June 2018 – FHLBank Atlanta’s Fixed Rate Credit (FRC) advance is a versatile funding solution that can help financial institutions reduce funding costs, manage liquidity, and mitigate interest-rate risk. With sufficient collateral in place, FHLBank Atlanta shareholders can access FRC advance funding on a same-day basis. The FRC provides fixed funding costs for a specific term and can be structured with additional features, such as interest rate caps and floors, to provide flexibility.
In today’s rising interest rate environment, the FRC advance is useful for funding both short- and long-term loans and for hedging the risk of holding these assets on the balance sheet. The below examples highlight common uses of the FRC advance and demonstrate how it can strengthen net interest margins, both as a stand-alone funding source and when blended with retail deposits.
The first example offers two options for funding a pool of 3/1 adjustable-rate residential mortgages (ARMs) at an initial interest rate of 3.75 percent. Under one scenario, an institution can fund these loans with a three-year FRC advance at 2.87 percent, securing a fixed spread for the initial three-year fixed period. Once the interest rate on the ARMs adjusts, the institution can roll over the FRC at current rates, adjusting the amount based on payoff behavior, and potentially maintaining a similar spread.
If the institution expects minimal refinance activity at the end of year three, funding the loans with a five-year FRC advance at 3.04 percent would offer additional potential benefits. This structure provides a fixed spread in years one through three with the potential for an increasing spread in years four and five, if funding costs hold steady and the mortgage rate adjusts upward.
A different funding strategy with FRC advances can be deployed to manage longer-term assets. Consider a 10-year amortizing commercial loan or loan pool at 4.25 percent with an average life of eight years. An FRC advance can help mitigate the interest-rate risk of holding the long-term fixed-rate loan on the books and help an institution gain a competitive pricing advantage. Furthermore, creating a blended funding mix of advances and deposits can help guard against higher rates while minimizing funding costs.
This simple tactic is particularly effective when using a ladder of FRC advances of different maturities. The following example shows a funding mix of 50 percent advances and 50 percent deposits. Advances include a two-year FRC at 2.71 percent, a five-year FRC at 3.04 percent, and an eight-year FRC at 3.36 percent. Assuming an average deposit rate of 0.75 percent, the initial blended funding cost is 1.89 percent, providing an initial spread of 2.36 percent to the commercial loan. As each advance rolls off, deposits are rebalanced to 50 percent to mimic principal pay-down on assets.
This approach provides flexibility for the institution to manage its wholesale funding levels more proactively. As each advance matures, the institution can decide if it needs additional funding to replace the advance. If funding is not needed at the time, the institution can simply let the advance roll off the books.
One of the main advantages to using the FRC ladder is the flexibility it allows throughout the life of the hedge. Funding can be extended or paid off at several points to meet the assets that are being hedged.
Strategic Benefits of FRC Advance Funding
- Keep Costs Low: FRC advances offer competitively priced wholesale funding to help institutions reduce funding costs. Blending FRCs with deposits enables institutions to lower funding costs further while being responsive to rising rates.
- Mitigate Interest-rate Risk: FRC advances allow institutions to lock in low-cost funding for a specified time, providing protection against rising rates.
- Achieve Portfolio Growth: FRC advances help institutions offer portfolio loan products to attract new lending business and maintain valuable customer relationships.
- Easy to Explain: FRCs are similar in nature to certificates of deposit and easy to explain to regulators, asset-liability committees, or the board of directors.
To learn more about how FHLBank Atlanta’s FRC advances can support your lending growth and risk management needs, contact your Relationship Manager at 1.800.536.9650, extension 8011.
The Federal Home Loan Bank of Atlanta is not a registered investment advisor. Nothing herein is an offer to sell or a solicitation of an offer to buy any securities or derivative products. You should consult your own legal, financial, and accounting advisors before entering into any transaction. All interest rates are presented for illustrated purposes only.