Installing an interest rate swap program at a community bank
Summary
Bob Newman interviews Kish Bank CFO Mark Cvrkel who shares how embracing and installing derivative capabilities at a $1 billion bank was simpler than expected. The conversation uncovers three benefits that favor the use of traditional swaps over indirect programs.Why do many community banks avoid direct contact with swaps?
Interest rate swaps are tailor made to solve the most universal problem facing a financial institution: an interest rate mismatch on the balance sheet. But because the word “derivative” may conjure up thoughts of complexity, many banks seek to access the benefits of swaps through indirect channels, while some choose to avoid them altogether. Rather than jumping to the conclusion that swaps are not worth the trouble, consider how your institution can access these three benefits by installing traditional swap capabilities.
Flexible balance sheet management
Banks that choose to avoid derivatives by sending loan swaps to an indirect third-party are missing out on a tremendous opportunity to hedge interest rate risk at the balance sheet level. With traditional swaps installed, banks can reduce wholesale borrowing costs and use strategies to optimize the securities portfolio, enhancing NIM without taking on undue exposure to a changing yield curve. Recent improvements to the derivatives accounting standard have increased access to portfolio hedging strategies while removing many of the “gotchas” that once made hedge accounting something to be feared.
Fee income and core business growth
Banks that switch to traditional swaps with commercial borrowers keep full control of their loan collateral and credit approval process and typically increase fee income by 30% to 40% compared with an indirect program. With traditional swaps, the borrower’s entire relationship remains local (a third-party is not contractually involved) while industry-standard documents provide transparency.
Framework for pricing and profitability with traditional swaps
With traditional swaps installed, community banks gain access to a market-based capital markets pricing framework, improving discipline in structuring fixed-rate loans and negotiating prepayments and opportunistic re-pricing requests from borrowers.
Roadmap for installing traditional swaps
With banks facing continued margin pressure in 2021 from the extended zero-interest rate environment, access to traditional swaps has become even more important. The best starting point is education for the management team and board. From there, establishing a derivatives policy, a counterparty relationship, and a regulatory compliance plan creates a solid foundation on which to build hedging programs for the bank and its customers.
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Disclaimers
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 chathamfinancial.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.
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