The saying “Make hay while the sun shines” might not seem seasonally appropriate until days grow longer and sunlight pours down in abundance, but the guiding principle behind the saying—capitalize on windows of opportunity before the opportunity passes—can be applied any time of year. 

One of the goals of this column is to identify some of those opportunities and when windows to pursue them are open. Though there are certain similarities with prior years, 2025 has started off with a very different set of opportunities than the recent past.

Of course, reference point matters. While the current environment differs meaningfully from the past several years, there are very few interest rate environments that seasoned managers haven’t seen before. 

However, given that the yield curve was inverted—with yields on short-term investments higher than yields for longer-term investments—for more than two years, the strategy playbook for a steepening yield curve environment may feel like a distant memory. Despite having gathered some dust, the evolution of the yield curve over the past several months has made growth strategies (also known as leverage strategies) viable again.

Why now?

To address the elephant in the room, the yield curve can hardly be considered “steep” from a historical perspective. At the time of writing, the 2s/10s Treasury spread, a widely followed metric that measures yield curve slope, sits at about 40 basis points (0.40%). This is a considerable increase from its recent low of -108 basis points (-1.08%) but remains well below its long-term average of roughly 100 basis points (1.00%).

However, most growth strategies pursued by community banks do not invest proceeds in the Treasury market. Return targets for such strategies are almost universally 100 basis points or more, and reaching this target with a reasonable duration mismatch between assets versus funding typically requires buying securities that generate some spread over benchmark Treasury rates. 

Currently, the best candidate on the purchase side is agency mortgage-backed securities (MBS). The combination of strong relative valuation, moderate duration and consistent performance across a wide variety of interest rate scenarios give agency MBS a compelling profile for the purchase side of a growth strategy.

Though a multitude of variables can affect the spread on a growth strategy, let’s assume that the two-year Treasury rate plus 10 basis points (0.10%) is a reasonable proxy for funding cost. Let’s also assume that an average of the 15-year and 30-year Fannie Mae current-coupon mortgage rates is a reasonable proxy for asset yields. This allows us to track the historical spread available via growth strategies.

Examining the data in the graph shows that the spread on this simple growth strategy has averaged roughly 85 basis points (0.85%) over the past five years. However, this spread started moving higher in late 2024 and currently sits above 115 basis points (1.15%), which is in the 89th percentile for observations since the beginning of 2019. Thus, in addition to broaching the 1.00% spread that many consider the floor level for considering growth strategies, this indicates that the opportunities available today are attractive relative to historical precedent.

Food for thought

From a strategic perspective, growth strategies are a relatively straightforward way to improve income while using some degree of capital. In this manner, it is similar to a portfolio repositioning that incurs a loss (commonly referred to as a “loss/earnback” trade). However, there are a couple key differences.

One difference is how the capital gets used. Growth strategies spread existing capital over a larger asset base, which reduces capital ratios but keeps the amount of capital the same. By contrast, a loss/earnback keeps the asset base the same but reduces the amount of capital supporting those assets.

Another difference is the impact each has on profitability metrics. Because growth strategies typically feature a narrower spread than the rest of the balance sheet, they tend to compress net interest margin (NIM). Increased use of the existing equity base adds to return on equity (ROE), while the impact to return on assets (ROA) could be positive or negative based on both the specifics of the growth strategy and the starting point for ROA. On the other hand, loss/earnback trades are accretive to all three ratios (NIM, ROA and ROE) in the future, but the recognition of losses typically reduces ROA and ROE for the current period.

The near-term reduction in ROA/ROE made many management teams reluctant to pursue loss/earnback strategies, while the inverted curve environment of the past several years limited opportunities to pursue growth strategies. As such, a sizable portion of community banks took a hands-off approach to managing the investment portfolio until market conditions improved. Recent shifts in curve shape have done that, and it may well be time to give growth strategies another look.