 billion higher than the previous record of $111 billion set in 2008. Whether to borrow from the BTFP or the discount window depends on the needs of each respective financial institution. However, one of the largest deterrents of the BTFP is its more stringent collateral requirements.
Discount Window vs. BTFP and Important Changes
|Term||Advances for up to one year||Advances for up to 90 days|
|Collateral Valuation||Collateral is valued at par and not market value, collateral must be available for purchase by the FRBs in the open market, and must be owned by the borrower as of March 12, 2023.||Collateral is traditionally valued at market value, however as of March 12 the FRBs are currently lending at par for collateral that is eligible for the BTFP including Treasuries, agency debt, and agency MBS. For more information, see Collateral Valuation.|
Direct obligations of the following entities are eligible collateral for the BTFP:
In addition, mortgage-backed securities (including pass-throughs, CMOs, REMICs, and CMBS) that are issued and/or fully guaranteed by the following entities are eligible collateral for the BTFP:
Further, pool certificates and development company participation certificates that are fully guaranteed by the Small Business Administration are eligible collateral.
The above listed securities are generally acceptable for pledge, with the exception of interest only (IOs), principal only (POs), IO-ette, residuals, inverse floater, and Z tranches.
If an eligible borrower has questions about whether other assets are eligible collateral, it should contact the FRB in the district in which it is located.
|Primary credit collateral eligible for purchase by the FRBs in the open market (everything the BTFP can use) AND numerous other types of collateral. See Exhibit A for the full list.|
|Interest Rate||Fixed-rate for the term of the advance on the day the advance is made based upon one-year overnight index swap rate plus 10 basis points, currently at 4.70% as of March 23, 2023
||Floating rate, the primary credit rate is at 5% as of March 23, 2023|
|Margin||There will be no haircuts applied to eligible collateral.||The margins for other collateral eligible for the discount window but not eligible for the BTFP are not affected. Primary credit will apply the same margins used for the securities eligible for the BTFP, further increasing lendable value at the discount window.|
|Mechanics||FRB Operating Circular No. 10 (Lending)||FRB Operating Circular No. 10 (Lending)|
Perhaps the largest difference between the BTFP and the discount window are the collateral requirements, with fewer types of collateral qualifying for the new program. These stricter collateral requirements make the BTFP less helpful to financial institutions without a large percentage of assets in securities because such banks generally do not have enough high-quality assets on their balance sheet for the BTFP to give them the same benefits.
Collateral under BTFP is valued at par. The discount window previously valued collateral at fair market value, but as of March 12, 2023, certain other collateral that is eligible for the BTFP is also valued at par at the discount window. Specifically, the discount window is currently lending at par for Treasuries, agency debt, and agency mortgage-backed securities. The Federal Reserve Board announced this change to help protect borrowers from the recent and future interest rate hikes and increase the lendable value of the high-quality collateral at the discount window.
As for the requirement for a borrower under the BTFP to have owned collateral as of March 12, 2023, for it to be eligible, the Federal Reserve Board provided guidance on March 16th for merged entities. If two federally insured depository institutions merge and the surviving institution of the two is an eligible borrower, the assets of the surviving institution would be eligible collateral if the assets (i) are eligible for purchase by the FRBs in open market operations and (ii) were owned by either merger party as of March 12. Similarly, if a federally insured depository institution or U.S. branch or agency that is an eligible borrower (the purchaser) acquires all or substantially all of the assets of a federally insured depository institution or a U.S. branch or agency of a foreign bank, the assets of the purchaser would be eligible collateral if they (i) are eligible for purchase by the FRBs in open market operations and (ii) were owned by either the purchaser or a federally insured depository institution as of March 12. Finally, if an eligible borrower purchases particular assets, or a portfolio of assets, from another institution after March 12, those assets are not eligible collateral for purposes of the BTFP.
The fixed interest rate of the advances under the BTFP versus the floating interest rate available from the discount window is another notable difference. In addition, the BTFP allows financial institutions to lock in the fixed interest rate on the advance for the term of the advance to avoid any interim increases in interest rates as happened on March 22, 2023. Further, the BTFP could allow financial institutions to take advantage of lower future market interest rates by prepaying the facility and drawing down at the lower rate as the advances are pre-payable.
Finally, advances for BTFP can be made for a term of up to one year, as opposed to up to 90 days for the discount window. Operating Circular No. 10 (OC 10) governs advances from the BTFP and the discount window because OC 10 contains the terms under which an entity may obtain advances from, incur obligations to, or pledge collateral to a FRB.
The greatest lingering question with the BTFP is what will happen when the BTFP ends in one year, on March 11, 2024.
For your reference, please see (i) the term sheet released by the Federal Reserve, (ii) the FAQs document released by the Federal Reserve, and (iii) attached as Exhibit A, a copy of the collateral chart published by the Federal Reserve to determine what type of collateral is currently eligible for purchase at the discount window.
