Printable Version

May 19, 2009

By Kevin Martin, Vice President, Member Financial Strategies

During an 82-day period between mid-June and early September 2003, the five-year Classic advance rate increased by 170 basis points. Over the next three years, the federal funds rate rose 400 basis points and the five-year Classic advance rate increased by an additional 155 basis points or a total of 325 basis points.  During this period of rising rates many members saw their cost of funds rise dramatically as their deposit portfolios became increasingly weighted in the direction of CDs. Institutions saw their CD portfolios reprice several times during this period, resulting in an escalating cost of funds and tighter net interest margins. Long-term FHLB Boston advances are an effective tool to slow down the increase in your institution’s cost of funds in rising rate environments.

Since the credit crisis began in mid 2007, interest rates have fallen considerably. As shown in exhibit 1, the federal funds rate has fallen by 500 basis points and the five-year Classic advance rate has declined by almost 250 basis points. As some economic reports begin to show signs that the nation’s economic woes may be easing, institutions exposed to rising interest rates may want to consider lengthening their funding.

While most institutions have seen strong deposit growth since late 2008, many of these deposits are being “parked” there temporarily. When rates start to increase, much of the recent growth will probably seek higher returns elsewhere. And remember what occurred in mid 2003 — when rates rise, they can increase significantly in a very short time frame.

Of course, you would prefer to lengthen your funding through long-term CDs, but this generally requires offering a special at a premium rate. Even if some customers are willing to extend now, can you truly rely on this as long-term funding?  A relatively small increase in CD rates makes it possible for customers to earn more by paying the early withdrawal penalty and reinvesting at the higher rate.  Exhibit 2 illustrates how little rates have to increase in order for the CD customer to break-even. Note that if CD rates increase by more than 78 basis points, CDs with two or more years to maturity and rates of three percent or less are at risk of early withdrawal. Once Suze Orman publicizes this, the deposits you paid up for may very well end up being short-term funding at above-market rates.

When your institution needs long-term funding, HLB Boston Classic or Amortizing advances are readily available with maturities as long as 20 years with the assurance that you will have the funding until maturity. These advances contain no embedded options held by HLB Boston that would allow the Bank to cancel the advance prior to maturity. The five-year Classic advance rate is currently 3.15 percent or 63 basis points above its low of June 2003. It is an opportune time to evaluate your institution’s need for long-term funding through your interest-rate risk simulation model. When modeling rising rate scenarios, examine the impact if some of your recent deposit growth left the institution. If you have to replace it at higher rates, what is the effect on profitability? Locking in long-term funds at rates that are still low by historical standards might be the stabilizing force that could anchor your funding costs as the interest rate tide rises. Many institutions regret that they failed to lock in more funding, for longer maturities, six years ago.

Watch for long-term advance specials to be offered by the Money Desk over the next several weeks. In addition, members may qualify for lower-cost funding programs offered by the Bank that support housing and economic growth such as the Community Development advance and the FHLB Economic Stimulus advance. Please see the Housing and Economic Growth  section of the Bank’s website for more information on these programs.

Contact your relationship manager (888-595-8733) or the Money Desk (800-357-3452) with any interest or questions.