Hedging fixed-rate loans
Competing for profitable loans has never been easy. There are many external constraints to lending. Many larger financial institutions run “specials” where 15-year fixed-rate loans are offered well below market terms. Insurance companies compete for the best credits with fixed rates that only make sense in the context of their fixed, long-term liabilities. Perhaps the clearest evidence of competition is tightening credit spreads.
One way to compete and meet customer demand for long-term fixed rate financing without carrying the interest rate risk is by hedging individual fixed rate loans. This is a great strategy for loans greater than $2M in size and longer than five years because they are more challenging to manage from an interest rate risk perspective. Additionally, hedging fixed rate loans is a simple way to break ground on hedging.
How it works:
- The borrower enters into a fixed-rate loan with the financial institution.
- The financial institution enters into a pay-fixed swap with a dealer bank, passing on the fixed-rate exposure, effectively leaving the the financial institution a variable rate loan of SOFR or Prime + spread.
- The financial institution designates the swap as a fair value hedge of the fixed-rate loan, eliminating income statement volatility due to changes in value from the swap.
- Note that there is no fee income potential with this hedging strategy; instead all of the income generated from the loan flows through the margin.
End Result
Your financial institution is able to meet borrower demand for long-term fixed rate financing as-needed.
Our fixed rate loan hedging expertise
Chatham serves as a strategic partner to financial institutions looking to hedge fixed-rate loans, providing the necessary technology, advisory, and process infrastructure to ensure that their program is successful:
- Guided implementation (policy, procedures, and education)
- Transaction management
- ISDA negotiation and and management
- Complete ASC 815 hedge accounting support from inception documents to maturity
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Hedge fixed-rate loans and compete more effectively. Get started today.
