The Northwestern Mutual Model

Hi, friends. Welcome back to another episode of Peer Connections, the podcast series brought to you by the Global Peer Financing Association, also known as GPFA. These podcasts offer our GPFA members and global beneficial owner friends a forum for information sharing and discussion on topics most important to them. And we hope you, our listeners, appreciate the insights, best practices, and transparency offered from our members and industry friends about securities, finance, or related investment areas. Now let's get into the episode. Thanks for joining us for another podcast episode of Peer Connections from the GPFA. My name is Chris Benesch. I'm a Portfolio Manager here at the State of Wisconsin Investment Board. Today, we're going to hear from one of the newest members of the GPFA. They're coming to us actually from just down the road here in Wisconsin. I'd like to welcome Brian Yazel and Chris Breitzman from Northwestern Mutual. Welcome, gentlemen. Good morning, Chris. Thanks. Good morning. Thanks for having us. Guys, maybe to get started, why don't you tell us a little bit about Northwestern Mutual and a little bit about your roles there? Sure, I can fill in some gaps there. So Northwestern Mutual is now the largest provider of whole life insurance in the United States. We have about 250 to 270 billion of assets that we manage for our life clients, but we also provide other products such as long-term care insurance, disability insurance, and we have a very large and growing wealth management company as well. We're managing actually client money directly. Company's been in business for over 160 years. It dates back to the 1850s. We are one of only a couple of AAA rated companies in the United States. So very strong financial standing as recognized by all the major rating agencies. And as you've mentioned, we are homegrown in Wisconsin. We've been located in Milwaukee since the company was founded and we have every intention of staying here. And also to mention, we're not a public company. We are a mutual company, which means we are owned by the policy owners and we don't have many of the pressures that public companies have in terms of quarterly reporting requirements, responding to shareholders, those types of things. So we were very comfortable being a mutual company and think that's the best way to run our business. Thanks, Brian. Tell us a little bit about what you do at Northwestern. Sure. So I've been with Northwestern Mutual since 1994. I was brought in to manage the cash for the company. And over the years, my role has expanded. I started an in-house securities lending program back in 1996. I still oversee that program as well as the cash, but I'm also now involved with macroeconomic analysis for our fixed income team and also running duration strategy for our public fixed income investments. That's excellent. And Chris, welcome. Why don't you tell us a little bit about your role as well? All right, thanks. So I've been working with Brian for a few years now. I have been with Northwestern Mutual for roughly 15 years, but I came up more through the investment side, active equity management, kind of did a little bit of strategist type work there. And now I've been focusing mostly on the macroeconomic part of the effort here, as well as a little bit in emerging markets, but that's ancient history at this point. And going forward, kind of carrying Brian's bags in terms of what he's built here in terms of the security lending and repo operation, maybe bring a little bit of a different investment perspective to it. But otherwise, just trying to continue with the successes that we've had. Excellent. And as both of you are aware, GPFA was founded by folks that are deeply involved in securities finance at our various organizations. Maybe you guys can share a bit about your securities finance activities, how they're structured, what you guys are engaged in, whether it be collateral management, liquidity management, maybe some unique aspects of how Northwestern Mutual views these activities. Sure. You know, as I mentioned earlier, I've run the securities lending book since we started bringing it in-house back almost 25 years ago now, 26 years ago. And over the time, that role has really changed. Initially, it started out lending just about anything in fixed income, whether it was treasuries to corporate bonds to high-yield bonds. We manage that internally, and we've always managed the cash internally. We feel that that's an area where we have a bit of a competitive advantage since we have such a large cash portfolio to begin with, and this was just kind of an add-on to that activity. When it came to lending out some of our equities years ago, we found it beneficial to use a third-party custody agent for that. A larger amount of transactions that go there, the operational efficiency. We just didn't have the team in place to do that internally, so we thought it would be better to have an agent do that for us. I felt that was the best use of our resources from that standpoint. Back in 2008, the financial crisis changed the way the banks and brokers could interact with firms like ours. Their repo books began to shrink. They had less demand for assets from lenders such as us. And over time, we have shifted or transitioned our lending book to now where we are not really lending directly to banks and