Solutions

Overview 

During a period of flat yield curve, it can be hard to grow income as asset-liability spreads grind lower. Balance sheet leverage is a great solution to address the problem of declining income and return on equity (ROE). However,leverage worth the income? How will my ROA, ROE, and efficiency ratios be affected? How do I figure out what kind of funding to use and how much I will need? We attempt to answer some of these questions in the leverage strategy described in this white paper.

Key Takeaways

• Using leverage can increase income and ROE for financial institutions; however, such strategies can also magnify risks like credit risk or interest rate risk
• Here we describe a leverage strategy that adds to income, has minimal credit risk, and uses advances to efficiently manage interest rate risk
• Fixed rate advances can be used to hedge interest rate risk on long duration mortgage securities
• Callable advances can be used to hedge extension and contraction risk, although their cost will lower income received
• Leverage strategies can increase ROE and lower efficiency ratios while having a small effect on ROA

To Learn More

To see an example of investing in a $25M MBS portfolio to increase income, visit eBanking to read the Balance Sheet Leverage: Optimizing Income and Risk white paper.

For further information on using this strategy or to have a scenario modeled for your institution, contact your Sales Director at membership@fhlbc.com.

Contributors

Ashish Tripathy
Managing Director, Member Strategy and Solutions



Erin Hunter
Director Member Strategy and Solutions

Disclaimer

The risks of using leverage strategies should be reviewed by each financial institution to ensure they do not breach any regulatory requirements and understand the characteristics of any investments and borrowings they are making before engaging in such a strategy. The scenarios in this paper were prepared without any consideration of your institution’s balance sheet composition, hedging strategies, or financial assumptions and plans, any of which may affect the relevance of these scenarios to your own analysis. The Federal Home Loan Bank of Chicago makes no representations or warranties about the accuracy or suitability of any information in this paper. This paper is not intended to constitute legal, accounting, investment, or financial advice or the rendering of legal, accounting, consulting, or other professional services of any kind. You should consult with your accountants, counsel, financial representatives, consultants, and/or other advisors regarding the extent these scenarios may be useful to you and with respect to any legal, tax, business, and/or financial matters or questions.

Federal Home Loan Bank of Chicago | Member owned. Member focused. | October 2018