We believe all banks should have a hedging program to manage interest rate risk while providing a variety of loan structures to satisfy the borrower’s, not the bank’s needs.
Relationships between different variables can be very complex in the real world and banking is a perfect example of this complexity. The human mind, however, is skewed to perceive relationships in a linear fashion and this can lead bankers to make the wrong decisions. With the odd shape of the yield curve, we are seeing smart bankers making very profitable lending decisions because they understand their business model, the shape of the yield curve and the nonlinearity of commercial loan pricing.
For all banks, the flattening yield curve is impacting profitability. The difference between the Two-Year swap and the Ten-Year swap rate is around 12 basis points. For banks over $15B, this flattening moves net interest margin (NIM) lower and then improves past the one year mark. However, for community banks under $15B, the flat curve not only moves net interest margin down, but this lower profitability becomes worse over time.
Everyone agrees that using the correct tool for the job is an important rule for successfully completing a project. Using a sledgehammer on tacks will leave dents, and applying a screwdriver to move boulders will likewise be equally counterproductive. The same rule applies in banking, and most community bankers are well aware of this. Community bankers appreciate that their project is very different than the projects at national and regional banks. Community banks have different business models and different customers compared to the nation
When banks decide to adopt a loan hedging product the initial management strategy is to reserve it as a defensive tool only. Typically bankers decide to adopt a swap program because borrowers demand longer fixed rates, competition is willing to accommodate such structures (often with a swapped solution) and extending loan duration in a rising interest rate cycle does not make sense for prudent ALM purposes.
Compared to larger lenders, community banks have faced significant challenges in generating non-interest income.
In a previous blog, we described what factors community bank managers might want to consider in analyzing a loan hedging program for their specific needs. In that blog, we listed the pros and cons of using a hedge to control risk and increase profitability. We then wrote a follow-on article that analyzed the various instruments and strategies common in the bank hedging market to include swaps and other interest rate derivative instruments. We provided an in-depth
The Federal Reserve held off in raising rates at its November meeting, preferring to assess the results of the presidential election and allow time to make further progress on their twin goals of full employment and price stability. Since that November meeting, the results of the presidential elections have convinced markets of future expected inflationary pressures resulting from fiscal stimulus in the form of tax cuts and increased government spending. Furthermor
If banking had an Olympics, creating loan value would be an event. While many lenders and business development officers are good at gathering new business, they are often reactionary when it comes to structure not taking the time to find the best structure for the client. They may provide what the client wants, but not what the client needs.
Commercial banks grew loan balances by 2.11% in the second quarter of this year compared to the first. This growth belies that some banks increased their commercial loan portfolios more than the industry average and other banks experienced shrinking loan volumes. While the industry is experiencing much needed total growth, that growth is not evenly distributed among banks.