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Banking
Services
A small agricultural bank faced heavier loan demand in the spring and summer when many of its customers made capital expenditures for the growing and harvest seasons. To ensure it had adequate liquidity to meet customer needs, the bank used the Cash Management Advance (CMA) which provides adjustable-rate overnight funding. CMA advances can be obtained and repaid regularly, similar to a line of credit. Using the CMA allowed the bank to meet customers needs without gathering additional retail deposits to address only a short-term seasonal cash requirement.
Short-Term, Fixed-Rate Advance
Serving a community with a strong economy, a local bank was experiencing increasing commercial and mortgage loan demand while its deposit base was growing at a much slower pace. To ensure it could readily meet loan demand, the bank secured three-month, fixed-rate advances from the Federal Home Loan Bank of Seattle. While it revised its deposit pricing in an effort to attract new funds, the advances allowed the bank to fund loans until deposits reached the desired levels. The benefits of using advances for this purpose were the immediate availability of funds and control over the amount and term of the borrowing.
A customer retained an excess cash position during its 6-month, off-peak loan demand period in order to meet anticipated strong seasonal demand. Returns on these liquid assets were insufficient to meet the customers return-on-equity targets at yearend. By planning to blend deposits with a strip of attractively priced 2- and 3-month Auction Advances during peak demand periods, this customer was able to replace cash instruments with higher-yielding loans and securities. Shareholders benefited from stock appreciation, while the community continued to benefit from a reliable and competitively priced source of funds.
A small community bank held its real estate loans in portfolio, and maintained a loan-to-deposit ratio of 70 percent or higher. Concerned about the interest rate risk in its long-term mortgages, the institution uses fixed-rate advances to balance its asset/liability mix. Management developed a financial model of its mortgage portfolio and, estimating prepayments and other factors, determined the desired funding mix. The bank now meets its funding needs that cannot be satisfied through retail deposits with Federal Home Loan Bank funding, generally through 5-, 7-, and 10-year advances. Advances reduced the interest rate and prepayment risk sufficiently to permit the bank to provide home financing, particularly nonconforming mortgages, in its rural market.
Amortizing Advances were the ideal funding source for long-term mortgage loans originated by a mid-sized savings institution. The lender funded 15- and 30-year, fixed-rate mortgages with strips of 5-, 7-, and 10-year Amortizing Advances, assuming the mortgages will prepay. By better matching the funding source with the cash flow of principal and interest, these advances reduced the interest rate and prepayment risk sufficiently to permit the bank to provide home financing, particularly fixed-rate mortgages.
A small savings bank had a sizable portfolio of small business loans that carried adjustable interest rates tied to the Prime rate. The bank used five-year Guaranteed Spread Advances also tied to the Prime rate. With the advance rate and the loan rate pegged to the same index, the spread remained constant through the term of the advance, ensuring the profit margin was secure as long as the loan was outstanding. For this lender, access to Prime-based funding enabled it to provide credit at the terms and pricing demanded by its small business customers, while minimizing its interest rate risk.
A financial institution used Callable Advances to fund specific assets on its balance sheet. For example, it used a three-year, $5 million Callable Advance to fund its three-year adjustable-rate mortgage program. Since there is little or no prepayment fee for paying off the advance early, the structure of the Callable Advance is well suited for mortgage loans which tend to be repaid prior to maturity. This allows the lender to reduce the principal on the advance on a semi-annual basis by the amount of paydowns actually occurring. The Callable Advance helps institutions guard against prepayment and interest rate risk.
A customer with a neutral interest rate risk position wanted to reduce its liability costs. The institution had strong loan demand and a loan-to-deposit ratio nearing 90 percent. It used a $5 million fixed-rate Putable Advance with a 5-year term and a 3-month lock-out priced at 59 basis points below the comparable 5-year Treasury rate. The customer was comfortable with the 5-year final maturity, noting that the 5-year average yield on 1-,2-,3- and 5-year CMT were all higher than the funding cost for the Putable Advance. The customer was also comfortable with the possibility of the Seattle Bank terminating the advance after three months, as the institutions overall balance sheet would benefit from rising rates and/or a steepening of the yield curve. The customer would then have the option of utilizing another of the Seattle Banks funding services or participating in another putable offering.
Letter of Credit
A financial institution used a Letter of Credit from the Federal Home Loan Bank of Seattle to enhance the credit rating on bonds issued by a state housing authority. The housing authority was issuing bonds to fund the development of an assisted-living center for senior citizens. The Letter of Credit conferred a AAA rating on the bond issuance, reducing the risk for the investors. The Federal Home Loan Bank customer earned fee income for pledging the Letter of Credit.
A savings bank had a negative gap and wanted to reduce its overall asset/liability mismatch by lengthening its liabilities. Due to capital constraints, the bank could not grow its balance sheet by assuming additional liabilities. As an alternative, it entered into a three-year Interest Rate Swap in which it paid a fixed interest rate and received a variable rate interest payment based on the three-month LIBOR rate. Using this Interest Rate Swap extended the banks liabilities by three years, and helped protect it from interest rate risk.