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
Want to learn more?
Contact our team to discuss how Chatham can help with your treasury and risk management needs.
Contact usDisclaimers
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 cf.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.
