The Forward Starting Advance - a solution against rising interest rates
posted on Friday, March 31, 2017 in Advances
By Brandon Casey, Member Strategies
Even though the old adage states, "You can't have your cake and eat it, too," we think the FHLB Des Moines Forward Starting Advance lets you enjoy the best of both worlds.
While increasing interest rates can certainly bode well for future loan and investment yields, it's important to consider the negative impact a rise in rates can have on your cost of funds. The ever-present, less rate-sensitive non-maturity retail deposits may finally rise from historical lows. Managing this rise in your institution's cost of funds may prove problematic if rates were to shoot up rather quickly, limiting future net income.
FHLB Des Moines has a solution to protect against rising interest rates without being forced to take the funds today - Forward Starting Fixed Rate Advance (FSA).
The FSA allows you to lock in a fixed rate advance that will settle at a future date of your choice, up to two years. This allows you to lock in a rate for future funding, at a premium to our non-forward settling advances, which varies by the forward start term.
The FSA provides a number of benefits, including protection from a rise in interest rates, no requirement to receive funds before needed, and cost-certain funding.
How the Forward Start Advance Works
The FSA allows you to lock-in funding costs today and take settlement of the advance proceeds at some future date. The FSA does require credit and collateral capacity at time of trade, but the stock purchase is not required until settlement date. The premium on the FSA varies by both the forward settle length and the maturity term of the advance. Click here to see the comparison between a regular bullet advance and corresponding bullet FSA.
When entering into an FSA advance, even though you will not be receiving the funds on the trade date, you are making a commitment that is both mandatory and discrete. Thus, you must take the funds on the settlement date and the FSA does not allow for prepayment of the advance during the forward settle period. One day after settlement date, the settled advance can be prepaid and is subject to a prepayment fee calculated by the standard FHLB Des Moines methodology.
Potential uses for the FSA
Now to the question at hand, what are some reasons to use an FSA advance? The ability to lock in a rate not only hedges against the chance that rates could rise during the forward start period, but also offers both duration and cost-certain funding. This can be useful for a couple of different situations:
- Replacing maturing deposits or advances. If there are known maturing retail or brokered deposits, or advances, coming due, an FSA will allow you to secure funding closely resembling today's cost. This is an ideal tool to use during times when rates are expected to significantly increase or the premium to forward settle the advance is immaterial or low relative to settling the advance today.
- Another use for the FSA is to lock in cost-certain funding for an upcoming construction project or securities purchase. If the project were slated to start six months from now and funding is needed, using an FSA allows you to confidently set a borrowing rate based on the FSA rate and add additional spread to attain the net interest margin you are hoping to achieve. This helps avoid situations in which you commit to a rate for a customer and then either unnecessarily execute on funding now, or wait and hope rates don't move higher and diminish your targeted net interest spread.
Benefits of Borrowing from FHLB Des Moines
There are many benefits to borrowing from FHLB Des Moines, aside from the usual highlights of size discounts and the 3.50% dividend received on activity stock. A minimum advance size of $100,000 allows any institution to take advantage of an FHLB Des Moines advance. For institutions unable to enter in derivatives contracts, an FSA is a great alternative to lock in a rate instead of using a forward settling swap. Additionally, another perk of borrowing from FHLB Des Moines is the ability to use eligible collateral. If you have collateral that is unable to be pledged elsewhere, take a look at pledging it to FHLB Des Moines to collateralize potential advances.
The FSA is an ideal tool for any size institution looking to acquire future dated, cost certain funding. If you need future dated funding and you are of the belief that there will be significant increases in interest rates, contact us to lock in your funding needs today.
Enjoyed this whitepaper? Check out the article, How to Use Letters of Credit to Your Advantage.