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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.

 

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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.

 

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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 kevin.martin@fhlbboston.com or Office Phone icon 617-292-9644 to see what will work for your institution.

 

 

 
 
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