CUSTOMER STORIES A Midwest-based Bank Wanted to Extend Funding Duration While Minimizing Cost Challenge Banks are looking for cost-effective ways to fund longer-term liquidity needs. While term funding from wholesale sources such as FHLB may be available, the bank will pay a premium for this term liquidity. The bank had utilized hedging transactions for balance sheet interest rate risk management in the past, but was concerned that it didn’t have the in-house expertise to design, support and report a hedge accounting compliant relationship. Solution The Bank partnered with Derivative Path, Inc. (DPI) and its partner Sandler O’Neill Hedging Services LLC to ascertain the best hedging strategy to meet its funding goals. By combining a pay-fixed interest rate swap with a variable rate (3-month) FHLB rolling advance, the bank was able to materially lower its cost of longer-term financing. Specifically, the bank was able to synthetically lock in a 5-year fixed rate with a pay fixed swap at an expected savings of 30 basis point savings vs. like-term FHLB financing. For hedge accounting, we helped the Bank designate changes in the 3-month LIBOR swap rate as a hedge of the contractually specified 3-month FHLB advance rate. By designating the hedged risk as the contractually specified 3-month FHLB funding rate, the bank will be able to substitute another funding source if the FHLB 3-month advances are not available in the future and maintain hedge accounting as long as the hedge relationship continues to be highly effective. Hedge effectiveness was assessed by comparing the FHLB advance rate to the index on the interest rate swap (i.e., 3M LIBOR) via regression analysis. Alternatively, the bank could also identify the hedged risk as the 3M LIBOR component of the FHLB advance rate which may allow a more effective hedge assessment, but potentially limit alternative funding sources to maintain the hedge relationship to other 3M advances, such as brokered CDs. Banks can elect either hedge designation depending on their potential available funding sources and effectiveness assessment preferences. Utilizing its leading-edge derivative platform DerivativeEDGE, Derivative Path will provide ongoing assistance on the Bank’s hedging portfolio with full trade lifecycle journal entries and effectiveness assessments so that hedging relationships can be monitored and reported, and hedge accounting treatment can be continued.