brokers through a lending program, but we're actually doing more direct repo with other asset managers, so-called end users of these assets. And we find that that's where the demand now for treasury and high quality collateral really is coming from. So that shift has been relatively recent, since about 2018 or 2019. But now that makes up almost 100% of our book of business on the lending side. And what asset classes are you lending through the repo structure? Right now, we're lending treasuries and mortgage-backed securities, interestingly enough. For a counterparty like a money market fund, a government money market fund, they need AAA-rated, high-quality liquid assets, and mortgages do fit that definition. Of course, there's more transactional issues with lending mortgage securities. And what we did to get around that was we now lend under a tri-party agreement where we deposit our securities with the custody bank. And that way the custody bank handles all of the operational side of what happens with mortgage paydowns and coupon payments each month. All the things that would be very tricky if we were doing bilateral becomes much smoother and easier using a tri-party platform. That's interesting. And as you built out that roster of counterparties, how did you approach them and help them get comfortable with Northwestern Mutual as a credit counterparty? Well, there's two parts to that answer. The first part is from our risk management team, we can only lend to rated counterparties at this time. And that meant finding other asset managers that actually have ratings. So as you know, Chris, many pension funds don't have ratings. It's much more difficult for us to consider pension funds as a counterparty. But the government money market funds are all rated by the rating agencies, and most of them have AAA ratings. So from our risk standpoint, going to a AAA rated counterparty was a very good trade for us, you know, reduces the risk. Similarly, from the perspective of the asset manager, Northwestern Mutual being a AAA rated counterparty, there are maybe one other AAA rated counterparty that they could borrow from. So we become a very high quality counterparty for them. So there's a really natural fit for our firm with these asset managers to do business with one another. You know, that historical perspective, I think, is really important as we think about kind of how not only your organizations evolve, but the industry itself. As you kind of look to the future, what's on the roadmap? What do you see changing either within your organization or in the market? Sure. So, you know, we were just at the Beneficial Owners Conference a week ago. I got some really interesting perspective on some of the changes that are occurring right now in the industry. And I think from my perspective, the biggest change that I'm seeing right now is with the Federal Reserve having raised interest rates. So now we're out of that zero interest rate environment. I think the opportunity for beneficial owners or for lenders is that you don't have to go just for non-cash collateral. There's more opportunities receiving cash collateral and reinvesting that again with some interest rate opportunity, there is an opportunity to pick up yield on the reinvest side of the book that I think is going to make lenders look more closely at how their programs are structured and whether maybe they should be going for a mix of both cash and non-cash collateral and what the appropriate mix might be. The other issue that we have going forward is there's a lot of regulatory change on the horizon that we talked about at the conference. It will be very interesting to see over the next few months how the regulation will change, what will actually be implemented, and where the industry can provide feedback to the SEC in terms of, you know, for some of the proposals may not make sense, so they may actually reduce liquidity in the markets. And of course, we want to have a means to provide that feedback to the regulators as well. You know, Brian, you also mentioned how it's a better earning environment with the rates being a little bit higher. I think that that's giving us the opportunity to look at maybe some new asset classes as well. You mentioned that we used to do equity security lending. We don't really do equities enough to do that anymore, but we do still have a rather large emerging markets portfolio. We could start looking at expanding our efforts into that direction. And it makes a little bit more sense to start looking at new avenues for securities financing, whereas when rates were zero, it just wasn't really worth the effort. Makes sense. Certainly a number of opportunities there. You know, one thing you mentioned, Brian, regarding regulatory changes. I'm curious, as a mutual company, which you mentioned earlier, are there any unique regulatory issues that either create barriers or opportunities based on how you guys are structured? Well, that's an interesting question because an insurance company, we don't fall under some of the same regulatory requirements that a money market fund or an asset manager might fall under or a pension fund might fall over. We all have specific regulators that we have to respond to. And we found that from our standpoint, some of the proposed changes probably will not have or will have very limited impact on what we can do. And that might actually