Planning for the Future
The forward-starting fixed-rate bullet advance is designed to help members mitigate the impact of rising interest rates by letting them plan ahead for their future liquidity needs based on current interest rates. Simply put, a member executes a rate commitment for a fixed-rate bullet advance today that would start in the future. The advance combines a forward-rate commitment during the initial “forward-starting” period, followed by a fixed-rate bullet advance after settlement. The advance rate is determined at the time of the commitment.
With the forward-starting advance, FHLBI can offer much longer rate commitment periods – up to three years – so members benefit from the current low interest-rate environment without adding immediate liquidity. In comparison, the forward settlement commitment for a standard fixed-rate bullet advance with a term of one year or longer is capped at five business days. Further, the member pays no interest on the forward-starting advance until the fixed-rate bullet advance is funded. And because all pricing, hedging, and funding costs are built into the forward-starting advance rate, there are no associated up-front costs.
Current interest-rate spreads indicate that timing may be right to consider a forward-starting advance. One way FHLBI evaluates the attractiveness of the forward-starting advance is by analyzing the change in the spread between the 2-year Treasury yield and the 10-year Treasury yield. From January 2010 through the end of April 2015, the Treasury yield curve has flattened and the 2-year/10-year spread is at – or close to – period lows. Typically, a flatter yield curve will result in a less expensive forward-starting advance. While the absolute rate environment and the length of the forward settlement do play a role in the pricing of the forward-starting advance, we have not seen a better time in the recent past to consider the potential benefits of the forward-starting advance.
How it works
Here's an example of how a forwarding-starting advance works.
An FHLBI member’s customer needs a $5 million loan to construct a small retail store and provide permanent financing following construction. The customer, expressing concern about rising interest rates, asked about locking in the fixed rate on the permanent loan BEFORE construction begins. To meet the customer’s needs, the member would need to simultaneously fund a construction-to-permanent loan with a construction period of one year, and a permanent loan of five years. The illustration below demonstrates how a $5 million forward-starting advance with an initial 1-year commitment period addresses the customer’s need while saving the member money by becoming a 5-year fixed-rate bullet advance with a rate of 2.12%.
The FHLBI member knows that it could get a standard fixed-rate bullet advance offered at 2.04% for six years, with interest payments totaling $612,000. But what if instead the member borrowed the full amount in a variable rate advance offered at 0.44% for the construction phase and used the forward-starting advance for the permanent loan at the terms referenced above? Total interest expense for the six years would be $555,000, a nearly $60,000 savings. Considering that most members would not borrow the full $5 million at the beginning of the construction phase, the interest expense savings calculated here is conservative.
Members can also consider using the forward-starting advance to replace known deposit runoff or to fund expected loan growth on future dates using current rates.
If your institution is interested in learning more about the forward-starting advance, or any other FHLBI advance product, please call your account manager or contact the FHLBI Credit Desk at (800) 442-2568.
About the Forward-starting Advance (Available only in conjunction with a fixed-rate bullet advance)
- For an advance term of 2 to 5 years, forward settlement dates up to 1 year.
- For an advance term of 3 to 5 years, longer forward settlement dates may be available.
- An application will be required to specify terms.
- Actual advance rates will be set at the time of origination/commitment. A Confirmation of Mandatory Takedown Rate Commitment for Term Advance must be executed by two of a member’s authorized officers to confirm commitment and advance terms.
- Once a forward-starting rate commitment is made, takedown on the forward settlement date becomes mandatory.
- A member will be required to collateralize of 10% of the principal amount of the advance. Upon settlement, customary collateral requirements per FHLBI’s Collateral Policy apply.
- Given the complexities of funding this product, FHLBI must receive a total of $5 million in requests to execute a forward-starting fixed-rate bullet advance.