If someone asked you which US city has the most unpredictable weather, you probably wouldn’t say Rapid City, South Dakota. Unfortunately, you’d be wrong if you answered with anything else. The city is positioned in the Black Hills, nestled between the opposing forces of the Rocky Mountains and the Great Plains. The city is reported to suffer major rain and snow storms on short notice because of this. In addition, Chinook winds, which are warm, dry, rapid winds from the Rockies, can cause rapid temperature changes. The area is also subject to a compressed severe weather season, with an average of 300 severe thunderstorm and tornado warnings per year, mostly from May to August. It’s safe to say that you can’t guess what the weather will be in Rapid City on any given day. Anyone in the city would need to be prepared for anything to happen. Nearly as unpredictable is the interest rate environment community financial institutions (CFIs) contend with from one week to the next. This type of environment means management is likely focused on how to mitigate risk. Hedging at the loan level can help mitigate interest rate risk. While hedging strategies have historically been underutilized in smaller institutions, they offer a valuable tool to help CFIs navigate shifting interest rate environments with confidence. In fact, loan-level hedging can be a strategic way to stabilize portfolios and enhance lending flexibility without disrupting core banking operations.However, as interest rate volatility continues to impact financial institutions, more CFIs are exploring ways to safeguard their portfolios while maintaining a competitive edge. At the same time, many CFIs have an increasing number of loans that might be coming due for repricing after 5 years (from COVID-19 days) or facing balloons. These types of loans can be considered for hedging as well. The Power of Loan-Level HedgingOne of the most effective applications of hedging is in a CFI’s loan portfolio. Hedging at the loan level provides CFIs with a tactical way to protect earnings, manage risk exposure, and meet customer demand for fixed-rate loans — all without unnecessary complexity or liquidity concerns.Why Consider Loan-Level Hedging?
- Enhanced risk management. Hedging strategies help financial institutions mitigate the impact of interest rate fluctuations, allowing them to offer competitive fixed-rate loans while retaining floating-rate flexibility on their balance sheets.
- Regulatory and examiner focus. Regulators are paying close attention to interest rate risk management. The FDIC, for example, has emphasized that banks must implement sound risk controls to manage interest rate exposure. A well-structured hedging approach aligns with these expectations.
- Optimized loan portfolio strategy. CFIs thrive on lending, but mismatches between funding costs and loan structures can impact profitability. Loan-level hedging enables CFIs to confidently expand their loan offerings without undue risk. Also, additional fee income from loan-level hedges can help improve loan profitability.
Making Hedging More AccessibleIn the past, concerns over complex accounting and collateral and capital requirements have made some CFIs hesitant to hedge. However, innovative hedging solutions now address these challenges, making it easier than ever for financial institutions to integrate hedging into their risk management strategies.Modern hedging approaches can eliminate the need for complex derivative accounting, reduce collateral burdens, and provide seamless execution with minimal operational impact. For example, some solutions allow financial institutions to offer hedged fixed-rate loans to borrowers while maintaining a floating-rate position themselves — without requiring derivative expertise.What To Look for in a Hedging PartnerSelecting the right hedging provider is key to a successful strategy. Consider these essential factors when evaluating your options:
- Regulatory compliance. Choose a provider with a strong reputation that aligns with FDIC and industry regulations. Your regulator may be helpful in suggesting possible partners.
- Experience with CFIs. A provider familiar with the needs of CFIs and their portfolios can offer tailored solutions.
- Transparent pricing and expertise. Look for a partner that provides clear guidance, outstanding customer service, knowledgeable staff to answer your lender’s questions, ongoing support, and easy-to-understand pricing structures.
- Operational simplicity. The best hedging solutions should integrate smoothly with existing banking processes, without requiring extensive training or additional resources.
Getting Started: Six Key StepsIf your institution is ready to explore loan-level hedging, here’s how to get started:
- Engage your board and leadership. Educate decision-makers on the benefits of hedging and address any questions they have. Their comfort and their understanding of how hedged loans can help your CFI are essential to gaining approval for a structured program.
- Define your hedging strategy. Identify loan types, terms, and scenarios where hedging provides the greatest advantage. Sometimes, there’s a particular industry, like commercial real estate, that suits hedged loans well.
- Select a hedging partner. Seek a trusted provider that understands the unique needs of CFIs and wants to build a relationship.
- Equip your team. Provide training and access to resources that simplify the hedging process both for your internal staff and your borrowers.
- Establish documentation and monitoring processes. Ensure proper tracking and compliance with regulatory expectations. Engage with regulators early in the process to get their feedback on your plans and partners.
- Monitor and adjust as needed. Interest rate conditions change, and so should your approach. Regularly review hedging strategies and engage in conversations with your hedged loan partner on how to optimize performance in the current market.
A Smarter Way To Manage Interest Rate RiskWhile CFIs have traditionally been cautious about hedging, modern solutions make it easier, more effective, and more accessible than ever. With the right approach, loan-level hedging can empower CFIs to confidently navigate interest rate uncertainty, strengthen their lending strategies, and continue serving their communities with competitive financing solutions.For institutions looking to stay ahead in an evolving financial landscape, integrating hedging into portfolio management can be a game-changer — one that enhances both risk control and lending flexibility. PCBB’s Borrower’s Loan Protection® (BLP) offers a seamless and effective way for CFIs to hedge loan-level interest rate risk without the burden of derivative accounting or collateral requirements, enabling them to confidently offer fixed-rate loans while maintaining a floating-rate position. This approach simplifies hedging, eliminates derivative accounting complexities, and helps CFIs remain competitive in any rate environment.
