2 minutes
Combine loan hedging and forward rate lock strategies to mitigate interest rate risk and ensure the financial well-being of your borrowers.
Sponsored by PCBB
In today's ever-changing economic landscape, credit unions face the challenge of managing interest rate risk while meeting the needs of their members, especially their commercial members. With interest rates fluctuating and borrowers seeking stability, navigating these complexities to stay competitive and protect relationships may seem difficult. However, by combining loan hedging and forward rate lock strategies, which we’ll explain more fully in the next section, financial institutions can mitigate rate reset risk, protect against unexpected rate fluctuations and ensure the financial well-being of their borrowers. This strategy can provide the same safeguards for your credit union, too.
The Power of a Forward Rate Lock
Forward rate lock hedges have become a valuable tool in the current interest rate environment, particularly for commercial real estate borrowers. FRLs allow lenders to establish fixed rates for future financing, protecting against rate changes before the loan begins or before it is due for repricing. These hedges are particularly beneficial when the yield curve is inverted or interest rates are rising, offering borrowers security and flexibility.
Divergence between market expectations and Federal Reserve Bank rate policy creates a unique opportunity for borrowers seeking fixed-rate loans. As the bond market projects falling rates while the Fed emphasizes rates will be higher for longer, forward starting swaps are currently available at a discount compared to standard spot rates. In this environment, you can leverage FRL agreements to mitigate rate uncertainties, protect your institution and business borrowers from credit stress, and safeguard net interest margins against compression.
The Forward Rate Lock and Rate Reset Risk Mitigation
Loans originated in recent years are approaching repricing, which exposes borrowers to the possibility of significantly higher interest rates and credit unions to the risk of losing commercial loan relationships to competitors. To get ahead of this, lenders can adopt strategies like hedging, which allows loan term adjustments to be combined with an FRL—locking in borrowers with fixed rates before they refinance elsewhere. This forward starting swap also eliminates future rate uncertainty for commercial borrowers and provides them time to plan for and adjust to new rates. Moreover, you can prevent NIM compression by leveraging FRLs to reprice loans at shorter intervals, aligning rising deposit costs with increasing interest income from loans.
Unlocking the Benefits
Mitigating rate reset risk is crucial for lenders in today's financial landscape. Implementing a commercial hedging strategy and utilizing forward rate locks can safeguard you and your borrowers from the impact of interest rate fluctuations. These solutions provide borrowers with stability and lenders with risk mitigation, ensuring long-term success and financial well-being.
Femi Audifferen has more than 23 years of banking, finance and capital markets experience. At PCBB, Audifferen is SVP/manager of hedging solutions. In that role, he helps clients to strategize, structure and execute hedging solutions to mitigate interest rate risk. He also holds the financial risk manager designation, a globally recognized certification for financial risk managers. Partnering with institutions like PCBB and our loan hedging solution, Borrower's Loan Protection®, you can access expertise and support in implementing these strategies effectively. To discover which hedging strategy is right for you—including understanding the different programs available in the market today—download our insights paper, Developing and Implementing a Hedging Strategy.
