April 7, 2014

Interest Rate Swaps: Consider all the Options in Managing Interest Rate Risk

Interest Rate Swaps can be an effective tool in managing asset/liability mismatches present in many of our member’s balance sheets. Mismatches occur when a member funds long-term assets using short-term liabilities, or vice versa. Interest Rate Swaps involve an exchange of a fixed-rate payment for a floating payment, which is generally tied to LIBOR, Prime, or a Treasury index, based on a specified notional amount and an agreed upon day count convention.

   Pay Fixed/Receive Floating
Interest Rate Swap

FHLBNY as Interest Rate Swap Counterparty

Liability-sensitive members may lock in spread and guard against a rise in rates by utilizing a “Pay Fixed/Receive Floating” Interest Rate Swap, where the floating rate received would increase in a rising rate environment, offsetting the associated increase in a member’s cost of funds relating to their short-term or floating-rate liabilities. Asset-sensitive members are vulnerable in declining rate environments, and conversely may opt to pay floating and receive a fixed payment when executing Interest Rate Swaps.

For example, if a segment of a deposit base demonstrates a high correlation to 3-month LIBOR, a member may elect to “lock in” the rate of that floating rate deposit category for a period of time by engaging in a Pay Fixed/Receive Floating Interest Rate Swap (see the diagram on the right for an example). This would effectively transform the floating rate liability to a fixed rate equal to the term of the Interest Rate Swap. You can potentially receive favorable “hedge” accounting treatment provided that certain criteria are met at the inception and throughout the life of the Interest Rate Swap. Please consult with your accountant as a first step in deciding whether Interest Rate Swaps are appropriate for your institution.

  • Program Features and Benefits:
  • Lock in spreads to preserve margins without increasing the size of your balance sheet
  • Mitigate Net Interest Income at Risk and Economic Value of Equity at Risk
  • Meet asset/liability management goals
  • Achieve operational ease by using pledged mortgages to collateralize the Interest Rate Swap transaction – keeping highly liquid marketable securities unencumbered
  • FHLBNY assumes associated responsibilities as reporting entity with Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank Act) compliance
  • There is no activity-based stock purchase requirement for Interest Rate Swap transactions
  • FHLBNY is a triple-A-rated counterparty (Moody’s and Fitch) and AA-rated by S&P
  • Considerations:
  • With regard to the newly implemented Dodd-Frank Act reporting compliance rule regarding final swap data and recordkeeping (known as Part 45), the FHLBNY, as the “market maker” in the transaction, would be the reporting entity and would submit the record of a Interest Rate Swap transaction quarterly to a swap data repository (SDR). There will be no Dodd-Frank Act reporting required by our members for Interest Rate Swap transactions with the FHLBNY as long as the Interest Rate Swap is for hedging purposes and not deemed speculative. Members’ derivative transactions with the FHLBNY are done direct, and are not required to be cleared through an exchange as the FHLBNY is not considered a “Swap Dealer” or “Major Swap Participant.”
  • A member would have to collateralize the Interest Rate Swap transaction based on the mark-to-market valuation of the swap plus the potential future credit exposure of the transaction.
  • Achieve asset/liability management goals without increasing the size of the balance sheet

Please consult with your accountants regarding the accounting treatment and ongoing requirements associated with an Interest Rate Swap transaction. For more information on how FHLBNY Interest Rate Swaps are issued and how this product can be used to help meet your institution’s needs, contact a Calling Officer at (212) 441-6700.