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The Fixed-Rate Advance with a LIBOR Cap (Fixed-Rate with Cap) is a hybrid funding option that combines a fixed-rate borrowing with an embedded interest-rate cap tied to 3-month LIBOR index. The advance rate remains fixed but may be reduced quarterly if 3-month LIBOR rises above the cap that is chosen by the member prior to the transaction. If 3-month LIBOR rises above the predetermined cap, the interest rate would adjust downward depending on how many basis points LIBOR is above the cap. Interest rate adjustments are performed either on a one-to-one basis (1×) or by one basis point for every two basis points (0.5×) 3-month LIBOR is over the cap. The net adjusted advance rate cannot be less than zero percent.
For liability-sensitive members, this product could potentially be helpful with mitigating risk associated with regulatory interest-rate-shock scenarios. A rapid rise in interest rates could cause the interest expense of the advance to plummet (quarterly reset and a floor of zero), which would help offset declining net interest income. Additionally, the falling coupon rate would increase the present value of the advance in a rising environment, serving to assist with an institution’s Economic Value of Equity at Risk.
|Example: 5-Year Fixed-Rate with Cap, 1× Multiplier
Initial Advance Rate: 1.39%
3-Month LIBOR Cap: 1.75%
In this example, when the 3-month LIBOR rose to 1.80% in the third quarter of year four, the rate of the Fixed-Rate with Cap lowered to 1.34% (calculated by subtracting the difference between the actual LIBOR rate and the LIBOR cap from the initial advance rate). If the advance cap was structured on a 0.5× basis, the difference would be divided in half, then subtracted from the initial rate, lowering the advance rate to 1.365% .
- Minimum advance size: $5 million per trade
- Maturity: 1 to 10 years
- Multiplier options: 1× and 0.5×
- Day count basis: Actual/360
- Embedded interest-rate cap index: 3-month LIBOR
- Rate adjustment frequency: quarterly reset with a 2-business-day lookback
- Prepayable: yes
- Provides protection against rising interest rates (lowers your institution’s cost of funds as rates rise)
- Flexible medium-long-term funding option best used to extend liabilities, potentially enhance spreads, and preserve margins
To discuss how the Fixed-Rate Advance with a LIBOR Cap may provide additional margin relief from sharp increases in interest rates, contact a Calling Officer at (212) 441-6700.