Prepare Now for Future Mortgage Production

Mortgage lenders with strong deposit bases may not face many challenges funding mortgage production, but those that hold long-term loans in portfolio still face interest-rate risk. Given the historically low interest-rate environment and recent volatility in the markets, now may be a good time to lock in an interest rate for term funding. How can a lender that’s flush with retail deposits balance its liquidity and interest-rate risk management needs?

Prepare and Compete Later

  • Goal: Introduce new 10-year and 15-year fixed-rate mortgage portfolio product while managing interest-rate risk.
  • Solution: Forward Starting advance with two-year forward starting period and three-year fixed-rate period. Fund loans off deposits for first two years and take on advance funding at year three.
  • Result: Savings of $337,000 in interest expense on a $10 million advance compared to a traditional five-year Fixed Rate Credit Hybrid advance.

Case Study:
A small community bank in Athens, GA, has built a deposit base from its local municipality, as well as from individuals in the surrounding counties. It has a strong market presence that has allowed it to gather deposits and provide banking services to its clients. It has offered 3/1 and 5/1 ARMs, along with HELOCs, to meet the residential mortgage needs of its customers. With rates at historically low levels over the past several years, several of the institution’s competitors began offering 10-year and 15-year residential mortgage loans.

In 2014, the community bank’s management decided that it needed to revamp its mortgage loan offerings to retain existing customers and add new ones. To offer the longer-term loans that its residential customers were seeking, management had to become comfortable with a portfolio mortgage strategy.

While funding the loans was not a significant concern due to its strong depositor base, the interest-rate risk that these loans would generate was an issue. How could the bank offer competitively-priced term mortgage loans without exposing itself to a significant increase in interest-rate risk?

The management team decided to use a Forward Starting advance from FHLBank Atlanta to help offset the interest-rate risk generated by the pool of longer-term loans. They identified the interest-rate exposure of this new loan program to be at the five-year mark. Instead of borrowing a traditional five-year Fixed Rate Credit advance and placing the funds on its balance sheet today, the bank borrowed $10 million using a two-year forward starting, three-year Fixed Rate Credit Hybrid advance. This gave their management team the ability to lock in a three-year fixed-rate advance at today’s funding costs, but not actually place the funds on the balance sheet – or incur interest costs – for two years.

The community bank will fund the pool of fixed-rate mortgages for the first two years from its robust deposit base, and then at the end of the two-year mark, will automatically receive the advance funds at a rate negotiated up front with FHLBank Atlanta. The rate on the Forward Starting advance is 2.46 percent, which is 31 basis points above the rate on a five-year Fixed Rate Credit Hybrid advance. However, since the Forward Starting advance is only funded for the last three years, the total interest cost is $738,000, which represents a $337,000 savings over a five-year Fixed Rate Credit Hybrid advance.

Strategic Benefits of Forward Starting Advance

  • Compete for Members: Offering an intermediate-term fixed-rate portfolio product for which the funding and pricing are fixed for a known time provides loan officers the opportunity to retain existing customers and attract new ones.
  • Keep Costs Low: The forward starting feature enables institutions to leverage a strong deposit base to fund the first three years of the pool, then use an advance negotiated at today’s low rates to fund the next two years. Because the advance is on the balance sheet for less time than a traditional advance carrying the same term, total interest cost is significantly lower.
  • Lock in Interest Rate Protection at Today’s Lower Rates: Locking in funding at today’s lower rates can potentially help mitigate interest-rate risk at the five-year mark when management was most concerned about its exposure.
  • Achieve Portfolio Growth: The bank has the opportunity to grow its loan portfolio 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.

FHLBank Atlanta is the NAFCU Services Preferred Partner for Credit Union Liquidity and Financing Services. Learn more about our Preferred Partner by visiting


Funding Strategies for a Fluctuating Market

By: Dan Brenton, Senior Relationship Manager, and Todd Wacker, Regional Sales Coordinator, for Federal Home Loan Bank of Atlanta.

Interest rate volatility, persistent net interest margin pressures, and continued global economic weakness highlight the critical need for credit unions to evaluate their balance sheets and establish a strategy for the future.

