Derivatives. Done. Right. · 2019-12-17 · An Interest Rate Cap is an agreement where one...

Derivatives. Done. Right.

Strictly Confidential – For Discussion & General Information Purposes Only 2015 Derivative Path, Inc. All Rights Reserved.

Presented to:

Western Independent Bankers2015 Education Summit and ExpoSeptember 21-23, 2015, San Diego, CA

Contents

Derivatives Historical Timeline 3

Introduction: Derivatives 101 11

Market Update 18

Hedging Strategies for 2015 and Beyond 25

Hedging Ideas 29

Dodd-Frank Considerations 35

Risk Management/Credit Exposure 43

Concluding Remarks 48

Company Information 51

Derivatives Historical Timeline

Not Just a Modern Phenomenon

Renaissance Europe

1540 – Royal decree in Antwerp makes contracts

for future delivery transferable to third

parties. Merchants start to trade contracts for differences, similar to cash-settled futures.

Early 1600s – Tulip-mania in Amsterdam:

asset price bubble arises about newly introduced Tulips. Speculators play

on contracts for differences and options.

1700s – Commodity traders buy and sell forwards on London’s

Royal Exchange.

4

Early Futures Markets

1848 – Creation of the Chicago Board

of Trade. Grain Traders create “to-arrive” contracts to lock in price,

which are standardized around 1865.

1874 – Chicago Produce Exchange is

formed, becomes Chicago Mercantile Exchange in 1919,

and by 1925 modern futures

contracts are traded through

clearinghouses.

1922 –First US effort to regulate futures

with Grain

Futures Act.

1936 –Commodity Exchange Authority

established. Options of

futures banned.

1955 – Two onion traders corner

the onion futures on CME. Onion Futures Act is

passed, and still to this day, bans

futures on onions.

5

Early Innovation

1971 – Breakdown of Bretton Woods

system: US currency is taken off gold

standard. Currency futures take off.

1972 – CME creates International

Monetary Market, which allowed

currency future trading.

1973 – Creation of Chicago Board

Options Exchange. Publication of famed Black-Sholes options

pricing model. Derivative industry

sees explosive growth.

1974 – Congress creates US

Commodity Futures Trading Commission

(CFTC), replaces Commodity

Exchange Authority.

6

Swap Era

1981 – IBM and World Bank arrange

the world’s first swap, swapping USD debt payments for Swiss franc and

deutsche mark debt payments.

1982 – CME creates Eurodollar contract, now most actively

traded future contract of all. First

index future contracts are also

launched.

1994 – Invention of the modern Credit Default Swap by JP Morgan to protect

the $5 billion loan to Exxon given for

Exxon Valdez spill damages.

Simultaneously, Orange County

declares bankruptcy.

1995 – Barings Bank (est 1762 London) loses $1.8 B and

collapses due to the futures trading

losses of a single trader, Nick Leeson. Gibson Greetings

posts $20 mm loss due to derivatives

trading, sues Bankers Trust.

7

Early 2000s

1999 – Congress repeals Glass-Steagall:

commercial banks become more involved

with derivatives.

2000 – Congress passes Commodity Futures Modernization Act,

which exempts Credit Default Swaps and

other OTC derivatives from regulation.

Early 2000s – Sub-prime lending takes off, as do derivatives based on sub-prime CDOs and

MBS.

8

Financial Crisis

2008 – Lehman Brothers collapses on a tangled web of

declining portfolio value, counterparty confidence, and

available liquidity.

2008 – Liquidity crisis at AIG, as AIG fails to post collateral on

hundreds of billions of dollars of Credit Default Swaps on

declining Collateralized Debt Obligations. Government bailout

ensues.

9

Dodd-Frank

July 21, 2010 – Dodd-Frank Wall Street Reform and Consumer

Protection Act signed into

law.

August 13 2012 – Under Dodd-Frank,

CFTC publishes

“Final Rule” defining swaps in the Federal

Register.

October 12 2012 – Key elements of Dodd-Frank begin to take

effect, including new eligibility requirements.

December 31 2012 –Swap Dealers and Major

Swap Participants (Category 1) must report credit and interest rate swaps to Swap Data

Repositories, and comply with Internal and

External CFTC Business Conduct Rules.

10

Introduction: Derivatives 101

Why Banks Use Interest Rate Hedging Products?

To mitigate specific risks to the balance sheet.

