By Jim Reber
Community banks just never seem to have enough floating-rate assets. Or is it fixed-rate deposits? Actually, statistically it’s both, especially in this extended low-rate setting.
Good news has arrived, in three shipments:
- Your community bank can convert its fixed-rate assets, such as commercial loans, to floating-rate assets.
- It can convert its floating-rate liabilities, such as Federal Home Loan Bank advances, to fixed-rate deposits.
- It costs less to do either than it has in many years, if not ever.
Why the opportunity? It’s a combination of regulatory burden (imagine!) on interest-rate swaps dealers and Systemically Important Financial Institutions, the flattening yield curve, and supply-demand vagaries. This is one area in which community banks benefit from Basel III and the Dodd-Frank Wall Street Reform Act. The efficiency of the interest-rate-swaps market is measured in swaps spreads, which numerically is the difference in a pay-fixed contract and the corresponding maturity Treasury.
Today, the five-year swap spread is negative, which means a community bank can borrow at a rate using a five-year pay-fixed-interest-rate swap that is lower than that at which Uncle Sam can issue a five-year note. This, needless to say, is highly unusual.
Swaps applied to commercial loans. You want to lend floating, and your customer wants to borrow fixed. Your community bank can enter into an arrangement whereby you both get your ways. It will swap the fixed-rate payment it receives from the borrower for a floating-rate payment with a third party, effectively reducing the duration to 90 days. The yield given up today will depend on the term of the loan, but all pay-fixed rates today are very compelling.
Swaps applied to wholesale deposits. A common source of funding is Federal Home Loan Bank advances. Today, 90-day floating-rate advances are available at about LIBOR plus 25 basis points. That sounds good now, but every 90 days that rate could be pegged higher. Perhaps it would be better for the long haul to lock in the fixed cost today. As of early June, it only cost about 58 basis points (0.58 percent) to effectively extend the advance from three months to five years.
Either way, a confluence of factors has presented community banks with an exceedingly rare opportunity. Whether you’re hedging your community bank’s lending risk, or lowering its cost of funds, interest-rate swaps put you in the driver’s seat.
Jim Reber (firstname.lastname@example.org) is president and CEO of ICBA Securities, ICBA’s institutional fixed-income broker-dealer for community banks.