MANY MEMBERS MAY BE LOOKING FOR CLARIFICATION regarding the mechanics of how a SOFR Advance works. To assist with this we will walk through the process for how the interest is calculated on a SOFR Advance is determined and how the FHLB sees the program maturing over time.
How is the SOFR Advance interest calculated?
SOFR is based on Treasury collateral Repurchase Agreement transactions that were executed the prior day. (For more information on how SOFR is set go to: https://apps.newyorkfed.org/markets/autorates/SOFR)
If you are looking for the SOFR setting you can look at the Federal Reserve website or you can look on Bloomberg at SOFRRATE INDEX. You will notice that there will be no data for the current date. If it is Monday and not a holiday, the last setting will be from the last good business day (Friday if it was not a holiday). Again, this is due to SOFR being calculated from the previous business day’s Treasury Repo transactions.
The Advance follows this same convention, utilizing the previous day’s rate for the current date, assuming no holidays. On Friday, the rate will be set utilizing the setting from Thursday. This setting will also be used for Saturday and Sunday. On Monday the Friday SOFR setting will be available and used in calculating the interest on the Advance for Monday.
The Advance uses a 360-day year to calculate a daily interest factor which is multiplied by the amount of the Advance, to calculate a daily interest amount. At the end of the interest period, the daily interest amounts are summed up to calculate the interest due on the Advance. Please see the example below.
Amount of the Advance $10,000,000
Advance Rate = SOFR +14
How does a callable SOFR Advance work?
The FHLB recently introduced a callable SOFR Advance. The first product offered was the 7 month non-call 6 month. This gives the Member the option to call the Advance 6 months into the Advance period with a notification period of a few days to the FHLB. Depending on the specified structure, one-time call, quarterly call, annual call, this could give more flexibility to the Member to terminate the Advance if the funding is no longer needed.
What does the FHLB see as the next iteration of the SOFR Advance?
The Federal Home Loan Bank System is investigating compounding of SOFR. This would allow the Advance product to match the conventions in the derivative or swap market. This could provide a better matching to the Member for derivatives that are already on the books or that the Member may be looking to transact.
When will the FHLB be able to offer a forward looking term SOFR Advance?
The FHLB is monitoring the market for developments in this area. A positive sign that the market is moving closer to being able to offer a term SOFR rate is the development of the SOFR futures market. On October 15, 2019, the Chicago Mercantile Exchange announced that as of January 5, 2020 they would list 12 options on three-month SOFR Futures Contracts for open outcry trading.
Utilizing a highly liquid SOFR futures market, a term structure could be built to be able to benchmark a term SOFR index. The Federal Reserve Alternative Reference Rate Committee has the development of term SOFR at the end of its published timeline. This is due to the need for deep liquid markets to develop in the underlying derivative markets. While we cannot define the exact timeline for a term SOFR, there have been positive signs in the derivative markets.
What if I do not want SOFR and I do not want LIBOR?
Please let the FHLB know if there is another index that you are interested in such as the Overnight Index Swap (OIS) or ICE Bank Yield Index. The FHLB is looking for ways to help the membership with their funding needs and is open to developing new products but we would appreciate hearing from the membership to ascertain the balance sheet requirements and how the FHLB can be part of the solution.