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
Community bankers are currently paying close attention to commercial loan pricing given near-record tight credit spreads and increasing interest rate risk. The vast majority of commercial loans in the market are priced to an index plus a credit spread. Determining the appropriate credit spread that will win the business and provide sufficient return to the lender is a key element of RAROC (risk adjusted return on capital) analysis. However, the underlying index to
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
Historically community banks have been hesitant to use derivatives, mostly interest rate swaps, to manage credit, interest rate, and sales risk. Derivatives have been historically stigmatized and even more so after the last recession. Interest rate hedges have predominantly been used by larger and more sophisticated banks. However, approximately 15% of all commercial banks now report some form of a derivative on their balance sheet, and 9% report interest rate swap exposure.
Until approximately ten years ago, interest rate loan hedging (using swaps) was prevalent for national and larger regional banks, but most community banks avoided loan hedging for various reasons. In the last ten years, more community banks have started to offer their borrowers some form of loan hedging option.
In this era of compressing margins and volatile rates, not having a prepayment provision on your loans is likely costing your bank a material amount of income.
The competition for qualified borrowers is intense, and both pricing and structure are being compromised. In our dealing with hundreds of banks and thousands of borrowers, we observe strategies and structures that have worked for our customers. In today’s competitive environment, it is important that bankers keep a close watch of what is working and think creatively to try to maintain structure and price. We would like to share ten strategies that we and other community banks have effectively deployed to win bus