Derivative Sales Program
Success Stories

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Regional Bank Wanted to Protect Returns on Cash Balances & Customer Loan Portfolios

Challenge:

Cash balances are routinely deployed in customer loan portfolios.

The returns on cash balances & customer loan portfolios are both indexed to the Fed Funds rate.

As interest rates decline, the return on these assets is reduced.

Fed Funds is not as liquid as LIBOR and therefore more expensive to hedge.

However, hedging with a LIBOR-based product results in basis risk since the indices are not perfectly correlated.

The Bank had executed a few hedge transactions for balance sheet interest rate risk management before, but did not have the in-house expertise to design and support a hedge accounting compliant solution on its own.

The Bank wanted to maintain a minimum fixed-rate return on these variable assets.

Should interest rates increase, the bank did not want to give up the opportunity to continue to participate in the higher interest rate returns.

Solution:

The bank partnered with Derivative Path, Inc. and our partner Sandler O’Neill Hedging Services LLC to ascertain the best hedging instrument to meet their goals.

A purchased floor was utilized in order to protect the rate of return in a downward rate environment while maintaining the ability to participate in upward rate movements.

A LIBOR-based floor was determined to be more cost-effective than a Fed Funds-based floor.

A LIBOR-based floor, however, introduced basis-risk to the hedge items and required hedge accounting analytics to assess the effectiveness of the hedging structure.

Derivative Path performed multiple regression scenarios in order to assess the effectiveness of a one-month LIBOR based hedge vs a hedge based on Fed Funds.

A ratioed, notional hedge exposure was identified as a way to maximize the effectiveness expectations of the hedge.

To ensure that at least the hedged exposure amount would continue to remain outstanding over the term of the hedge, the hedge relationship was established to include cash balances and any customer loans indexed to the Fed Funds rate.

Utilizing its leading edge derivative platform DerivativeEDGETM, Derivative Path will provide ongoing assistance on the Bank’s hedging portfolio with full trade lifecycle journal entries and effectiveness assessments so that the hedging relationships can be monitored and reported. This hedge effectiveness will be monitored in case 1M LIBOR were to diverge from the fed funds rate over time.

Client Profile:

A West coast regional Bank active in the tech industry.

The bank has not historically hedged their excess cash balances but had recently grown concerned about the impact of a declining interest rate environment.

A Midwest-based Bank Wanted to Extend Funding Duration While Minimizing Cost

Challenge:

Banks are looking for cost-effective ways to fund longer-term liquidity needs.

While term funding from wholesale sources such as FHLB may be available, the bank will pay a premium for this term liquidity.

The bank had utilized hedging transactions for balance sheet interest rate risk management in the past, but was concerned that it didn’t have the in-house expertise to design, support and report a hedge accounting compliant relationship.

Solution:

The Bank partnered with Derivative Path, Inc. (DPI) and its partner Sandler O’Neill Hedging Services LLC to ascertain the best hedging strategy to meet its funding goals.

By combining a pay-fixed interest rate swap with a variable rate (3-month) FHLB rolling advance, the bank was able to materially lower its cost of longer-term financing.

Specifically, the bank was able to synthetically lock in a 5-year fixed rate with a pay fixed swap at an expected savings of 30 basis point savings vs. like-term FHLB financing.

For hedge accounting, we helped the Bank designate changes in the 3-month LIBOR swap rate as a hedge of the contractually specified 3-month FHLB advance rate.

By designating the hedged risk as the contractually specified 3-month FHLB funding rate, the bank will be able to substitute another funding source if the FHLB 3-month advances are not available in the future and maintain hedge accounting as long as the hedge relationship continues to be highly effective.

Hedge effectiveness was assessed by comparing the FHLB advance rate to the index on the interest rate swap (i.e., 3M LIBOR) via regression analysis.

Alternatively, the bank could also identify the hedged risk as the 3M LIBOR component of the FHLB advance rate which may allow a more effective hedge assessment, but potentially limit alternative funding sources to maintain the hedge relationship to other 3M advances, such as brokered CDs.

Banks can elect either hedge designation depending on their potential available funding sources and effectiveness assessment preferences.

