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.
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
Hedge fixed-rate loans and compete more effectively. Get started today.
Our featured insights
Semiannual Market and Economic Update
Jackie Bowie and Amol Dhargalkar will host Chatham’s upcoming webinar, providing perspectives on the current global economic landscape and financial events impacting today’s market. Examine ways to mitigate risk and enhance decision-making in the capital markets.
Fed minutes recap and market outlook: Higher for longer
In what was a relatively light week on the economic data side, the market looked to the highly anticipated January Federal Open Market Committee (FOMC meeting) minutes for any insight on what the Fed will do next.
Back-to-Back Swap Program Benchmark Statistics Report
Our back-to-back swap benchmark report compares customer swap transactions across years, regions, and bank asset size. While your financial institution may not yet be using swaps to win more commercial loan business, you can still find value in reviewing this report.
Mixed sentiment in markets as inflation outpaces expectations
The most recent CPI reading strengthened fears that inflation will persist at its current levels, leading markets to reevaluate the timing and quantity of upcoming interest rate cuts.
Navigating rate cuts: Fed caution vs. market optimism
A relatively quiet week on the economic data front made for a loud week of Fed speak. Fed officials continue to reiterate that the FOMC does not want to act too soon or too quickly regarding rate cuts. The market, on the other hand, outpaces the Fed’s path.
Interest rate collars gain appeal as rate cut uncertainty ensues
Interest rate markets remain uncertain within the United States. Although the market expects rate cuts, continued strength in the U.S. economy and labor market provides the potential for inflation to re-accelerate or remain elevated. As a result, corporates with floating-rate debt are considering...
BoE and ECB keep rates on hold, but rate cuts grow more likely
The Bank of England (BoE) voted to keep rates on hold as expected at 5.25%, though one member of the Monetary Policy Committee (MPC) voted for a rate cut, the first vote since the Bank cut rates to a record low in March 2020. Two members voted to hike rates, but a subtle change in the...
Fed maintains rates level while the market looks ahead to easing cycle
On Wednesday, January 31, 2024, the Federal Open Market Committee (FOMC) voted unanimously to hold the fed funds rate at a target range of 5.25% – 5.50%. The FOMC made a few notable changes to its first statement of the year. Importantly, while acknowledging that the Central Bank’s employment and...