So how can credit unions prepare for whatever the economic environment brings them? At the Federal Home Loan Bank of Atlanta, we collaborate with our members to develop strategies based on their institution’s profile and strategic goals.

In our most recent webinar, we talked through four real customer profiles and the customizable advance structures that helped them manage interest-rate risk, compete for lending opportunities, and boost profitability:

Profile 1: Incremental Hedgingprofile-1

A credit union with more than $4 billion in assets achieved double-digit mortgage growth over a four-year period through heavy advertising and a low-cost pricing strategy. The credit union’s mortgage portfolio included 15- and 30-year fixed-rate mortgages, with weighted-average life of 5 years and 6.5 years, respectively, as well as ARMs up to 10/1. The institution was seeking to hedge the interest-rate risk of holding fixed-rate mortgages in portfolio, while continuing their track record of growth.

Solution: Provide a ladder of Fixed Rate Credit (FRC) advances with maturities of three, five, and seven years. With an initial blended funding cost of 1.59 percent and weighted-average life of 5.8 years, the FRC ladder provided an incremental hedge to the institution’s fixed-rate loan production. When each advance matured, the credit union could roll over the advance or pay it off, based on the payoff behavior of the mortgage portfolio and volume of new originations.

Benefits of FRC advance:

  • Manage risk with fixed-rate funding through stated maturity
  • Maturities of one week to 20 years
  • Alternative to issuing CDs

profile-2Profile 2: Minimize Hedge Cost

A credit union with more than $5 billion in assets and a growing residential mortgage portfolio was seeking ways to obtain interest-rate risk protection while minimizing hedging costs. The institution used a combination of CDs, brokered deposits, advances, swaps, and caps to hedge balance sheet risk. With a liquidity ratio of 22 percent, the institution was not seeking to add funding to the balance sheet immediately.

Solution: Provide a five-year Fixed Rate Credit Hybrid advance with a two-year forward starting period. With this advance, the credit union could lock in a fixed interest rate on the advance immediately without taking on funding or paying interest costs until after year two. This structure reduced total interest costs compared to a seven-year FRC Hybrid that funded immediately while still providing an effective hedge against a potential rise in rates in the future.

Benefits of forward starting FRC Hybrid advance:

  • Fixed rate determined today
  • Interest payments begin after forward starting period ends
  • Symmetrical prepay – ability to capture positive net present value in an up-rate scenario

Profile 3: Matching Off Risk of Long-term Loans

Our third scenario involved a credit union with assets between $500 million and $1 billion with loan growth between four percent and 14 percent over the past five quarters. The credit union serves an affluent customers base and has an average loan size of more than $300,000. They were seeking a funding strategy to match-fund portfolio mortgages while reducing interest-rate risk.

Solution: Deliver a 15-year fully amortizing advance at a rate of 1.97 percent, enabling the institution to match projected principal reductions and lock in the interest rate spread over a 15-year term. To manage payoff risk, the amortizing advance can also be structured with a one-time call option.

Benefits of amortizing advance:

  • Match loan amortization schedule
  • Flexible amortization: straight-line, mortgage style, or custom; interest-only periods and balloons available
  • Add call option for even more flexibility and pass the cost of the call to the customer

profile-4Profile 4: Managing Liquidity Needs

Our final scenario centered on a $2 billion credit union with an 8.5 percent liquidity ratio and loan-to-assets ratio of 82 percent. The institution wanted to improve its liquidity ratio while minimizing funding costs.

Solution: Deliver a Callable Fixed Rate Credit Floater advance, which is a term advance that resets periodically to a predetermined FRC rate (monthly, quarterly, semiannual, or annual). The structure reduces borrowing costs by providing long-term funding at short-term interest rates. See below for an example:

Benefits of Callable FRC Floater advance:

  • Reduce costs by accessing term funding at short-term rates
  • Maximize balance sheet flexibility with the callable feature

As the market continues to fluctuate and economic realities affect your strategic plans, work with FHLBank Atlanta to ensure your funding strategies match your institution’s profile and strategic outlook.

For more information on “Funding Strategies for a Fluctuating Market” and to hear real customer case studies, watch the full webinar here.

FHLBank of Atlanta is the NAFCU Services Preferred Partner for Credit Union Liquidity and Financing Services. More information and education resources can be found here