Community banks, correspondent programs, and interest rate swaps
Key Takeaways
- Community banks that rely on correspondent fixed-rate programs to meet borrower demand are starting to revisit how well those programs serve them as they grow
- As those programs grow, banks are taking a fresh look at hidden trade-offs in pricing, economics, and collateral control
- By accessing interest rate swaps directly through swap dealers, banks can keep fixed-rate lending on their own paper while managing rate risk on the balance sheet
Overview
In a new article in Great Lakes Banker, Josh Cannington, Vice President, Interest Rate Risk Management at StoneX, looks at how one Great Lakes community bank rethought its approach to fixed-rate lending and interest rate risk.
The bank initially turned to a correspondent “turnkey” fixed-rate program to meet demand for seven- and ten-year payment certainty without building full derivatives capabilities in-house. Over time, as more production flowed through the program, leadership began to see pressure on loan pricing, margin, and relationship flexibility. That prompted a closer look at how these programs are structured and where the economic value ultimately sits.
When “easy” fixed-rate solutions create new questions
For many lenders, correspondent fixed-rate programs solve real problems at the outset. They simplify quoting, streamline documentation, and allow banks to book floating-rate assets while borrowers receive long-term payment certainty.
As the Great Lakes bank’s use of the program grew, familiar tensions began to surface. Competitive deals with strong credit quality became harder to win on rate. Post-close events – early payoffs, refinancings, restructurings – were more complicated to navigate because key elements of the payoff math sat with a third-party desk.
These experiences led the bank’s finance team to run a simple comparison: how the economics of its correspondent program stacked up against what it could access by hedging directly with swap dealers.
Trade-offs in pricing, economics, and control
That analysis highlighted three key trade-offs:
Pricing. Instead of discovering price in the swap market, the bank was accepting levels passed through from a correspondent desk that was itself sourcing from swap dealers. In practice, the institution was several steps removed from the wholesale interest rate swap price it could have accessed directly.
Economics. While the bank earned something at closing, much of the hedge value – execution spread, embedded fees, and optionality – accrued outside the institution.
Control. Structures designed to protect the correspondent’s position often relied on participation or assignment mechanics. The originating bank kept the borrower relationship, but no longer held all of the levers on collateral and payoff flexibility.
The bank concluded it hadn’t been “avoiding swaps” so much as paying to buy someone else’s swap.
Taking back pricing and balance sheet control with interest rate swaps
The bank decided to explore a more straightforward interest rate swaps approach instead of trying to build out a complex derivatives infrastructure. By doing so, it was able to keep the fixed-rate loans on its own paper, while retaining the first lien on collateral and hedging rate exposure directly with swap dealers.
For borrowers, not much visibly changed. They still signed straightforward fixed-rate notes and made one payment to the bank each month, while the bank could use interest rate swaps as balance sheet hedges, turning its fixed-rate exposure back toward floating.
That shift gave lenders more room to work. They could price and structure deals with greater flexibility and see more clearly how each hedge affected the economics of a loan. And there was an added benefit. The bank was also able to bring payoff and modification conversations back under its own credit standards and relationship approach.
A transitional step for many banks
Cannington points out that correspondent fixed-rate programs exist for a reason. They give banks a way to meet fixed-rate demand before they’re ready to build full derivatives infrastructure of their own. For many institutions, however, they become a transitional step.
Once a bank takes the time to see how these programs are put together, and who is getting paid for what, it becomes easier to spot the moments when going directly to swap dealers might be a better fit.
In those situations, interest rate swaps can help on both sides of the table. Borrowers still get the fixed payments they’re looking for, while the bank gains more control over pricing and a balance sheet that can better handle rate moves.
Access the full article
Read the full story in Great Lakes Banker here.
StoneX delivers interest rate swaps and balance sheet hedging solutions for banks, credit unions, and other lenders. Drawing on our interest rate trading and derivatives capabilities, we provide access to competitive swap pricing and execution through straightforward, turnkey programs. Backed by StoneX Group Inc. (NASDAQ: SNEX), a fully regulated and Moody’s/S&P-rated Fortune 50 company, StoneX Pro maintains rigorous compliance and governance standards.
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