Reduce asset or liability sensitivity

Manage interest rate risk and spread compression

Manage basis risk

Support loan structures that banks may not want on their balance sheet

Interest rate hedging products can be applied to most instruments on either side

of the balance sheet.

Effective hedging strategies do NOT mean being 100% risk neutral – can be used

to selectively exploit market opportunities, prepare for business cycle changes, etc.

(e.g. enhance asset sensitivity in current environment).

12

Why Banks Use Interest Rate Hedging Products?

To increase competitiveness –facilitating customer swap transaction offering

Help clients better manage interest rate risk

Provide clients more rate protection flexibility and economic upside

Better compete on loan terms/structures without accepting unwanted balance

sheet risk

Better able to enforce loan cost of funds pricing risk

Increase revenue opportunities

Interest rate hedges are effective tools for Banks to mitigate interest rate risk exposure and protect their Net Interest Margin (NIM) and earnings. As separate contracts, hedges allow Banks to tailor ALM solutions independent

from sources and uses of funds decisions.

13

Swap Description

An Interest Rate Swap is a contract between two parties (your bank and your

borrower or your bank and a swap dealer) to exchange interest payments based

on a notional principal schedule over a defined time period.

In plain terms it’s a financial contract that converts exposure from floating to fixed

rates or vice versa.

Allows companies to manage risk associated with individual loans or portfolio

balance sheet risks.

Swaps typically do not require upfront premiums or upfront cost.

Structured where the transaction costs are embedded in the rate or spread in

the transaction.

Swaps are separate contracts from the underlying exposure a counterparty is

trying to hedge (e.g. a borrower looking to hedge their floating rate loan).

14

Cash flowsAggregate Payments Over 10

Years

Fixed Payer Floating Payer

PV of Fixed Leg PV of Floating Leg

Based on today’s forward curve, the fixed leg of the swap is equal to the floating leg of the swap on a present value basis. This is the break-even swap rate.

Market Expectation

of future LIBOR

Fixed Rate

How Are Swaps Prices Determined?

15

Cap Description

An Interest Rate Cap is an agreement where one counterparty agrees to

compensate the other counterparty for the difference between a floating-rate index

and a specified strike rate should the floating-rate reset above the strike rate. In

exchange for this protection, the counterparty is required to pay an upfront

premium.

A cap is completely customizable for tenor, frequency, floating-rate index, notional

schedule (bullet, amortizing, accreting, etc.), and the strike rate.

Caps are used to limit interest expense associated with floating-rate exposures

(revolver, term loan, floating rate FHLB Advances etc.) and are typically used when

the user prefers to insure against higher rates versus locking-in a fixed rate

through a swap.

16

How Are Cap Prices Determined?

Like swaps, an option is worth the present value

of its expected future value.

Unlike swaps, option prices include a charge for

volatility (uncertainty).

This is because option buyers don’t accept the

same risks that forward buyers do.

Thus, an option premium equals the intrinsic

value (if any) plus a charge for volatility.

There are essentially five factors affecting option

prices (expectations of future values):

Interest (growth) rate

Time to Expiration

Volatility - price dispersion, or uncertainty

Price of Underlying Asset

Strike Rate

Value

Strike Spot Price (on Settle Date)

17

Market Update

18

Market Update Summary

After more than 5 years of a 0-0.25% rate policy, there is general market

consensus that “when” not “if” is the central question around future FOMC

increases in short term U.S. interest rates.

Historically, market rates have tended to move in anticipation of, rather than

coincidentally to or after, actual Fed rate increases.

Driven in part by international and technical market factors extraneous to U.S.

economic fundamentals, long term U.S. interest rates have recently been held

in check, reversing the trend higher we saw from April to June.

Corporate long term new debt issuance is currently running well above typical

issuance volumes as opportunistic, low coupon long term rates are being locked

in.

19

Market Update

The US economy continues to make

strides towards the Fed’s mandate of

“maximum employment. We’ve had

consistent monthly job gains of

200K+ until the August dip, and the

unemployment rate currently sits at

5.1%, a 7-year low.

It is worth noting the historically low labor

force participation rate, which measures

those who have stopped looking for jobs

Manufacturing and housing have both rebounded nicely after

slow starts to the year, when West Coast Port issues disrupted

production and the dollar was on a rapid incline. The most

recent reading of the ISM manufacturing index declined to

51.1, but it remained above 50, signaling an expansion.

