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The Floating-to-Fixed Advance: Helping Shareholders Maximize Short-term Margins and Protect Against Future Rate Increases

July 2013 - As the economy and housing market show signs of longer-term stability, policymakers and economists are pointing toward a potential increase in short-term interest rates beginning in late 2014. With the prospect of higher rates on the horizon, many FHLBank Atlanta shareholders are looking for funding solutions that will enable them to take advantage of the current low-rate environment while protecting net interest margins against future rate increases. FHLBank Atlanta offers many advance structures that can help shareholders mitigate interest-rate risk, including the Floating-to-Fixed advance.

The Floating-to-Fixed advance allows shareholders to take on fixed-rate protection while minimizing the impact to current funding costs. The advance’s interest rate initially floats at a spread to Libor, and then, at a predetermined time, changes to a known fixed rate for the remaining term. There is no optionality in the advance, so the shareholder cannot elect to keep the advance at a floating rate beyond the predetermined date. For added flexibility, the shareholder can select the spread to Libor for the floating period or the interest rate for the fixed period, and FHLBank Atlanta will determine the other value. The shareholder can also select the date the advance rate changes from floating to fixed.

The following example demonstrates the asset/liability management benefits of a five-year Floating-to-Fixed advance compared to a Fixed Rate Credit Hybrid advance. The advance is structured to float for two years at a rate equal to three-month Libor then change to a fixed rate of 2.16 percent for the remaining three years of the term.

Compared to a five-year Fixed Rate Credit Hybrid advance at 1.45 percent, the Floating-to-Fixed structure enables the shareholder to maximize margins and minimize the cost of carry in the short term. Additionally, because the fixed rate is known, the shareholder can take advantage of current long-term rates and protect against a future increase in rates in years three through five.

Floating-to-fixed Chart one

The Floating-to-Fixed advance is one of several advances FHLBank Atlanta shareholder FineMark National Bank & Trust uses to support its asset/liability management strategies. The $600 million Florida-based bank currently has a five-year Floating-to-Fixed advance on the books to help mitigate interest-rate risk.

“We plan as best as possible to mitigate rate risk,” said Brian Eagleston, chief financial officer for FineMark National Bank & Trust. “The Floating-to-Fixed advance allows us to take advantage of low rates now and lock in a known rate for the future. If rates go up, we will be protected.”

The Floating-to-Fixed advance is one key piece of FineMark’s asset/liability management toolkit, which also includes a Forward Starting advance, a Fixed Rate Credit Hybrid advance with an embedded interest rate cap, and several Principal Reducing Credit advances with custom amortization schedules.

“FHLBank Atlanta has been a great resource for our asset/liability management,” said Eagleston. “They provide funding solutions, such as the Floating-to-Fixed advance, that we cannot find anywhere else.”

Custom Options The Floating-to-Fixed advance also offers customization options to allow shareholders to use the advance for numerous purposes, from competing for commercial real estate loans to hedging risk associated with construction-to-permanent loans.

As a hedging tool for a construction-to-permanent loan, the Floating-to-Fixed advance locks in funding in today’s rate environment but allows the shareholder to tailor payments on the advance to mimic those of the two separate periods of the construction-to-permanent loan.

The example below shows a 12-year Floating-to-Fixed advance that floats for the first two years at a spread to three-month Libor, then is fixed for 10 years at 2.90 percent. The final portion of the advance is fully amortizing based on a straight line schedule. The advance’s reduction schedule can be set for a monthly, quarterly, semi-annual, or annual basis. The Bank can also match any custom reduction schedule, and the amortization can be set at straight line or mortgage style.

Floating-to-fixed with Straight Line Amortization

The Floating-to-Fixed advance also can incorporate an option to cancel. Adding this feature would give the shareholder the ability to cancel the advance should the borrower choose different terms on the permanent loan.

Other Terms Floating-to-Fixed advances can have final maturities of up to 20 years, or 20 years average life. The initial floating period can be as short as three months. The minimum advance amount is generally $1 million and same-day pricing generally requires a minimum of $5 million. A prepayment fee generally is equal to the Bank’s cost of unwinding the transaction, which can be either negative or positive to the shareholder. Interest is calculated on an actual/360 days basis and is payable monthly or quarterly.

For more information about how the Floating-to-Fixed advance can help you manage your institution’s asset/liability position, call your FHLBank Atlanta Relationship Manager.

© 2013 Federal Home Loan Bank of Atlanta, All Rights Reserved. 1475 Peachtree Street NE, Atlanta, GA 30309

Interest rates used in the article are as of June 14, 2013. 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.

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