Revisiting assumptions and assessing market conditions to position your institution for the remainder of 2015
July 2015 – It’s halfway through 2015, and the market environment may not look the way you expected based on assumptions made earlier in the year. Now is a good time to review your 2015 funding plans – check vital signs, run tests, and reevaluate assumptions – and determine what, if any, steps to take to adjust plans for the remainder of the year.
Two of the biggest areas of concern for most financial institutions continue to be a potential interest rate increase on the horizon and effects on deposits in a higher-rate environment. Given continued economic instability abroad, sluggish wage growth at home, and weak GDP growth in the first half of the year, the timing of any interest rate move by the Federal Reserve remains uncertain. Market expectations are regularly adjusting.
Interest Rate Environment – Waiting for Lift Off
Consensus among economists in early 2015 was that the Federal Reserve would likely make its first move to raise interest rates at the June Federal Open Markets Committee (FOMC) meeting. However, the June meeting has come and gone with no move by the committee. New forecasts issued by the committee implied two quarter-point increases in 2015 but a slower pace of increases in 2016. The timing of the first move is still uncertain. Earlier in June, approximately 72 percent of economists surveyed by the Wall Street Journal said the U.S. central bank will start raising rates in September. This figure is up from 65 percent in the April survey and 38 percent in the March survey.
Many financial institutions have been preparing for a potential rate increase, but it is still a valuable exercise to look at funding opportunities that can help you take advantage of the status quo while preparing for a rise in rates in the coming months. For example, with a six-month floating-rate advance that changes to a three-year Fixed Rate Credit (FCR) Hybrid advance, you can benefit from the current low-rate environment while locking in a future fixed rate that will help protect net interest margins if rates rise later this year. Rate indications for this structure, as of the time this article was written, were three-month LIBOR plus 25 basis points for the floating-rate period and 1.72 percent for the fixed-rate term.
Mitigating Deposit Runoff
Financial executives have also been expecting a shift in the current deposit mix and migration to higher yielding assets in 2015. With tepid loan growth and interest rates holding steady through June, this shift has not occurred as expected, and many institutions remain flush with retail deposits. Given the extended low-rate environment, however, an increase in interest rates could create a potentially rapid shift as pent up demand for yield drives depositors to the exits. Competition for deposits may become more intense in a higher-rate environment.
Institutions that are anticipating significant deposit runoff can prepare by locking in an advance rate today with FHLBank Atlanta’s Forward Starting advance. This advance provides the opportunity to secure a known interest rate for future funding without taking on additional liquidity today. Any structured product can include a forward starting feature. The savings can be significant because interest does not accrue until the advance funds.
For example, compare a $5 million five-year FRC Hybrid advance borrowed today at 1.95 percent to a three-year FRC Hybrid at 2.55 percent with a two-year forward starting period. Total interest for the five-year advance at the lower rate would be $487,500, while total interest on the forward starting FRC Hybrid, funding at year three, would be $382,500 – a savings of $105,000.
Addressing Regulator Concerns
Banking regulators have also expressed concerns with interest-rate risk mitigation and deposit runoff given the current state of the economy and potential for rate changes in the near future. The FDIC detailed many of its concerns in its winter 2014 “Supervisory Insights” publication and provided checklists and other tips to help institutions prepare for examinations. According to the publication, the examiners look for evidence that institutions are planning for these challenges, including evidence that management and the board are engaged in interest-rate risk mitigation and assumptions used in financial projections are robust and regularly reviewed.
To help you position your balance sheet for potentially higher rates and lower deposit balances, your FHLBank Atlanta relationship manager can conduct a strategic funding review with your management team, ALCO, and board. During this review you can discuss advance options and opportunities to expand your borrowing capacity in preparation for market changes on the horizon.
For more information on strategies to mitigate interest-rate risk and manage deposit runoff, contact your relationship manager at 1.800.536.9650.
“Fed Says Rate Hike Still on Track for This Year,” Bloomberg, June 17, 2015.
“WSJ Survey: Economists Think Fed Won’t Raise Rates Before September,” Wall Street Journal, June 11, 2015.
“Supervisory Insights,” Federal Deposit Insurance Corporate, Vol. 11, issue 2. Winter 2014.
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. Rates are for illustrative purposes only and are as of the time this article was published.