Derivative Hedging
Unmanaged risk can cause major headaches down the road.
Derivative hedging from Catalyst helps you establish a proactive risk management strategy to minimize exposure to changes in interest rates. Interest rates will rise, and they will fall, both of these can lead to earnings pressure. This is where a proactive risk management strategy using interest rate derivatives can help. Concerned about asset yields being too “sticky” when rates rise? We have a derivative strategy for that. Concerned about funding costs not falling fast enough when rates decline? We have derivative strategies for that too! Want to grow your mortgage portfolio, but hitting up against your NEV limitations? Yep, we have a strategy. Interest rate derivatives are extremely versatile and flexible tools created for the purpose of interest rate risk management. Let the experts at Catalyst help you understand how interest rate derivatives can improve the operating profile of your credit union through all the expected and unexpected rate gyrations.
Derivatives offer a host of benefits in managing interest rate risk.
- Extremely flexible and customizable to meet your specific needs.
- No balance sheet and capital impact that occurs from using borrowings.
- More cost efficient than borrowings.
- Greater risk management capacity than on balance sheet options
- Preserves liquidity sources for their intended purpose…liquidity!
There are no one-size fits all strategies, so the team at Catalyst works with you to build the strategy that meets your needs and comfort levels. The team of experts at Catalyst does more than just build strategies, we support staff training and education, trade execution, post trade support, policy development, and counterparty reviews.
Start an engagement with our experts today.
Important Disclosures:
"Catalyst" is a brand name for the financial services business conducted by Catalyst Corporate Federal Credit Union ("Catalyst"), both directly and through its subsidiaries, including CUSOURCE, LLC, d/b/a Catalyst Strategic Solutions ("CSS"). Balance sheet management services and asset liability management services are offered through CSS, a SEC registered investment adviser. CSS is a separate entity from Catalyst and all investment decisions are made independently by CSS employees. Neither Catalyst nor CSS provide its clients with legal, tax or accounting advice.
Frequently Asked Questions
Derivative hedging, as it applies to credit unions, is the practice of executing a contract with a third party to provide payment to the credit union if the events outlined in the contract are met. Credit unions use derivatives to mitigate interest rate risk.
NCUA authorized certain federal credit unions to enhance their interest rate risk mitigation strategies by purchasing derivatives. While credit unions have had access to derivative instruments for some time, using them to hedge risk is unchartered territory for most. Catalyst offers derivative hedging services as an interest rate risk management solution for credit unions.
Derivative hedging may allow credit unions to hold a greater concentration of longer-term higher-yielding assets – most commonly mortgages – without the associated interest rate risk. These instruments also are used to stabilize a credit union’s cost of funds, for hedging mortgage pipelines, and to provide an alternative to selling an asset or taking out a borrowing, with the added benefit of not diluting capital ratios.
Services include in-depth training and education throughout the process, assistance with NCUA derivative applications, development of derivative policies and procedures, interest rate risk modeling, legal review of all derivative documentation, counterparty credit analysis, derivative hedging strategies, trade execution and transaction management, daily monitoring of derivative pricing and collateral management, among other services.
It takes approximately six months to institute a program.
The first month includes board education and pre-approval. Month two involves the development of derivative policies and a hedging strategy, plus the submission of an application letter to the NCUA or state authority. Months four through six include International Swaps and Derivatives Association (ISDA) agreements and derivative analytics, performing ALM analytics, setting up accounting functions, obtaining hedge counterparties, legal review, and hedge execution and strategy implementation.
Catalyst has managed derivative transactions for interest rate risk mitigation for more than 20 years and was an approved derivative vendor under the NCUA’s investment pilot program.
Approved for the NCUA’s pilot program 10 years ago, Catalyst’s team of experts has tailored a solution to support the needs of credit unions seeking to take advantage of the benefits of the new derivatives regulation.
While there is a wide array of derivative structures, the new regulation only allows for specific interest rate derivative instruments, including: interest rate swap, basis swap, interest rate cap, interest rate floor and U.S. Treasury note futures.
Interest rate derivatives are financial contracts executed between two parties, designed to protect the balance sheet from exposure to changing interest rates.
Derivative strategies can utilize forward dates of up to 90 days. These include plain vanilla swaps, amortizing swaps, interest rate caps and interest rate floors.
Insights from Catalyst
Catalyst has seen a sharp uptick in derivative trading activity through the first half of 2023, and it appears more than just Catalyst clients are increasing their trading activity. Since the end of 2019, total derivatives outstanding have increased from $13.2 billion to almost $34 billion as of March 31, 2023.