Utilizing its leading-edge derivative platform DerivativeEDGETM, Derivative Path will provide ongoing assistance on the Bank’s hedging portfolio with full trade lifecycle journal entries and effectiveness assessments so that hedging relationships can be monitored and reported, and hedge accounting treatment can be continued.

Client Profile:

A Midwest-based bank serving consumers, small businesses, middle market companies and professionals.

The bank has historically locked-in longer term, fixed-rate funding from wholesale sources.

Large Regional Bank Wanted to Establish a Derivative End User Program Despite Dodd-Frank and Clearing Uncertainties

Challenge:

Newly-hired senior commercial lending bankers had familiarity with offering commercial clients interest rate hedging products at their previous bank, but the product was not yet approved to offer to their new Bank’s clients.

Conservative bank management wanted to carefully consider their willingness to offer interest rate derivatives as a product solution in a post-Dodd-Frank environment.

The Bank had executed a few derivative transactions for balance sheet management before, but did not have the in-house expertise to design and support a Dodd-Frank compliant client hedging program.

As a Bank over $10 billion in assets, the Bank was required to execute its derivative transactions that would not qualify for end-user or other exemptions on a Clearing Exchange through a Futures Commission Merchant (FCM).

The Bank wanted to remain competitive in winning commercial loans vs. large regional and national banks active in their market, who had greater legal. compliance, and capital markets resources to support a client hedging program.

The Bank wanted to continue to diversify revenue and create non-interest income opportunities.

Solution:

The Bank entered into a partnership with Derivative Path, Inc. in 2013 and utilized the team as their fully outsourced client hedge program solution.

DPI provided a full set of white-labelled client marketing, legal and operational documentation.

DPI helped establish bank credit and risk management policies for client hedging program.

DPI provides ongoing assistance with full trade lifecycle processing and real-time information about the Bank’s derivatives portfolio utilizing DerivativeEDGETM.

DPI helped analyze the incremental cost/benefit impact of clearing on the establishment of their client hedging program as well as helping to analyze and negotiate their best clearing exchange and FCM alternative.

The Bank has experienced strong loan growth and robust fee income generation since the client hedging program was established.

Client Profile:

West-coast regional bank with over $17 billion in assets.

Active in C&I, CRE and Corporate lending.

Had historically hedged some large fixed rate loans, but never offered interest rate derivative transactions to their commercial borrowers.

Regional Bank Needed to Maintain and Expand a Derivative End User Program in the Face of Dodd-Frank Challenges

Challenge:

Had to consider their ability to continue offering interest rate derivatives as a product solution in a post-Dodd-Frank environment.

With no in-house infrastructure and resources to address the complex regulatory requirements, the bank was forced to a) evaluate its ability to continue servicing its existing derivatives portfolio and b) question whether it could continue to offer new derivative hedging solutions to its commercial clients.

Desire to remain competitive in winning commercial loans vs. larger banks with greater legal, compliance, and capital markets resources to support a more regulated client hedging program.

Desire to continue to diversify revenue and create non-interest income opportunities.

Solution:

The Bank signed on with Derivative Path, Inc. in 2013 and utilized the team as their fully outsourced derivative program solution.

DPI onboarded and reconciled over 150 existing derivative positions in less than 2 weeks onto the DerivativeEDGETM trading platform.

Ensured all existing positions were properly hedged, documented and being reported accurately to the Swap Data Repository.

Negotiated new ISDAs and expanded access to trading liquidity with newly established Swap Dealer relationships.

On a daily basis, produce white-labelled payment notices and reconcile them to dealer notices ready to deliver to clients, eliminating hours of manual copy paste processes.

Provide monthly client mark to market statements.

Reviewed bank credit and risk management policies.

Provide ongoing assistance with full trade lifecycle processing.

After hiring DPI, have had the business pass internal audits and other reviews.

Continue to offer hedging solutions to eligible commercial clients and compete very effectively with large and small banks alike.

Client Profile:

Midwestern regional bank with $2.5 billion in assets.

Active in C&I and CRE lending.

Had existing portfolio of interest rate hedging transaction booked prior to Dodd-Frank implementation.