provide opportunities for us to, as Chris mentioned, increase into other asset classes or at least increase the amount of lending that we're doing with our current counterparties, just because they may have other counterparties that are being more restricted going forward. So it may actually provide more opportunities for us. Thanks. That's great. So maybe talk a little bit now about how you got connected to the GPFA and maybe what you're both hoping to either learn or contribute with the organization. Well, I'll start with that because I've known Rob Gooby for a number of years from going to the Beneficial Orders Conference for many years now. We've been on panels together and he started talking about this, must've been before 2014, 2015, when he started talking about how we could create some sort of an organization where lenders could interact either to make direct connections as counterparties or to provide, educate, and help teach one another about what we're doing, how we do it, what would best practices look like in certain features. I'm very excited for him that he got the GPFA off the ground. And I know he's worked very closely with Brooke on this for a number of years. I think it's really started to get some traction here. We kind of looked at it from the outside for a couple of years, thinking that, well, in the financial environment, the zero interest rate environment, and budgets are tight everywhere, how can we make this work, but found out that we think it's going to be very cost effective for us to be a member. I've sat in a couple of the conference calls that the GPFA has held hitting on specific topics. And I think the education aspect of it, there's really tremendous to be able to share the knowledge from people who are either very involved in lending and repo and multiple asset classes or those that just want to learn more about it. I think it's worthwhile for both. And that's where I want Chris to be involved there as well. I think that'll really help him being relatively new to this type of program to learn more about it. I was going to add that myself, having come up from the other side of the business and not having extensive experience in this area, I'm finding it very valuable for the opportunity to share best practices and network with these people that have been doing it for literally decades in some cases, and really an opportunity to pick their brain in a productive environment where everybody's really pretty collaborative. I've enjoyed that part of it that I've been in environments in the past where it's very much cutthroat and you're always playing your cards close to your vest. You don't want to share your investment thoughts or whatever. Here, everybody's been very open with what they've learned over time, how they've evolved, and everybody's followed their own model. And it's been an opportunity to learn fairly rapidly in my case, and I'm looking forward to doing that more in the future. Well, that's great. And certainly hope that you guys find that connection and that collaboration that is really one of the founding principles of the GPFA. Well, guys, this has been great. I just want to see if there's any final thoughts you have as we wrap up for today. Yeah, Chris, thanks. As I mentioned, I started our in-house program many years ago, and it is surprising to me how few people understand how the securities lending market and the securities financing market works. It's not rocket science, but if you go to your board or even to your manager, most people will not understand how it works. And therefore that uncertainty that creates a lot of fear about what are the downside risks. So I think it's important in our role as subject matter experts within our organizations to really be able to talk to what are the risks associated with this? You know, you're never going to add a hundred basis points to your portfolio, but boy, if you can add a couple of basis points in a very low risk fashion, that becomes attractive or even offset some of your costs of your custody business. That becomes very attractive for most organizations, I think. So learn as much as you can about where are the risks associated with this and talk to other people that are subject matter experts, be involved with the GPFA and go to these conferences because you will learn a lot about how the business model works, what could work best for you and how to explain it to your management team. I couldn't agree more. Brian Yazel, Chris Breitzman, thank you so much for joining us today, sharing a little bit more about Northwestern Mutual. Really appreciate you guys taking the time. Thanks, Chris. Thanks for listening to another episode of Peer Connections by GPFA. We hope you found the information shared in this podcast interesting and beneficial. And as always, please feel free to reach out to GPFA with ideas or interests for future episodes. And if you liked what you heard today, don't forget to subscribe wherever you get your podcasts. Now for the disclaimer, The opinions expressed in this podcast are those of the presenters and do not necessarily reflect the views or opinions of their respective employer organizations. This material is for your private information and does not constitute legal, tax, or investment advice. There's no representation or warranty as to the current accuracy of nor liability for decisions based on this information.