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Advantages of Term Funding in the Current Market

July 2017 - Over the last 18 months, the extended low interest-rate environment and steep yield curve have driven demand for short-term advance borrowings from FHLBank Atlanta shareholders. However, current market movements may point to a shift in the rate environment and warrant a closer look at longer-term maturities.

In a widely expected move, the Federal Open Markets Committee raised the federal funds target interest rate by a quarter point in June to between 1.0 and 1.25 percent and announced detailed plans to begin reducing the central bank’s bond portfolio later this year. These moves indicate a tightening monetary policy, which may lead to higher borrowing costs for businesses and consumers.

Furthermore, during the spring, the yield curve flattened due to a rally in the long end of the curve and higher short-term interest rates. Markets in mid-May saw the spread between two-year and 10-year Treasuries converge to the narrowest level since just before the November 8 presidential election.

With potentially higher rates on the horizon, now may be an advantageous time for financial institutions to consider securing longer-term funding and obtaining protection against rising short-term and longer-term rates. 

Funding Options for the Current Rate Environment

Depending on an institution’s balance sheet, extending liabilities in today’s environment by locking in longer-term fixed-rate funding could be an advantage. With the flatter yield curve, the interest-rate premium for borrowing longer-term FHLBank Atlanta funding compared to short-term funding has declined.

Fixed Rate Credit

Rate differentials between 3-month and 18-month Fixed Rate Credit (FRC) advances narrowed between late March and late June along with the flattening of the yield curve. The table below shows approximate rates for these two maturities as of June 27, 2017, and March 31, 2017.

FRC Maturity

June 27, 2017

March 31,  2017

3 months

1.19%

0.93%

18 months

1.53%

1.53%

Rate Difference

0.34%

0.60%

                                                                                                        Rates are for illustrative purposes only

FRCs, including the FRC Hybrid, offer simple, yet effective ways to secure liquidity and manage interest-rate risk if short-term rates continue to rise.

For added flexibility and protection against exposure to higher short-term rates, shareholders can embed an interest rate option into an FRC Hybrid advance. The option price is included in the advance rate, and the advance rate decreases when LIBOR exceeds the interest rate cap specified in the advance structure. The option can be leveraged up to three times, which may provide protection for a greater portion of the balance sheet relative to the size of the advance. Furthermore, FRC Hybrid advances offer symmetrical prepayment, which may allow the advance to be prepaid at a gain in certain rising-rate scenarios.  

Convertible

Shareholders seeking to achieve potentially greater funding cost reduction may consider a Convertible advance. The Convertible advance offers fixed-rate funding in exchange for selling the Bank the option to cancel the advance at a future date. The option can be European (one time only) or Bermudan (at regularly stated intervals until maturity). The advance rate is reduced by the value of the sold option, and shareholders may achieve lower borrowing costs compared to a traditional FRC to the option date. However, shareholders bear the risk of holding above-market funding beyond the option date if the Bank chooses not to cancel the advance. 

Recent pricing indications for Convertible advances showing the savings compared to an FRC advance are below.

Term

Rate as of June 27, 2017

Savings

2-year FRC

1.60%

-

Convertible: 5-year/2-year European

1.43%

0.17%

Convertible: 5-year/2-year Bermudan

1.41%

0.19%

                                                                                                            Rates are for illustrative purposes only

Adjustable Rate Credit

If shareholders consider themselves to be asset-sensitive or believe that interest rates will remain flat, they may benefit from longer-term floating-rate funding. Interest rate differences for short- and longer-term maturities of FHLBank Atlanta’s Adjustable Rate Credit (ARC) advance have similarly narrowed in the last few months, as noted in the table below.

ARC Maturity (indexed to 3-month LIBOR)

June 27, 2017

March 31, 2017

6 months

1.24506%

0.97956%

18 months

1.32506%

1.17956%

Rate Difference

0.08%

0.20%

                                                                                                            Rates are for illustrative purposes only

 Common Uses and Benefits

 

Common Uses

Benefits

FRC and FRC Hybrid

Fund fixed-rate loans and investments, manage liquidity

Mitigate risk of holding long-term loans in portfolio

Symmetrical prepay (FRC Hybrid only)

Convertible

Provide liquidity, macro fund the balance sheet, manage asset/liability positions

Reduce funding cost relative to traditional FRC advances

ARC

Fund adjustable-rate loans, lines of credit, and investments

Manage interest-rate risk

 

Contact Us

To discuss funding strategies for today’s interest-rate environment, contact your FHLBank Atlanta relationship manager or the Funding Desk 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.

Sources:

Cox, Jeff. “Fed Hikes Interest Rates Despite Declining inflation, Sets Plan for Balance Sheet Reduction.” CNBC Web. June 14, 2017.

Smialek, and Condon, Christopher. “Most Fed Officials Saw Tightening ‘Soon,’ Favored Unwind Plan.” Bloomberg L.P. Web. May 24, 2017.

Chappatta, Brian. “Fed's Rate-Hike Odds Tumble After Washington Chaos Hits Bond Market.” Bloomberg L.P. Web. May 17, 2017.

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