How It Works: Symmetrical Prepayment Advance

How It Works: Symmetrical Prepayment Advance
0:01 
Hi everyone. Thank you for tuning in today. My name is Andrew Paolillo, and today, in this case study, we will be going through how one of our products works, the Symmetrical Prepayment Advance
.0:19 
So, what we'll do is take a look at some of the features and defining characteristics of this Advance, but also some potential applications and relative value that it may present.
0:29 
Before we do that, let's look at some of the basic features of this Advance, and as the header outlines, it is very similar to an advance that many of you are already familiar with, the Classic Advance. So if we look at the table below, it shows some of the characteristics of the Advance.
0:45 
All of those are identical to what the long-term Classic Advance affords, except for the last one on the bottom right, highlighted in blue in that in a rising rate environment, there is the potential to receive a prepayment credit by unwinding the Advance, and we'll take a deeper look at that in the following slide.
1:10 
So, as mentioned, the core value of the Symmetrical Prepayment Advance is what happens in a higher-rate environment.
1:18 
But before we get there, let's take a look at this generic example to see what both the Classic and the Symmetrical do in a lower-rate environment. And that will set the stage for moving to higher rates. So we look at this generic example down below of potential prepayment profiles in different rate scenarios.
1:39 
So, as we look to the left-hand side, we can see that if rates move down after initiating an Advance, then there will be a prepayment fee assessed. So and that is both for the Classic Advance and the Symmetrical, so you can see the lines are overlapping there. But as we shift towards a higher rate environment, we can see that the Classic Advance starts to flatten out. There's that green line, not rising as you move further and further to the right. And the Symmetrical is different, as the name implies in that you do have the potential to receive a prepayment credit to realize the market value of that liability, which, in a higher rate environment, would have significant value similar for our depository members - how your deposits, your low-cost deposits, have that much more value as interest rates move higher and higher.
2:40 
OK, so we've identified what the value proposition of the Symmetrical Advance is that if we were to take it out today, interest rates were to move higher in the future, then there would be a potential market value differential that could be captured if the Advance were to be unwound. But how is the advance price? So here is pricing from a little earlier in the month. And as you can see that the symmetrical prepayment advance is usually priced just two basis points above the classic Advance, so a very modest premium to get that flexibility to be able to capture the market value differential in a favorable rate environment.
3:28 
So when we asked the question, how and why would we use the Symmetrical Prepayment Advance? The answers to that question are going to be the same ones that you would ask yourself when using the long-term Classic Advance. So, it would be to manage liquidity risk or interest rate risk, either at the asset or group of asset level or even at the overall boundary level. But you'd be layering in some extra flexibility. As we talked about being able to efficiently collapse that Advance and reduce the amount of wholesale funding that you may need in the future, and given the path of interest rates, there may be opportunity to capture again. So let's look at an example.
4:12 
So along the left-hand side, we're doing some scenario analysis where we're using the current yield curve presently inverted as we sit here in April of 2023. And we're going to look at taking out a Symmetrical Advance at various tenors. Either two, three, four, or five years and we're going to shock interest rates, up 50, 100 or 200 basis points. And we're also going to look at it one year forward from the date of initiation. So as we can see, in all scenarios, there is a potential gain that could be realized in the shock scenario if you were to unwind the Advance. So to point out one example, if you were to take a five-year advance, interest rates go up 200 basis points. That's the light green bar there. We're rolling forward one year. So now there's four years remaining, that the potential gain would be 6.8%.
5:09 
So it's very similar to how things work in the bond portfolio. Wherever you buy a bond and rates go down, you'd have an unrealized gain that you could realize by selling the bond. So let's move over to the top right there, where we're looking at that the shape of the yield curve, as we mentioned, at present, it's inverted where short-term rates are higher than the rates when we move further out the curve. But we're also introducing an example of a hypothetical example of a positively or normally sloped yield curve. That's the dashed blue line, which we don't have right now. So going back to the bond portfolio side of things, there's a term that many of you are familiar with in terms of rolling down the curve. So that's where you buy a bond at a yield and absent any changes in interest rates. And just the passage of time, that there's going to be a mark-to-market gain there. Because you're going to be your higher yield is going to be getting judged versus a lower yielding point on the yield curve, again, through the passage of time.
6:21 
So when we think about how to look at liabilities in an inverted curve world, then that is where there's that opportunity to what we call roll up the curve. Where you can take the liability out at a lower rate, and then absent any changes in rates, you would see some potential mark-to-market gains. So, you know, we look, we look at the scenario analysis in the bottom right. And you and I apologize. I see the video is obscuring some portion of that, but you should be able to click on the PDF to see the full amount of details there.
7:03 
So when we run a scenario analysis for the Symmetrical using not the curve that we have today but the hypothetical, positively sloped yield curve that, we can see that the market value is different than when we look at what we have using the current rates along the left-hand side. So we can see that even in some of the in the up 50 scenarios that there isn't a again to be harvested. That is because of the rolling down the curve doesn't support the mark-to-market for a liability. It helps with the asset but not the liability. And as we get to have more and more interest rate shock, so looking at the up 200 cases, for example, there is a gain to be captured. But it pales in terms of the magnitude of what we see along the left-hand side, in the shocks, in the inverted curve.
8:08 
​So this is just to point out that the shape of the curve when it's inverted like this, can be favorable for the arithmetic, for the Symmetrical Advances, to capture those potential gains. So, if you're, if you're thinking about extending up the curve for balance sheet reasons, not necessarily the potential to capture gains in a rising rate environment.
8:38 
But if other things on your balance sheet are leading you to look at two, three, five-year Classic Advances as we kicked off with this slide initially, you know, take a look at the symmetrical because for two basis points extra, you can layer in some of that added flexibility that is nice to have if conditions change in the amount of funding that you may need, can change and you want to be able to reduce that amount in an efficient and cost-effective manner.
9:14 
Well, that brings us to the end of this case study here. I thank you very much for joining us, And if there's any questions you may have about this Advance or anything that we can be of assistance with, please feel free to reach out. My contact information is there. Or you can always reach out to your relationship manager, and we will be happy to assist in any way that we can. Thank you very much and have a great day.