Academic journal article ABA Banking Journal

Climbing to Success on a Blended Ladder

Academic journal article ABA Banking Journal

Climbing to Success on a Blended Ladder

Article excerpt

Climbing to success on a blended ladder

Traditionally, community banks have employed one of two alternative investment portfolio strategies. These are the ladder strategy and the barbell approach.

Barbells and ladders. Both techniques afford the banker the comfort of knowing that some degree of liquidity and reinvestment opportunity is never too distant.

The basic principle behind both is simple. As funds become available for investment or reinvestment, they are channeled into a single maturity at the end of the ladder. Alternatively, they may be spread automatically across the spectrum of maturities contained in the ladder according to a predetermined "profile" of maturities.

The advantage of the ladder strategy is that by spreading investments over a range of maturities the bank gains an averaging out of interest-rate cycles.

An alternative to the traditional ladder is the barbell. This entails clustering maturities at the extremes of the ladder. This resembles a weightlifter's barbell, hence the name. This strategy trades added interest-rate exposure for the potential of greater return.

An enhanced merger. The blended ladder approach offers the attributes of both the ladder and barbell strategies. The ladder approach's avoidance of interest-rate risk is retained, but in a modified form that enhances the portfolio's contribution to earnings.

The typical ladder-style portfolio comprises three basic parallel--but separately run--maturity ladders: the liquidity component; the taxable investment component (also called "loan substitutes"), and the tax-exempt investment component.

By contrast, the blended ladder portfolio approach puts all three components onto one grand ladder. Then it compares the yield curves for each of three components. The intent is to fill the blended ladder only with those maturities and types of products representing the most attractive relative values. Investments are then concentrated in the maturity bands providing the best relative value.

The best way to illustrate the technique is by example. Every bank possesses unique characteristics, so a "one-size/one-structure fits all" approach is neither realistic nor credible. …

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