Community Bank Utilizing Derivatives to Help It Achieve Advantageous Funding Solutions and Better Balance Sheet Risk Management

Challenge:

As a community bank, they only had 1 existing Swap Dealer relationship.

They did not have the internal resources to fully manage their derivative program going forward.

They wanted to be able to continue to utilize derivatives to help them achieve better balance sheet risk management and find low cost funding solutions.

Their existing hedging positions required hedge accounting support.

Solution:

The Bank retained Derivative Path, Inc. and immediately began to onboard their existing portfolio of balance sheet trades onto DerivativeEDGETM trading platform.

DPI onboarded many existing, complex derivative contracts, such as step-up Bermudan cancelable swaps, that the Bank had previously executed to achieve cheaper funding.

Bank’s credit and risk management policies were reviewed and updated by DPI.

DPI expanded access to trading liquidity and negotiated an ISDA with a new Swap Dealer.

DPI provided hedge accounting support for all existing and new balance sheet hedge transactions.

DPI provides ongoing assistance with full trade lifecycle processing.

The Bank continues to utilize DPI team to evaluate new funding alternatives and to keep funding options that involve derivative transactions.

Client Profile:

Midwestern community bank with sub-$1 billion in assets

Actively looking to find low cost funding solutions and ensure good balance sheet risk management

Had existing portfolio of brokered CDs and other instruments on their balance sheet that included interest rate derivative contracts with Bermudan optionality

A large Non-Bank Financial Institution Needed to Manage Complex Rate Risk of a Commercial Real Estate Pipeline

Challenge:

The company needed to manage rate risk of a large set of fixed rate loans between origination through to sale to investors.

The company needed to establish relationships with swap dealers, a clearing exchange and a Futures Commissions Merchant (“FCM”) to begin its pipeline hedging program.

It also needed a cost-effective way to manage these transactions and be able to dynamically track the quickly changing portfolio as loans were originated and/or sold.

The company needed a partner that understood the complexities of Dodd-Frank while also being able to provide timely advice on its hedging strategy to offset the exposure in its loan portfolio and meet the demands of loan warehouse financing terms.

Solution:

The company signed on with Derivative Path, Inc. in 2014.

DPI helped the company rapidly establish Swap Dealer and FCM relationships, as well as get set up on the ISDA Protocol and Markit systems, to facilitate clearing and hedging activities.

On an ongoing basis, DPI reviews and assists with the most efficient execution of all trades to manage the rate exposure of the quickly evolving portfolio.

The firm has full access to its derivatives portfolio information through DerivativeEDGETM. The firm greatly values having a trading platform that is available at all times with pricing information updated with real time market data. .

All of these tasks are executed efficiently, while the company has the confidence that with DPI’s assistance, all of this hedging activity is conducted in compliance with Dodd-Frank requirements.

Client Profile:

A large diversified financial services firm founded on the West Coast in 2009, originates commercial real estate loans and sells them as whole loans to investors.

The company was looking to manage the interest rate risk of its rapidly growing new loan pipeline.

Derivative Path, Inc. ("DPI") is a member of the National Futures Association (NFA) and is registered as an Introducing Broker (IB).

This communication is for informational purposes only, is not an offer, solicitation, recommendation or commitment for any transaction or to buy or sell any security or other financial product, and is not intended as investment advice or as a confirmation of any transaction. Any market price, indicative value, estimate, opinion, data or other information contained herein is not warranted as to completeness or accuracy, and DPI accepts no liability for its use or to update or keep any such information current.

Transactions in over-the-counter derivatives have significant risks, including, but not limited to, substantial risk of loss. Past performance is not indicative of future results. Institutions should consider whether derivative transactions are appropriate in light of their own financial objectives, experience, operational resources, legal capacity and regulatory authority.

This communication is intended as an information resource only; it does not contain tax or accounting advice and should not be considered an explanation of all relevant issues or considerations in connection with tax and accounting rules and regulations. You should consult your own accounting and tax advisors before relying on the information contained herein.

These materials are confidential, privileged and only for the information of the intended recipient and may not be used, published or redistributed to any other party without the written consent of DPI.

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