General Eligibility Standards
|U.S. Treasury and Fully Guaranteed Agency Securities (Bills, Notes, Bonds, Floating Rate Notes, Inflation-Indexed and STRIPs)||
Pledged through FSS (and DTC on a limited basis)
This asset class also includes structured guaranteed notes issued by the Federal Deposit Insurance Corporation (FDIC) or the National Credit Union Administration (NCUA) that do not accrue interest at a stated rate and do not make payments prior to maturity.
|Government Sponsored Enterprise (GSE) Securities (Bills, Notes, Bonds, Zero Coupons)||Pledged through FSS (and DTC on a limited basis)|
|Foreign Government Guaranteed Securities and Brady Bonds||Investment-grade-rated foreign government, foreign government guaranteed securities, and Brady Bonds, denominated in U.S. dollars or, where applicable, an Eligible Foreign Currency, are generally eligible for pledge.||Pledged through Clearstream, Euroclear, or DTC
Includes securities backed by guarantees of export credit agencies
|Foreign Government Agencies Securities||Investment-grade-rated foreign government agency bonds denominated in U.S. dollars are generally eligible for pledge, as are AAA-rated foreign government agency bonds denominated in an Eligible Foreign Currency.||Pledged through Clearstream or Euroclear
Includes securities backed by guarantees of export credit agencies
|Supranationals Securities (Bills, Notes, Bonds and Zero Coupons)||
Investment-grade-rated supranational bills, notes, and bonds denominated in U.S. dollars are generally eligible for pledge, as are AAA-rated supranational bills, notes, and bonds denominated in an Eligible Foreign Currency.
Zero-coupon securities must be denominated in U.S. dollars to be eligible for pledge.
|Pledged through FSS, DTC, Clearstream, or Euroclear
|Corporate Bonds||Investment-grade-rated corporate bonds denominated in U.S. dollars are generally eligible for pledge, as are AAA-rated corporate bonds denominated in an Eligible Foreign Currency.
The following are not eligible corporate bonds:
Pledged through DTC, Euroclear, or Clearstream
Includes dollar denominated covered bonds issued by domestic institutions. Contact your local Reserve Bank for details.
|German Jumbo Pfandbriefe||AAA-rated German Jumbo Pfandbriefe denominated in U.S. dollars or an Eligible Foreign Currency are generally eligible for pledge.||Pledged through Clearstream or Euroclear|
Investment-grade-rated municipal bonds denominated in U.S. dollars are generally eligible for pledge, as are AAA-rated municipal bonds denominated in an Eligible Foreign Currency.
Unrated securities, including pre-refunded and escrowed to maturity bonds, may also be acceptable; contact your local Reserve Bank for additional information.
|Pledged through DTC, Clearstream, or Euroclear|
|Asset Backed Securities (ABS)||Investment-grade-rated Asset-Backed Securities (ABS) denominated in U.S. dollars are generally eligible with the exception of interest only (IOs), principal only (POs), IO-ette, residuals, inverse floater, and Z tranches.||Pledged through DTC|
|Collateralized Debt Obligations (CDOs)||AAA-rated collateralized debt obligations (CDOs) denominated in U.S. dollars are generally eligible for pledge with the exception of interest only (IOs), principal only (POs), IO-ette, residuals, inverse floater, and Z tranches.||Pledged through DTC|
|Collateralized Loan Obligations (CLOs)||AAA-rated collateralized loan obligations (CLOs) denominated in U.S. dollars are generally eligible for pledge with the exception of interest only (IOs), principal only (POs), IO-ette, residuals, inverse floater, and Z tranches.||Pledged through DTC|
|Agency-Backed Mortgage Securities (Pass-Throughs, Collateralized Mortgage Obligations, and Commercial Mortgage-Backed Securities (CMBS))||Agency-backed pass-through mortgage securities, commercial mortgage-backed securities, and collateralized mortgage obligations (CMOs) denominated in U.S. dollars are generally eligible for pledge, with the exception of interest only (IOs), principal only (POs), IO-ette, residuals, inverse floater, and Z tranches.||
Pledged through FSS (and DTC on a limited basis). This class includes structured guaranteed notes issued by the FDIC or NCUA, which may be backed by loans, RMBS, CMBS, or ABS.
|Non-Agency Residential Mortgage-Backed Securities (RMBS)||
Investment-grade-rated non-agency residential mortgage-backed securities (RMBS) denominated in U.S. dollars are generally eligible for pledge with the exception of interest only (IOs), principal only (POs), IO-ette, residuals, inverse floater, and Z tranches.
Investment-grade-rated RMBS denominated in U.S. dollars backed by subprime mortgages are generally eligible for pledge.
|Pledged through DTC|
|Commercial Mortgage-Backed Securities (CMBS)||AAA-rated commercial mortgage-backed securities (CMBS) denominated in U.S. dollars are generally eligible for pledge with the exception of interest only (IOs), principal only (POs), IO-ette, residuals, inverse floater, and Z tranches.||Pledged through DTC|
|Trust Preferred Securities (TPS)||
Investment-grade-rated trust preferred securities denominated in U.S. dollars are generally eligible for pledge.
Trust preferred securities that are currently deferring payments, even if not in default, are not eligible for pledge.
|Pledged through DTC|
|Certificates of Deposit (CDs), Bankers' Acceptances, Commercial Paper, Asset-Backed Commercial Paper (ABCP)||
Unrated CDs may be acceptable; contact your Reserve Bank for additional information.
Foreign denominated securities are not eligible.
Short-term ratings must be investment grade.
|Pledged through DTC|
© Arnold & Porter Kaye Scholer LLP 2023 All Rights Reserved. This Advisory is intended to be a general summary of the law and does not constitute legal advice. You should consult with counsel to determine applicable legal requirements in a specific fact situation.