PrecisionLender allows you to enter Liquidity Adjustments to the funding costs. This permits variance in the cost of funds for floating and adjustable rate loans that have longer durations. PrecisionLender believes it is important to use liquidity adjustments in pricing longer term floating and adjustable rate loans. Clients should feel free to develop their own liquidity curves using appropriate methods; however, for our clients that would like to use liquidity adjustments, but are uncertain how to develop them we provide a recommended curve. This curve will typically be updated by the first and third Tuesday of each month. If you'd like to be notified via email when our Recommended Liquidity Curve is updated, go here and click "Follow" on the right side of the page.
In this article:
- What is a Liquidity Adjustment?
- "All in" vs "raw" curves
- Method to determine liquidity adjustment
- How the liquidity adjustments affect ROE
- Adding a liquidity adjustment in PrecisionLender
- Recommended Liquidity Curve
What is a Liquidity Adjustment?
A liquidity curve is meant to provide an additional cost of funds for floating rate loans with longer maturities. This reflects the issue that of having additional costs and risks to support longer maturity loans compared with those of a shorter term. A Liquidity Adjustment reflects the increased costs over the maturity spectrum to support variable rate loan products. Thus, a one year floating rate loan might have a cost of funds based on the short end of the funding curve of 0.5%; however, for a three-year term there could be an added premium of 0.3% and perhaps 1.0% for a ten-year term due to a potentially changing economic environment.
“All-in” compare to “Raw” Funds Transfer Curves
- An “All-in” curve, such as the Federal Home Loan Bank Composite curve, represents the cost to raise funds and by its nature includes premiums for longer maturity debt.
- A "raw” curve such as the Libor/Swap curve (without any adjustments) removes these premiums.
Within PrecisionLender you can determine whether they want to have a “Raw” or “All-in” curve and if you wish to include Liquidity Adjustments.
Method to Determine the Liquidity Adjustment
We spoke with several clients and some outside parties about the methods they use to determine a Liquidity Curve. While there are a few alternatives used, the main one used by PrecisionLender is:
- We determine a current cost of funds curve based on brokered CD rates of different maturities.
- The idea is that the “all-in” (including commission) brokered rates represents the cost to raise various maturity funds without collateral support or other restrictions.
- We receive brokered CD indication from numerous sources, including:
- Wells Fargo
- Raymond James
- We take an average of the data received from these various suppliers.
- We subtract a “risk free rate”, the Libor/Swap curve from this average.
- We use the 1 year swap rate and not the 1 year Libor rate that some institutions use in determining a Liquidity Premium.
- We may make some minor adjustments to this calculation for rounding purposes.
- For Example: if the average of 5 year brokered CDs is 2% and the Swap curve at this point is 1.40%, the premium that would be use for this term is 0.60%.
How does using a Liquidity Curve affect an Opportunity’s ROE?
If you are currently using an “All In” funding curve like an FHLB curve or an adjusted Libor curve, any effects would be on floating and adjustable rate loans.
- the short end of the funding curve show a 0.5% rate.
- The Liquidity Curve has points of:
- 1 Year 0.10%
- 3 Year 0.40%
- 10 Year 0.75%
- Prior to Liquidity Adjustments, a one, three or ten year floating rate loan will have the same cost of funds of about 0.5%.
- After Liquidity Adjustments, the cost of funds will be:
- 1 Year 0.60%
- 3 Year 0.90%
- 10 Year 1.25%
- If the rate charged is the same for all three loans, the net income and ROE should be lower for the longer term.
- Loans that convert to a more permanent loan type, such as construction loans, would see a higher cost of funds the longer the permanent loan is.
- If you are using a “Raw” curve like Libor/Swap without any adjustments, the differences discussed in this paragraph would apply, and the funding costs of longer term fixed rate loans could be affected when using the liquidity curve.
What Do I Need to Do?
If you do not wish to make any changes, no actions is required on your part. If, however, you want to use the PrecisionLender Recommended Liquidity curve, reach out to your CSM, Consultant or Support and we will be glad to help you get this set up.
- Email: Support@PrecisionLender.com
- Phone: 1-877-506-2744
Adding A Liquidity Adjustment In PrecisionLender
On the Regions and Users pane of the Administration Section. Click on the name of the Funding Package to which you wish to apply a Liquidity Adjustment.
Click "Edit" in the top left hand corner.
Check the box next to Liquidity Adjustments. If you want to specify different adjustments for different maturities, click "Add Adjustment", and you can specify different periods of time.
To delete any of these adjustments, click the trashcan icon () next to them.
When you are done, you can click "Save" at the top to save these Liquidity Adjustments to this Funding Package.
- The duration on a liquidity adjustment specifies that the adjustment be applied to all points below it, that do not already have an adjustment.
- For Example: In the image above there are the following liquidity adjustments
|Duration||Adjustment||Months This Duration Applies To.|
|For All||0.25%||Over 18|