Residential Lending: Q1 2019
OverviewThe 30-year mortgage rate (according to Freddie Mac) and the FHLBank Chicago’s 10-year advance rate have decreased from recent highs at the end of 2018. While the rates have decreased, the spread between the 30-year mortgage rate and 10-year advance has risen (see the graph below). With the spread continuing to grow, it is a great time to consider holding mortgages on your balance sheet.
Here we will examine hedging both a 15-year and 30-year mortgage portfolio with advances. Please note that our summaries on net interest margin (NIM) use forward rates in all scenarios, including the base case. As of January 10, 2019, forward rates are trending upward in the short term, but are otherwise flat. All rates are from January 10, 2019.
30-Year Mortgage Example
In the example below, the portfolio is made up of 30-year mortgages at a rate of 4.75% with 13 basis points retained for servicing. The funding solution shown below includes a ladder of fixed rate and putable advances, as well as deposits. See the tables below for more information about the portfolio, how it is funded, 10-year average NIM, income, and duration.
As you can see in the example above, this strategy would yield income of $203,837 in year 1 in the base case scenario. The 10-year average spread earned is 105 basis points, averaged across four different rate-shock scenarios. Another important thing to consider is how holding 30-year mortgages on your balance sheet will affect your capital ratios. According to Basel III guidelines, mortgages are weighted at 50% for risk weighted asset calculations. In the example shown above, the institution has taken a 17-basis-point hit on the total risk-based capital ratio, but the 27-basis-point increase in return on risk-based capital more than makes up the difference. (See the table below.)
15-Year Mortgage Example
In the example below, the portfolio is made up of 15-year mortgages at a rate of 3.97% with 13 basis points retained for servicing. The funding solution includes a ladder of fixed rate and putable advances, along with deposits. Please see the tables below for more information about the portfolio, how it is funded, 5-year average NIM, income, and duration.
As you can see from the tables above, this strategy would yield income of $129,268 in year 1 in the 0, or base case, scenario. The 5-year average spread earned is 80 basis points, averaged across four different rate-shock scenarios. Another effect this strategy has on your balance sheet is related to risk-based capital. Mortgages are weighted at 50% for risk weighted asset calculations, according to Basel III guidelines. In this example, the institution’s total risk-based capital ratio will take a 17-basis-point hit when the strategy is implemented, but after one year, the return on risk-based capital will have improved by 32 basis points.
To learn more about the strategies discussed here, or to have your mortgage portfolio run through our model, please reach out to your Sales Director at firstname.lastname@example.org.
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DisclaimerThe 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. | February 2019