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Guide

Considering the customer when evaluating interest rate swap strategies

  • ben lewis headshot

    Authors

    Ben Lewis

    Managing Director
    Head of Sales

    Financial Institutions | Denver, CO

Summary

In this brief video, Ben Lewis discusses the impact indirect swaps can have on the community bank's borrower.

In a previous video, we discussed the two ways that community banks may offer interest rate swaps to their borrowers: traditional interest rate swaps (offering swaps directly to a borrower) and indirect swaps (where a community bank introduces a correspondent bank who then offers an interest rate swap to their borrower). Often put forth as a simple solution, there are important considerations that community banks should account for when evaluating indirect swaps. We previously highlighted the credit considerations and embedded costs of indirect swaps. Now we will focus on the impact of indirect swaps on the community bank's most important asset - its customers.

Community banks are all about relationships

There are a few things to think about as it relates to your customer and indirect swaps.

Entering into a swap with the third party

It's important to note that your customer doesn't know or have a relationship with the correspondent bank. They also rarely know the correspondent bank's creditworthiness. In comparison, when using traditional swaps, your customer is entering the swap directly with you, their relationship bank.

Understanding the differences in documentation

Correspondent banks use non-standard documentation for the swap between the correspondent bank and the customer, which might put your customer at a disadvantage. In contrast with traditional swaps, your customer will enjoy the legal precedents and protections provided by the industry-standard documentation.

Learning how the swap and loan are recorded on a monthly basis

With indirect swaps, your customer will receive a monthly payment notice from your bank, and it may appear to look like a fixed-rate loan to your customer. In reality, they have a floating-rate loan and an interest rate swap. That could lead to confusion in a scenario where the customer wants to pre-pay the loan and then finds out that they have some breakage related to the swap due to the correspondent bank.

In conclusion

Banks should consider the impact that indirect swaps can have on their customers. Because of these concerns, most community banks opt to offer traditional swaps directly to their customer, allowing them to deliver the full financing solution.

We'd like to hear from you

Contact us if you are looking to learn more about a traditional swap program.

About the author

  • Ben Lewis

    Managing Director
    Head of Sales

    Financial Institutions | Denver, CO

    Ben Lewis is a Managing Director and Global Head of Sales for our Financial Institutions team. He leads business development efforts in the Western U.S. and works with depositories helping them manage interest rate risk.

Disclaimers

Chatham Hedging Advisors, LLC (CHA) is a subsidiary of Chatham Financial Corp. and provides hedge advisory, accounting and execution services related to swap transactions in the United States. CHA is registered with the Commodity Futures Trading Commission (CFTC) as a commodity trading advisor and is a member of the National Futures Association (NFA); however, neither the CFTC nor the NFA have passed upon the merits of participating in any advisory services offered by CHA. For further information, please visit chathamfinancial.com/legal-notices.

Transactions in over-the-counter derivatives (or “swaps”) have significant risks, including, but not limited to, substantial risk of loss. You should consult your own business, legal, tax and accounting advisers with respect to proposed swap transaction and you should refrain from entering into any swap transaction unless you have fully understood the terms and risks of the transaction, including the extent of your potential risk of loss. This material has been prepared by a sales or trading employee or agent of Chatham Hedging Advisors and could be deemed a solicitation for entering into a derivatives transaction. This material is not a research report prepared by Chatham Hedging Advisors. If you are not an experienced user of the derivatives markets, capable of making independent trading decisions, then you should not rely solely on this communication in making trading decisions. All rights reserved.

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