Industry observers are beginning to note that loan growth has increased and deposit growth has slowed. An article from Reuters entitled “U.S. Banks Get Ready for the Day When Deposits Shrink” by Peter Rudegeair and Carrick Mollenkamp highlighted the fact that regulators are encouraging banks to begin considering strategies for dealing with an outflow of deposits. The authors further state that banks find it difficult to model expected changes in depositor behavior since rates are close to zero, and money can move much more quickly by using online and mobile banking channels to transfer money relative to previous low deposit rate periods. The duration of bank deposits will be much shorter when short-term rates begin to rise. At the same time, the durations of assets will lengthen as depositories begin originating more loans. In light of these issues, more focus has been given to balance sheet funding.
Furthermore, and important for institutions funding longer-duration assets, we saw a significant increase in longer-term rates.The idea of tapering became an important concept to most individuals that follow the capital markets and refers to when the Federal Reserve will begin reducing its bond-buying programs. Market expectations surrounding tapering had a significant impact on longer-term rates in 2013. The indicative 10-year Treasury rate, for example, fell as low as 1.63 percent at the end of April 2013 only to rise to 3.00 percent on September 5. However, on September 18, the Federal Reserve indicated that bond buying would continue and that it planned to re-evaluate tapering in future meetings. That sent the 10-year Treasury lower, and it has continued to decline as expectations surrounding future tapering subside.
Thanks to the concept of tapering, we have been given a clear signal that intermediate-term and longer-term interest rates will be headed higher when tapering begins or as the expectation for tapering reignites.
Fixed-rate bullet and bullet variations
As our members evaluate ways to mitigate liquidity risk or interest rate risk, FHLBI stands ready to provide assistance. The FHLBI offers a variety of advances products to meet our members’ funding needs. Given the necessity to extend liability duration and the fact that we likely know where intermediate and long-term rates are headed when talk of tapering reignites, it may be time to consider one of the simplest FHLBI products, the fixed-rate bullet. The fixed-rate bullet is available with terms up to 10 years (longer maturities may be available) and is used by members to provide protection against rising interest rates, funding loan originations or to support asset purchases. Fixed-rate bullet advances are always available in the exact amount and term needed. The FHLBI does not have the ability to “call” the advance or renegotiate the rate, and that certainty cannot be undervalued relative to future expectations of depositor behavior and interest rates.
FHLBI also offers variations of the fixed-rate bullet advance. The callable advance allows members to obtain a fixed-rate bullet advance with an option to prepay the advance on predetermined dates. The callable advance would be priced higher than a fixed-rate bullet advance with the same term, but members have the option to prepay the advance without penalty on certain dates and “reset” their liabilities if rates have acted differently than expected. Many depository members have a significant amount of optionality on the asset side of the balance sheet. Depositories offer free options to members when issuing residential mortgage loans and auto installment loans but own few, if any options, on the funding side.
FHLBI frequently provide members with fixed-rate bullet advance opportunities with maturities ranging from 1 year to 10 years. Often, specials include option-embedded structures, helping to remind members about the different alternatives available to them as they consider balance sheet funding alternatives.