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Long-Term Advances and Core Deposits: Funding Seasoned 30-Year Mortgages

June 13, 2016

The prolonged low-rate environment has been putting pressure on net interest margins. In combination with weak loan growth and strong liquidity you have few options but to hold some of your 30-year mortgage originations. You've been holding long-term mortgages for the past five years ̶ funding them short ̶ and the spread has helped your margin. ALCO is concerned about imminent rate hikes and wants to investigate locking in long-term advances to guard against rising short-term rates. The good news is that long-term advance rates are at levels that will allow you to maintain a reasonable spread for several years.

If you have been holding 30-year mortgages since the beginning of 2011, the average rate would be around 4 percent. We're going to blend some of your non-maturity deposits with long-term FHLB Boston advances to provide a stable earnings stream as rates rise. To use these non-maturity deposits to help fund the mortgages, it is important to complete a core deposit study to access pricing betas, decay rates, and a breakout of surge/non-surge balances. Most institutions find that the average lives of low beta, non-surge deposits provide an excellent funding source for long-term assets. Don't use surge balances or premium accounts to fund these long-term assets; instead, use low-beta, non-surge balances that react slowly to changes in interest rates. Let's take a look at a few alternatives.

Strategy 1 uses 20 percent each of three-, four-, and five-year Classic Advances, and 40 percent of low-beta, non-surge, non-maturity deposits. The initial spread at 2.84 percent is very stable as rates rise, declining only 21 basis points between the base case and up 300 basis points.



While the advances provide a stable spread, they are clearly more costly than the non-maturity deposits. Can we reduce the amount of advances without taking on too much exposure to rising rates?

Strategy 2 examines this approach by using 10 percent each of two-, three-, four-, and five-year Classic Advances and 60 percent of low-beta, non-surge, non-maturity deposits. The initial spread is higher than strategy 1 at 3.12 percent; and while it's more volatile than strategy 1 between the base case and an increase of 300 basis points, it only declines 45 basis points. NII of this strategy outpaces Strategy 1 in all rate environments.



Are you in a similar situation where your long-term assets to total assets has increased over the last several years and you haven't added any long-term FHLB Boston advances? We can model several funding ideas for you using your core deposits as a portion of the funding. Please contact me at or Office Phone icon 617-292-9644 to see what will work for your institution.



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