20

Market Update

Wage growth remains a headwind. While average

hourly earnings increased 0.2% in July and 0.3% in

August, they are now up just 2.2% over the past year,

in line with the pace of growth we’ve seen since the

financial crisis.c

Significant headwinds remain internationally,

primarily out of China. A recent private

survey showed China’s factory sector declined

at its fastest pace since March 2009, the

depths of the global financial crisis.

China’s perceived slow growth outlook has

dragged down commodity prices and global

stock markets, as investors fear slowing

demand from the world’s second largest

economy.

21

Market Update

22

The Bloomberg chart as of 9/17/2015 above shows the probability of move for every Fed meeting

through November 02, 2016. There is a 46.6% probability of a move by December 2015 and if

they move - a 93% probability that the target is between 25 bps and 50 bps and only a 7%

probability of it being between 50 and 100 bps.

Similarly, there is a 90.3% probability that the Fed would have made its first move by September

2016 and a given a move by September 2016, a 63.5% probability that the Target rate would be

between 0.5% to 1.75%.

Market Update

Markets tend to anticipate the Fed’s rate

actions before they are formally

announced. At the beginning of the last

rate cycle, 3ML started to increase about 3

months prior to the June 2004 FOMC

meeting. LIBOR increased ~50 bps before

the first hike was announced, and then

proceeded to move ahead of the official

Fed Funds shifts.

5-Year swap rates also

increased about 3 months

prior to the June 2004 FOMC

meeting, spiking about 150

bps before leveling off.

23

Market Update

24

LIBOR is starting to move!

Term swap rates not so much.

Hedging Strategies for 2015 and Beyond

Thoughts on Bank Balance Sheets

Community and Regional banks are often market takers of both assets and

liabilities in their local markets.

Customers typically demand the opposite of what banks really want to offer.

Bank balance sheets are inherently negatively convex.

Most bank CFOs struggle to find acceptable yields in today’s environment.

The short end of the curve has dropped to historic lows and expected to stay

there for the next several months.

26

Thoughts on Bank Balance Sheets

Banks looking to enhance yield on their investments have to go pretty far out

the curve.

Extending duration on investments creates duration risk in today’s rate

environment.

Combining Swaps with longer duration securities can offer a NIM enhancement

strategy to banks and mitigate any future loss of value, due to rising rates, in a

bank’s investment portfolio.

By using different derivative structures, a financial institution can take

advantage of curve shape and add risk reducing caps or swaps in its risk

management strategy.

27

Hedging Both Sides of your Balance Sheet

Assets

Individual loans

Loan portfolios

Individual securities

Fed Funds lending

Floating rate loans w/ floors

Liabilities

FHLB advances

Fed Funds facilities

Brokered CD issuance

Money market accounts

Trust Preferred securities

Other long term debt

Common Hedged Items Common Hedging Strategies

Both sides of a Bank balance sheet lend themselves to rate hedging products.

To mitigate risk against rising rates:

Pay Fixed Swaps

Interest Rate Collars

Purchased Options:

• Interest Rate Caps, Corridors

• Payer Swaptions

To mitigate risk against falling rates:

Receive Fixed Swaps

Reverse Interest Rate Collars

Purchased Options:

• Interest Rate Floors

• Receiver Swaptions

Other hedging strategies:

Basis swaps

Pre-Issuance hedges

Reset risk (FRAs, swaps)

27

Hedging Ideas

How A Spot Starting Swap Works Against An FHLB Advance The analysis is based on a bank borrowing $10 million from FHLB in a 3 month LIBOR floating rate

advance and executing a spot starting swap that begins immediately and matures in 10 years.

During the 10 year period, the bank would simply pay the FHLB a floating rate of interest equal to

3mL + 0.13%. In addition, you execute a swap with a dealer separate from your FHLB advance.

The swap would effectively fix the all-in interest rate on the advance.

FHLB

Swap Fixed Rate (2.37%)

3-Month LIBOR3ML (0.23% today)

+ 0.13%

Interest Rate Swap FHLB Advance

Dealer Your Bank

Sample Payment Exchanges

if 3 month LIBOR is +

Net Swap Payment /

Paid (Received) = Fixed Swap Rate +

FHLB Spread =

All-in Fixed Rate

0.00% + 2.37% = 2.37% + 0.13% = 2.50%

0.23% + 2.14% = 2.37% + 0.13% = 2.50%

1.23% + 1.14% = 2.37% + 0.13% = 2.50%

2.23% + 0.14% = 2.37% + 0.13% = 2.50%

3.33% + -0.96% = 2.37% + 0.13% = 2.50%

4.33% + -1.96% = 2.37% + 0.13% = 2.50%

5.33% + -2.96% = 2.37% + 0.13% = 2.50%

0.23% today

29

Portfolio Caps

Hedging with Interest Rate Caps

3mths 6mths 9mths 1yr 15mths 18mths

2.00%

LIBOR

Client gets paid only when LIBOR is above 2.00%

Upfront Premium

Cap

XYZBank

DealerBank

30

Cap payout

Cap payout

Portfolio Caps

Interest rate caps have become attractive

hedging tools as portfolio managers look to

protect unrealized gains from rises in rates

without giving up attractive yields on the

existing portfolio.

