Pub. 7 2019 Issue 1

Issue 1. 2019 19 A Case of Comparing Funding Rates Devotees of Gilbert and Sullivan may recall the line, “Things are seldom what they seem, skim milk masquerades as cream.” These cautionary words also apply to the need to dig below the surface when comparing rates on different sources of wholesale funding. Consider the case of a community financial institution that wishes to raise $1 million in the wholesale funding markets. There are two choices under consideration: Posted Bullet 15-month FHLB Des Moines Bullet Advance: 2.70% Posted Brokered 15-month CD: 2.60% On the basis of rate, favoring the 15-month brokered CD would appear to be a no-brainer, right? Hold on. The Dividend Impact on All-In Wholesale Funding Rates With the exception of Federal Home Loan Bank advances, other sources of wholesale funding do not entail investments or receipt of cash dividends. For example, the Federal Home Loan Bank of Des Moines currently requires its members to invest 4.00% of drawn advances in the form of activity-based stock. This class of stock currently supports an annualized dividend rate of 5.75%. A financial institution could assign a cost of funding the activ- ity-based stock that would likely be below the dividend return. The cost of funding the activity-based stock could, as an example, be represented by such assumed benchmarks as a hurdle rate of capital or an alternative investment. Effectively, this spread could be thought of as cash consideration that could be applied as a discount to a posted advance rate. Dividend-Adjusting: The Mechanics Going back to the example of a 15-month posted advance rate of 2.70%, let’s build a case for estimating the impact of the positive spread generated on the activity stock investment, per Figure 1. Figure 1: Derivation of Discount on Advance Rate Derived from Dividend Yield Spread RAISING WHOLESALE FUNDS: “THINGS ARE SELDOM WHAT THEY SEEM” By John Biestman, CFA, Vice President/Senior Relationship Manager at the Federal Home Loan Bank of Des Moines  Raising Wholesale Funds — continued on page 20