Financial Institutions Case Study: Asset Liability Management

Our Client:

A regional bank with a newly issued brokered CD portfolio.

Situation:

Our client was asset-sensitive and had just issued 5yr brokered CDs that paid a fixed rate of interest. The client lends to borrowers at a floating rate of interest plus a credit spread, with a nominal floor. The net interest margin (NIM) would benefit from rising rates in the future, but in the short-term NIM was compressed by the long-term funding rate relative to the floored variable rate loan portfolio.

Summary:

Chatham Financial assisted the client with alternative hedging scenarios to reduce the impact of its relatively high, fixed-rate long-term funding. The client was considering a receive-fixed swap vs. a floating rate with sold floor based on the Prime rate, with the intention to designate the combined swap/floor against its floating rate commercial loan portfolio. Chatham’s analysis and price indications showed that the client would not realize substantial economic benefit from selling the floor in their loan portfolio – leaving significant value on the table. In addition, the client could not assert that it was probable that the hedged principal balance would be outstanding for the life of the swap, jeopardizing its ability to receive hedge accounting. As an alternative, Chatham proposed that the client execute a receive-fixed swap based on LIBOR without the embedded floor and designate the swap as a hedge of the fixed-rate liabilities.

Outcome:

The client executed the receive-fixed swap designated as a fair value hedge of the fixed-rate CDs. In so doing, the client converted its 5yr fixed rate funding back to a floating rate at 3-month LIBOR plus a spread, meeting their objective to relieve short-term pressure on their NIM.