A cap has an asymmetric payoff profile,

where a purchaser pays a premium in

exchange for payment if rates move a pre-

determined amount in one direction. A cap

is a type of option contract, and can be

viewed as a form of insurance policy.

A cap is paid for upfront and then pays an

amount as a percentage of notional when

the interest rate rises above the strike rate

(set at time of purchase).

Principal is never exchanged and the

amount of interest calculated is based on a

notional amount over a specified term.

31

Value Drivers of Option Contracts

Option Value = f (Intrinsic, Time to Expiry,Implied Volatility)Discounted to Today

Option Value Sensitivities

Parameter Shift

Option Value

Time to Expiry

Increases Increases

Volatility Increases Increases

Moneyness/Intrinsic Value

Further-in-the-money

Increases

Discount Rate

Increases Decreases

Hedging Commercial Loans with Back-to-Back Swaps

Back-to-back swaps (as well as hedging individual fixed rate loans) allow banks

to be competitive in market by making longer-term lending commitments to

borrowers but retaining floating rate assets on their balance sheet.

The Bank issues a floating rate loan to the Borrower and executes hedge

documentation with the Borrower.

Credit agreement is drafted in a swap friendly manner. This language typically

includes securing hedge exposure with the debt on a pari passu basis.

The Bank executes an interest rate swap with their End-User, then in turn

executes an offsetting market hedge with the Swap Dealer.

32

Floating Rate Loan Libor + 3.00%

Interest Rate Swap 5.07%

Libor + 3.00%

5.07%

Libor + 3.00% Interest Rate Swap

Your BankBorrower(s) Dealer Bank

Hedging Commercial Loans with Back-to-Back Swaps

The trade details are typically identical to the loan: notional amortization,

maturity, floating rate index, reset fixing days, and payment frequency.

The interest rate risk is mitigated by the Swap Dealer; the default risk of the

End-User is retained by the Bank.

If you mark up the 25 due in 10 amortizing 5.07% rate above, it creates an

opportunity for your bank to earn a fee income.

33

Floating Rate Loan Libor + 3.00%

Interest Rate Swap 5.07%

Libor + 3.00%

5.07%

Libor + 3.00% Interest Rate Swap

Your BankBorrower(s) Dealer Bank

Dodd-Frank Considerations

Dodd-Frank Title VII (OTC Derivatives Reform)

Hundreds of banks around the country help their customers hedge loans by

entering into interest rate derivatives. These derivatives are executed bi-

laterally over-the-counter (OTC) (i.e., one counterparty faces another

counterparty directly – not through a clearing entity like LCH or via an

exchange like CME).

Historically, such OTC derivatives have been subject to broad bank regulator

oversight, but Title VII of the Dodd-Frank Wall Street Reform and Consumer

Protection Act changes that, to provide specific regulatory oversight for the

derivative industry activities.

Under Title VII, all derivatives — hedges executed by both financial and non-

financial end users — are subject to regulatory oversight and new

requirements.

35

Dodd-Frank Title VII (OTC Derivatives Reform)

As a result of these new regulatory changes, multiple business functions are

impacted, including treasury, compliance, risk, legal, operations and technology

in order to handle existing derivative positions and to enter into new derivative

transactions.

The Commodity Futures Trading Commission (CFTC), the agency selected by

congress to regulate interest rate, commodity and select foreign exchange and

credit derivatives, has broad enforcement authority and may impose stiff civil

and criminal penalties for non-compliance with the new, sometimes complex,

regulations.

36

What is Changing for Financial Institutions?

The derivatives business for banks, post Dodd-Frank, has undergone significant

change. Not all community and regional banks are fully focused on the changes

yet or are getting properly prepared to meet the challenge.

Community banks may not have the infrastructure or the personnel in place to

effectively manage the business once all the Dodd-Frank changes are in full

effect.

