3. Protecting your institution from Net Interest Margin (NIM) compression. In recent years, when interest rates were low, the cost of funding wasn’t a significant issue for banks. As rates have risen rapidly and more than expected, financial institutions have needed to increase the rate on their deposits to avoid losing customers to more competitive offers. As such, the substantially higher cost of funds has compressed NIM. Without hedging, institutions have to wait for the reset period (e.g. five-year reset on a 10-year term loan) to reprice their loans, while paying higher rates on their deposits in the meantime. This is where the FRL comes in to help reduce that risk. “With forward rate locks, financial institutions can essentially convert from conventional five year repricing loans, at their next reset, to one that resets every month,” explains Audifferen. “So as rates go up, deposit costs increase, but they are matched by rising interest income on the loan, with the borrower still benefiting from the fixed rate.” Banks also generate additional fee income from the swap with the refinancing. Your bank may be hesitant to offer hedging solutions primarily due to complexities related to derivatives, but there are options to outsource the hedging function when working with a correspondent bank. PCBB’s Borrower’s Loan Protection® uniquely eliminates the need for you to handle the derivatives associated with an FRL. “So, from the institution’s perspective, they handle the loan, while PCBB handles every other aspect associated with the swap,” Audifferen explains. “We carry the swap on our books and handle all of the operational, collateral, and regulatory requirements. Essentially, the financial institution is able to provide its customer with the fixed-rate term they want, while carrying a floating rate on their books, without engaging directly with a derivative.” With its many benefits, from helping ease credit stress to protection against NIM compression, an FRL is a unique solution that’s a great option for your borrowers as well. Thanks to their ability to protect the borrower against future rate uncertainty without exposing the bank to interest rate risk, an FRL agreement can be a win-win for everyone. To continue this discussion or for more information, please contact Jay Kenney, SVP and Southwest Regional Manager for PCBB, at jkenney@pcbb.com. Dedicated to serving the needs of community banks, PCBB’s comprehensive and robust set of solutions includes cash management, international services, lending solutions and risk management advisory services. Recognized by American Banker as one of the “Best Banks to Work For” in 2022. Thanks to their ability to protect the borrower against future rate uncertainty without exposing the bank to interest rate risk, an FRL agreement can be a win-win for everyone. Utah Banker 19
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