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 Hedging
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 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 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.