Swap dealers may not be positioned to provide many of the support systems

necessary to assist community banks run an effective derivatives business in

this new regulatory environment.

The changes needing to be addressed include business conduct rules, end user

eligibility, new counterparty and product identifiers, potential clearing /

exchange requirements, along with recordkeeping, record retention and trade

reporting requirements. Even swaps for bank asset-liability management not

involving bank end user clients are impacted.

37

Some Key Aspects of Dodd Frank

Swap Data Reporting: Any financial institution who enters into a swap with its end

user clients is responsible for reporting this swap activity to a Swap Data Repository

(“SDR”). As of July 1, 2013, such reporting must happen within 48 hours of entering

into a new transaction. The rule also requires reporting of a specific set of swap data

at the creation of the swap, ongoing reporting during the life of the swap, and also

defines specific historical swap reporting requirements as well.

Eligible Contract Participant: The Dodd-Frank Act makes it unlawful for a person that

is not an Eligible Contract Participant (‘‘ECP’’) to enter into a swap. In addition, the

Dodd-Frank Act makes it unlawful for a financial institution to enter into an interest

rate swap with or for a person that is not an ECP. Financial Institutions may rely on

the written representations of counterparties in the absence of red flags.

Recordkeeping and Record Retention: The Dodd-Frank Act calls for swap parties to

keep records relating to swaps throughout the existence of each swap and for 5 years

following final termination or expiration of the swap (and for transactional records to

be “readily accessible” throughout the term of the swap and 2 years following; non-

transactional records must be accessible during the first 2 years of the retention

period).

38

Some Key Aspects of Dodd Frank

Scenario Analysis: While this element of the external business conduct rules is

not required of financial institutions that are not registered as a Swap Dealer or

Major Swap Participant, Scenario Analysis must be made available by Swap

Dealers and Major Swap Participants to their end-user derivative counterparties.

In general, Scenario Analysis is an expression of potential losses to the fair

value of the swap in severe market/rate shocks. Notwithstanding the lack of

regulatory requirement, we believe making Scenario Analysis information

available to your swap clients is a best practice that should be instituted by any

financial institution offering swaps.

Credit Exposure in a Derivative: Section 610 of the Dodd-Frank Act expands

the definition of “loans and extensions of credit” to include credit exposures

arising from derivative and securities financing transactions. To reduce the

burden of these new credit exposure calculations, particularly for smaller and

mid-size banks and savings associations, the rule permits, in certain

circumstances, the use of look-up tables for measuring the exposures for each

transaction type.

39

Important Program Considerations

40

Com

pliance

The Dodd-Frank Act makes it unlawful for a person that is not an Eligible Contract Participant (‘‘ECP’’) to enter into a swap. Proper documentation must be signed before entering into a swap with a commercial borrower of your Bank. Your Bank is also required to report its commercial borrower trades to a Swap Data Repository within 48 hours of transacting.

Mark

eting

Your Bank will need to ensure that clients understand how an interest rate derivative transaction works and what some of the risks are. One of the important considerations of such marketing effort should be to provide client a Scenario Analysis. In general, Scenario Analysis is an expression of potential losses to the fair value of the swap in severe market/rate shocks over the life of the swap.

Cre

dit

Exposure

When a bank enters derivative contract with a client, it takes on credit risk. This risk is that a counterparty will default when it had a net remaining obligation to the bank on remaining payments. The OCC has defined two methods for regional and community financial institutions to calculate such exposure. Your Bank must choose one of these methods to calculate the credit exposure for any derivative transaction and obtain approval for it when underwriting the loan, as well as stay within legal lending limits per 610/611.

Tra

de

Execution

Executing a back to back swap for a client involves a simultaneous execution of two trades. One with the swap dealer of your Bank and the other with the client of your Bank. Both the dealer and the client enter into an oral contract with your Bank which is documented through a trade confirmation immediately following the oral agreement.

Tra

de

Serv

icin

g

Once the trade is in place and confirmed through a written trade confirmation, the trade will need to be operationally serviced throughout its life. Some aspects of servicing involve reporting to a Swap Data Repository, sending monthly payment notices to your Bank’s clients and providing mark-to-market statements, if requested, to the clients as well.

Who is an ECP?

41

No

Yes

Is the counterparty an individual?

Does the individual have discretionary investments in

excess of $5 MM?

Does the entity have total assets in excess of $10 MM

Does the entity have a new worth exceeding $1 MM and is entering into the transaction to manage an asset/liability?

Do all the owners qualify as ECPs?

