Correspondent Blog
Loan Hedging
How to Increase Commercial Loan Retention
Community bankers need actionable recommendations. For example, if your bank has a higher efficiency ratio, lower fee income, or higher loan prepayment speeds than its competitors, then advising management to decrease efficiency ratio, increase fee income, or reduce loan prepayment speeds is not actionable. How does management achieve those recommendations? We are big proponents of…
Getting Paid for Fixed Rate Loan Risk
Bankers agree that reward (revenue) is a prerequisite for accepting risk. It would make no sense to risk the bank’s capital without adequate compensation. However, to avoid commercial fixed rate loan risk, the first crucial step is to measure that risk. We will show how banks that start to accurately measure interest rate risk embedded…
Filtering Risk With a Bank Hedge Strategy
In our previous article (here), we made the argument that the next administration’s agenda is highly inflationary, will likely lead to higher interest rates and more volatility. We estimate a high probability that after this current interest rate cutting cycle, which may end sometime in 2025, that higher inflation will result in the Federal Reserve…
Community Bank Loan Performance Analysis
We conducted a loan performance analysis for over 5,000 individual hedged commercial loans originated by almost 400 community and regional banks across the country. We measured prepayment speeds, loan size, loan term, fee income, loan yield, credit performance, and return on equity (ROE) of hedged loans and compared this performance to community bank industry averages….
If You Are Tired of Being Transactional, You Need A Hedge Program
An inverted yield curve, continued bank failures, and the desire to manage risk and offer clients higher service are all factors that are driving more community banks to adopt a loan hedge program. Community banks’ main goals are to diligently support their local communities and make an acceptable return on capital in these challenging times….
Managing Interest Rate Risk With a Bank Loan Term Sheet
We recently reviewed a loan term sheet from a national bank for a $13mm commercial real estate (CRE) loan. The bank offered a 25-year amortizing loan with a ten-year term and required the borrower to hedge its interest rate risk. The borrower was provided options on the type of hedge and when to execute. The…
How to Lock a Forward Rate on a Loan
A forward rate lock allows lenders to deliver a known loan rate on future borrower financing. This strategy is used for various reasons discussed further in this article. Recently, larger lenders, including Bank of America, JPMorgan, Goldman Sachs, and Wells Fargo, have announced that they are seeing an elevated appetite for forward rate locks on…
Risk of Derivatives – The Fall of an Index
There are many historical examples of some sophisticated and some less sophisticated entities imploding from the risk of derivatives. Barings Bank, Orange County (CA), Enron, Long-Term Capital Management, and other entities misused derivatives or didn’t understand the difference between hedging and speculating. Some bankers will soon hear about another example of banks using derivatives that,…
Loan Hedging for Community Banks in 2024
Community banks’ use of swaps (banks’ primary tool to hedge interest rate risk on loans) has increased substantially over the last ten years. The market expects the current inverted yield curve to remain through much of 2024 (based on long-term interest rates and the expected rate cuts in 2024). Meanwhile, community banks face net interest…
Loan Performance Analysis – Hedged vs. Unhedged Loans
We analyzed the loan performance (return on equity, loan yield, fee income, and loan size) of hedged borrowings in a large group of community banks and compared this to the community bank industry averages. We conclude that loan-level hedging offers community banks a strong competitive advantage in the current interest rate and competitive commercial loan…
Yield Curve Impact on Bank Profits
The bigger risk to community banks’ business model is not a moderate recession induced by aggressive interest rate increases by the Federal Reserve. Instead, the more painful scenario for the banking industry is the following: no recession, short-term interest rates holding steady in anticipation of inflation reaching target rates, and a prolonged inverted yield curve….
Derivatives Usage By Community Banks
Our previous article discussed how the banking industry is taking advantage of interest rate swaps to offer borrowers lower rates, allowing banks to earn higher yields, generate substantial fee income, and protect deposit relationships. Of the largest 250 banks, 90% are using interest rate swaps, and because these largest 250 banks hold 83% of all…