The chart above shows the FHLBI dividend versus three-month LIBOR for each quarter since 1994.

Since 1994, the spread between FHLBI dividends and LIBOR has ranged from 125 basis points to 244 basis points. This yield on a floating rate instrument issued by a AAA-rated bank makes the stock an attractive investment for members. However, there is another less apparent impact from the FHLBI stock dividend.

FHLBI members are required by law to hold a certain minimum percentage of stock to advances. This amount is determined annually. As institutions borrow, they deplete their borrowing capacity based on their stock level. Once an institution exhausts this borrowing capacity, it must buy more stock for each additional dollar borrowed to maintain the required stock/advances ratio. The additional stock purchases have the effect of lowering the borrowing cost for that institution. Most members must hold a minimum of $1 of stock for every $20 of advances. Members can determine their stock/advances ratio from the , which is updated daily on the secured services of Member Link.  The report is also mailed out quarterly for those who have not yet signed up for Member Link secure services.

To determine how much of a reduction the additional stock purchase provides, an institution must compare the FHLBI stock dividend to its other investment alternatives of comparable risk. By comparing FHLBI stock returns with returns for an investment with similar risk, the yield pickup for FHLBI stock can be determined. The yield pickup is the difference between what an institution will earn on the FHLBI dividend and what it could earn on the alternative investment. Since the FHLBI dividend reprices quarterly, some institutions may decide to compare the dividend to their other three-month investment options. A variety of three-month investments such as fed funds, Treasuries, or CDs could be used to gauge the relative attractiveness of FHLBI stock.

The greater the yield pickup for FHLBI stock over a comparable risk investment, the greater the reduction in the effective borrowing costs. The amount of borrowing cost reduction will remain the same regardless of the amount borrowed so long as the yield pickup remains constant. In other words, as long as the spread between the FHLBI dividend and your alternative investment does not change, the effective cost savings to your institution will stay the same regardless of the amount or type of borrowing.

The example in the stock table shows that a typical FHLBI member at a 20:1 advances-to-stock ratio (which is equal to a 5% stock/advances ratio) would have had a 250 basis point yield pickup when comparing the first quarter 1998 dividend to fed funds. By applying the 250 basis points to the $50,000 stock purchase requirement, this institution would realize $1,250 of incremental income. Dividing this additional income by the $1,000,000 advance results in an additional 12.5 basis point savings in borrowing costs.

The net borrowing cost reduction represents those additional basis points that an institution should deduct from a given advance rate to determine the net cost. For example, if the institution above were to take down a three-month LIBOR advance at three-month LIBOR flat, it would in effect be receiving the funding at three-month LIBOR less 12.5. This institution would be hard pressed to find similar wholesale funding at a better cost.

When weighing alternative funding sources and the associated costs, an institution must factor in the borrowing cost reduction if it must purchase additional stock to borrow. Analyzing the total transaction with the FHLBI will help an institution decide if it is obtaining the cheapest source of funds.

This article has been presented for educational purposes only.  The FHLBI is not a financial or investment advisor.   It is solely the reader's responsibility to evaluate the risk and merits of any funding strategy or business proposal.