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A Look at Net Present Value Impacts of Fixed-Rate Advance Funding

May 2014 - Markets remain uncertain as to when interest rates will rise and how fast. In March 2014, Federal Reserve Chairwoman Janet Yellen indicated that the Fed might begin tightening as soon as six months after the termination of the current asset purchase program, which is on pace to conclude this fall. Based on this guidance, the Fed could start increasing rates in March 2015. 

Furthermore, the recent Fed speak has resulted in renewed focus of bank regulators. Financial institutions are now looking at how to position their balance sheets to manage these potential risks.

Shareholders often ask about the borrowing activity of their peers. Since the beginning of 2013, FHLBank Atlanta shareholders have borrowed approximately $3 billion in advances with maturities ranging from three to seven years. The common motive for new advance borrowing is to protect against the tail risk of the medium- and long-term assets financial institutions keep on their balance sheets. This has evolved into a strategy of layering some protection through advances while keeping blended funding costs low with low-cost deposits. 

Interest rates for FHLBank Atlanta’s fixed-rate funding remain near historical lows. Below is a sample of rates for Fixed Rate Credit (FRC) Hybrid advances with three-, five-, and seven-year maturities.

Term

Rate

3-year

1.12%

5-year

1.98%

7-year

2.63%

As of 4/25/14

As shareholders consider borrowing additional fixed-rate funding to manage interest-rate risk, it is important to look at how different interest rate scenarios may affect financial statements. For example, what kind of impact would borrowing $1 million of three-year, five-year, or seven-year fixed-rate funding have on financial statements under various interest rate shocks? 

The charts below show the estimated net present value (NPV) of a $1 million FRC Hybrid advance with maturities of three years, five years, and seven years in +100 basis points and +200 basis points shock scenarios over three time frames: today, six months from now, and one year from now.

Net Present Value of $1 million FRC Hybrid: +100 bps Interest Rate Shock

$1 MM FRC Hybrid NPV +100 BPS Shock

Parallel Shock + 100 bps

Today

6 months

12 months

3-year FRC Hybrid

$27,700

$26,400

$24,400

5-year FRC Hybrid

$48,600

$47,600

$44,900

7-year FRC Hybrid

$66,300

$65,000

$62,700

 

Net Present Value of $ 1 million FRC Hybrid: +200 bps Interest Rate Shock

$1 MM FRC Hybrid NPV +200 BPS Shock

 

Parallel Shock + 200 bps

Today

6 months

12 months

3-year FRC Hybrid

$55,300

$52,800

$48,200

5-year FRC Hybrid

$97,200

$95,300

$89,900

7-year FRC Hybrid

$132,600

$130,200

$125,300

Example – Five-year FRC Hybrid

Borrowing a $1 million five-year FRC Hybrid advance could hedge against 15-year fully amortizing loans, or a seven-year balloon loan on 15-year amortization. Under a parallel shock assumption of +200 basis points today, the advance would gain approximately $97,200 in NPV.

Given the nature of accounting for advances, the NPV will only affect the financial statements if the advance is prepaid. Typically, advances are treated similarly to held-to-maturity securities, where the quarter-to-quarter NPVs have no effect on the equity portion of the balance sheet. However, if the advance is prepaid, the NPV would flow through the income statement, offsetting negative marks associated with holding long-term assets. FHLBank Atlanta limits the realizable gain to 10 percent of the advances principal amount, although gains above that may be recaptured through restructuring the advance. 

Fixed-Rate Funding Short- and Long-Term Benefits:

Fixed-rate funding interest rates near historical lows

Potential realizable gain in up-rate scenarios

No hedge accounting

Manage interest-rate risk on the asset side of balance sheet

Defensive strategy for future deposit runoff

 

For more information on how FHLBank Atlanta’s fixed-rate advances can help you reduce funding costs and manage interest-rate risk, call your relationship manager or the Funding Desk at 1.800.536.9650, extension 8011.

 

Consult your accounting advisor as to the treatment of the NPVs on your financial statements. 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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