Meeting Borrower Needs and Fueling Portfolio Growth with Mortgages
Part 1: Blended Funding Can Support Your Competitive Positioning
Earning and maintaining the business and trust of key clients is more important than ever in the competitive banking landscape. With the tight underwriting standards associated with today’s secondary market, meeting the mortgage-related needs of these individuals can be challenging. The ability to offer a portfolio mortgage product enables you to serve clients who may not fit the typical secondary market borrower profile or who place value on a local relationship.
A second key benefit of portfolio mortgage lending is the ability to generate asset growth or take advantage of market conditions. In the 2015 FHLBank Atlanta Shareholder Outlook Survey, 55 percent of respondents stated that they expect residential mortgage lending to be their largest revenue driver over the next 12 months. Using all available funding options can be critical to winning the mortgage business of key clients and maintaining a profitable mortgage loan portfolio for your institution. FHLBank Atlanta’s mortgage-friendly advance solutions may enable you to structure and fund portfolio mortgage strategies to fit your institutional goals.
The following example – the first in a three part series – demonstrates how a funding strategy that blends deposits with FHLBank Atlanta fixed-rate advances can help an institution grow its mortgage portfolio while managing interest-rate risk.
Blend and Compete Now
- Goal: grow residential loan portfolio while managing interest-rate risk
- Solution: 50/50 blended funding with deposits and Fixed Rate Credit advance ladder
- Results: initial loan spread of 2.46 percent with flexibility to rebalance funding mix to match loan payoff behavior
A traditionally run community bank in Sarasota, Fla., has grown organically and serves the personal and commercial banking needs of its clients. Until recently, the bank sold most of its residential loans through brokers, keeping in its portfolio only those mortgage loans that fell outside of secondary market parameters. In 2015, the bank elected to start growing its loan portfolio by holding more of the residential loans being originated. Management was comfortable with the credit risk of the bank’s customers because of the long-term nature of these relationships. However, interest-rate risk was a concern given the low market rates over the past several years.
In implementing its strategy, management decided to first designate a specific loan product for the bank’s portfolio then develop a hedging strategy of both core and non-core funding sources. They decided to use a blend of Fixed Rate Credit advances from FHLBank Atlanta with low-cost deposits already on the balance sheet.
Management then provided the bank’s loan officers $20 million of 15-year, fully-amortizing residential mortgage funds to be priced at 3.50 percent to clients. In order to hedge the interest-rate risk of these loans, the bank took out a ladder of Fixed Rate Credit advances to provide funding for 50 percent of the loan pool, with the other 50 percent coming from deposits (Fig.1). Specifically, it used a 3-year advance with at an interest rate of 1.18 percent, a 5-year at 1.58 percent, and 7-year at 1.99 percent, resulting in a weighted-average rate of 1.583 percent for the advance-funded portion of the pool. For the other 50 percent of the pool, the bank used deposits at a cost of 50 basis points.
The total pool had a funding cost of 1.042 percent on day one, providing an initial spread of 2.46 percent. The advances mature every two years, giving the bank the option at each maturity to renew the advance or to pay it off, based on the behavior of the portfolio. If the mortgages are paying off more slowly than expected, then the advances can be recast and extended; if the loans are prepaying, then the advances can be repaid, and a higher percentage of deposits will comprise the funding mix.
Strategic Benefits of Blended Funding
- Serve Key Clients: Offering an intermediate-term fixed-rate portfolio product enables institutions to provide a competitively-priced, flexible alternative to small-business owners and other clients who may fall outside of the typical secondary market profile.
- Keep Costs Low: Mixing advances with current deposits provides a low-cost source of funding for the pool, allowing institutions to offer a competitive market rate on the pool of 15-year mortgages.
- Mitigate Interest-rate Risk: Taking down a series of advances with staggered terms enable borrowers to lock in low-cost funding, then extend the terms based on the behavior of the portfolio and their funding needs.
- Achieve Portfolio Growth: Institutions have the opportunity to grow their loan portfolios by attracting high-quality mortgage business from both existing and new clients at yields more attractive than other investment alternatives.
- Easy to Explain: The strategy is easy to explain to regulators, ALCO, or the board of directors. The advances are similar in nature to certificates of deposit.
For more information on how your institution can structure a blended funding strategy, call your FHLBank Atlanta relationship manager at 1.800.536.9650.
Next Up: Part 2 in our series on mortgage portfolio funding will highlight the Forward Starting advance and the benefits of locking in a fixed rate today to fund future mortgage production.
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. Interest and advance rates presented in this article are for illustrative purposes only.