DERIVATIVE HEDGING SERVICES

Meeting members’ needs, regardless of interest rate fluctuations, is critical to the long-term success of a credit union. However, when interest rates are rising, credit unions that add long-term mortgages or investments can bump up against policy limits, increasing risk. This may necessitate selling at a loss and obscure the best path forward.

Managing risk exposure keeps your credit union safe but can also lead to missing out on great opportunities. Good financial health is balancing risk management and future growth and investments. At Catalyst, our goal is not only to help you succeed, but also thrive well into the future.

Interest rate risk, while real, should not be a limiting factor for credit unions seeking to successfully grow and meet their member needs. It would appear that regulators share that opinion, as NCUA eased constraints when it approved a new derivatives rule that greatly reduces the barriers for entry.

Credit unions have long managed interest rate risk exposures through loan sales, loan participations and term borrowings. Each of these strategies, while having a strategic place in risk management, can present challenges ranging from lower long-term earnings potential to net worth dilution.

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Credit Union Insights for Understanding Derivative Hedging

What are interest rate derivatives?

Interest rate derivatives are financial contracts between two parties. Your credit union agrees to exchange interest rate payments with a counterparty. In this agreement, one party pays a fixed payment to the other, while the other party pays a floating rate payment back.
How do interest rate derivatives help credit unions?

Swapping interest rate payments with an interest rate swap effectively converts fixed rate assets into floating rate assets or floating rate assets into fixed rate assets. One of the many benefits to derivative hedging is it allows a credit union to originate mortgage loans without adding the full interest rate risk exposure of those long-term loans.
What place do interest rate derivatives have in a larger risk management strategy?

Interest rate derivatives are one of the many tools available to credit unions. It’s important for credit unions to be aware of how derivative hedging can help manage risk and when this tool is most effective. Interest rate derivatives offer a number of flexible solutions for managing risk in unusual market environments, especially during large fluctuations in interest rates.

The benefits of Interest rate risk derivatives help alleviate many of the challenges credit unions face:

Cost Efficient: Interest rate derivatives typically have a lower cost for the same term as term borrowings.
Flexible: Over the counter (OTC) derivatives can be customized to hedge your selected asset or liability, and they are easily liquidated if a hedged position changes.
No Penalty Fee: OTC derivatives can be liquidated at fair market value and do not have prepayment penalties that are common with term advances.
Preserve Net Worth: With successful hedge accounting treatment, interest rate derivatives are kept off-balance sheet, which means they do not increase total assets and thus do not dilute net worth.
Maintain Liquidity: Liquidity risk is very real. Interest rate derivatives do not consume secondary liquidity sources to manage interest rate risk as term borrowings do.

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"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.