Does the entity have a corporate guarantor with

assets in excess of $10 MM?

Counterparty qualifies as an ECP.

Does the cumulative net worth of the entity and all of the owners

exceed $1 MM?

Counterparty does not qualify as an ECP and CANNOT enter into a

swap.

Is the individual entering into the transaction to manage an

asset or liability?

Does the individual have discretionary investments in

excess of $10 MM?

No

No No

No

Yes

Yes Yes

Yes

YesNo

No

No

No Yes

Yes

Risk Management/Credit Exposure

Background on Credit Exposure

To reduce the burden of these new credit exposure calculations, particularly for

smaller and mid-size banks and savings associations, the rule permits, in certain

circumstances, the use of look-up tables for measuring the exposures for each

transaction type.

This method permits institutions to adopt compliance alternatives that fit their

size and risk management requirements, consistent with “safety and soundness

and the goals of the statute," according to the OCC.

The rule permits banks to choose from three alternative methods for calculating

“credit exposure” arising from derivative transactions. These methods are

described in detail on the following slides.

43

Defining Derivative Credit Exposure

“Credit exposure” from a derivative transaction is viewed as the sum of the current

credit exposure plus potential future exposure (PFE).

The interim final rule defines “current credit exposure” as the mark-to-market (MTM) of

the transaction.

PFE recognizes that the MTM may increase over time due to changes in market factors.

The PFE + the current MTM is the anticipated maximum potential exposure (“MPE”).

OCC Acceptable Exposure Calculation Methods

Method 1: Internal Model Method

Method 2: Constant Maturity Method

Method 3: Current Exposure Method

44

Method 2: Conversion Factor Matrix Method

This method is available for all banks. Under this method, credit exposure will be a fixed

amount during the life of the swap transaction equal to the notional amount of the

derivative transaction multiplied by the conversion factor set forth in a look-up table

(“Conversion Factor Matrix”).

This approach is considered significantly less burdensome than the Internal Model

Method because institutions would not have to establish statistical simulations of

future PFE calculations, nor measure actual MTM.

The conversion factor matrix method does not seem to take netting or collateral into

account.

45

Original MaturityConversion Factor for

Interest Rate Derivatives

1 year or less 0.015

Over 1 to 3 years 0.030



Over ten years 0.300

Credit Exposure = Notional amount x Conversion FactorExposure for a $10mm, 10-year transaction = $10mm x 12% = $1,200,000

Method 3: Current Exposure Method

This method is available for all banks. Under this method, the measurement of the

credit exposure incorporates both the current MTM and a set additional exposure amount

for the transaction’s remaining maturity.

Credit exposure is measured by adding the current MTM of the transaction to the product

of the notional amount of the transaction, a fixed multiplier based on remaining maturity,

and PFE.

As the remaining maturity of the derivative transaction decreases, the credit exposure

under this method also decreases.

46

Credit Exposure = Current credit exposure + PFE ORCurrent MTM + (Notional Amount x Conversion Factor)$10mm, 10-year Swap, with MTM of $0 Initial Exposure = $0+ (.015 x $10mm) =$150,000 or 1.5% of notional

Remaining MaturityConversion Factor for Interest Rate

Derivatives

1 year or less 0 (0%)

Over 1 to 5 years 0.005 (0.5%)

Over 5 years 0.015 (1.5%)

Concluding Remarks

Use of Derivatives by Banks in the U.S.

Derivative Use By Banks: $2bln to $20bln in Assets as of March 31, 2015

49

78% of medium-size banks

around the U.S. use some form

of interest rate derivatives to

either help their customers

hedge loans or to manage the

risk on their own bank’s balance

sheets. This percentage has

risen steadily since the financial

crisis.

Source: FDIC Call Report Data, March 31, 2015

Focusing on the Future

Back to back swap activity has picked up in anticipation of Fed move.

Demand for long-term fixed rate loans from commercial borrowers is a great reason to consider

using a similar program for your bank.

Banks remain focused on the liability side of the balance sheet (i.e. banks

paying fixed, purchasing caps, etc.).

As the Fed begins its tightening cycle, banks will need to recalibrate their expectations in

regards to the endless supply of deposits available in their local markets. We recommend

focusing on your future funding needs today and employing appropriate strategies to address

any vulnerabilities.

We’ve seen banks hedging future Federal Home Loan Bank borrowings by

paying fixed on forward-starting transactions (along with the hedging of other

wholesale funding options).

We have also seen some amount of cap buying to hedge against future rising

rates.

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