Positioning Your Balance Sheet for the Future
January 2014 - The Federal Reserve recently announced that it will begin tapering its ongoing asset purchase program (QE3) in January 2014. While the Fed also indicated its intent to keep short-term interest rates at a near-zero level, the tapering of QE3 and an increasing strengthening global economy could lead to an increase in long-term interest rates.
In anticipation of this transition, it is now a strategically advantageous time for financial institutions to determine if their balance sheets are positioned for the future. An ideal asset/liability management approach includes funding that capitalizes on today's historically low interest-rate environment and provides protection against a rate spike in the future. FHLBank Atlanta's Floating-to-Fixed advance is an excellent option to help institutions achieve this balance. Floating-to-Fixed advances can provide a short-term boost to net interest margins and establish a hedge against higher rates in the future.
The initial interest rate for a Floating-to-Fixed advance floats based on a specified index – typically three-month Libor. At a predetermined date, the advance rate changes to a fixed interest rate until maturity. At the time of borrowing the advance, the institution has the flexibility to set either the floating rate or the fixed rate. The borrowing institution can also determine the date the advance rate changes from floating to fixed.
Institutions with maturing fixed-rate term funding are well positioned to add new funding using the Floating-to-Fixed structure. Additionally, institutions with longer term fixed-rate advances on the books are not necessarily "locked in." Depending on an institution's balance sheet position, restructuring a fixed-rate advance into a Floating-to-Fixed can reap immediate rewards.
BrandBank, the oldest locally owned bank in Gwinnett County, Georgia, successfully repositioned its balance sheet with a Floating-to-Fixed advance, increasing earnings and creating a hedge against higher rates in the future. Robert Cochran, chief financial officer of BrandBank, joined the $1.7 billion institution in 2011 and found a balance sheet that was asset-sensitive with fixed-rate funding on the liability side. This "counterintuitive" position was limiting the bank's earnings potential while exposing it to undo risk.
"We needed to right-size the asset/liability position while maintaining a focus on earnings and reducing interest-rate risk," said Cochran.
At the time, BrandBank's FHLBank Atlanta funding included a Fixed Rate Credit (FRC) advance at 1.54 percent maturing in 2015. Cochran believed that is was important to move this funding off the books, but prepaying the advance would have generated a significant loss. BrandBank worked with FHLBank Atlanta to restructure the fixed-rate funding into a Floating-to-Fixed advance in July 2012.
At the time of the restructure, the forward curve indicated pricing of 1.11 percent for a four-year FRC. The Floating-to-Fixed structure allowed BrandBank to exchange its existing funding for floating rate, secure a low, fixed rate for the latter part of the advance term, and push out its loss on the original FRC advance. In addition, BrandBank bought down the initial 24-month floating rate of the advance to 3-month Libor minus 25 basis points, essentially providing interest-free funding for the first year.
"The Floating-to-Fixed advance provided benefits to us on day one," said Cochran. "We had below market-rate funding, which helped increase earnings, and the long-term benefit of a known fixed rate to help us manage interest-rate risk."
One year later, rates had increased and the forward curve indicated a rate of 1.54 percent for a four-year FRC advance. The net present value of the loss on BrandBank's original fixed-rate funding had declined by more than two thirds. The buy down of the floating rate had also provided an additional $25,000 in earnings for the first year of the advance. In total, Cochran says that BrandBank saved a quarter of a million dollars by restructuring into the Floating-to-Fixed advance versus prepaying the FRC in 2012. BrandBank paid off the advance in July 2013 but continues to hold another Floating-to-Fixed advance on the balance sheet.
"The Floating-to-Fixed advance turned out to be the perfect fit for us. It helped our earnings, reduced the loss on our fixed-rate advance, and hedged interest-rate risk on the back end." said Cochran.
Cochran notes that this recent experience is but one example of how FHLBank Atlanta helps institutions manage interest-rate risk by offering the right products.
"It's difficult to manage rate risk through your retail customers," said Cochran. "FHLBank Atlanta products are very effective at filling the gaps in our asset/liability management plan."
For more information on how FHLBank Atlanta can help your institution manage its balance sheet, contact your relationship manager or the funding desk at 1.800.536.9650.
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