Riding the Spread

A bank’s mix of fixed and floating loans helps determine its risk profile, or how its profit margins react to rate movements. A bank might be asset sensitive, meaning its assets reprice faster than liabilities. “Banks who have asset sensitivity have benefited from the 425 basis point rise in rates over the past two years,” Dwyer says. Or a bank might be liability sensitive, meaning its liabilities—including deposits—reprice faster than assets. That can lead to problems in a rising interest rate environment. (Many of the banks North American Capital Markets works with, Dwyer adds, tend slightly toward asset sensitivity.)

The interest rate derivative marketplace offers ways that banks can protect themselves against a rate cycle that hurts their sensitivity profiles. Mike Wier, president of North American Capital Markets, cites a variety of instruments:

•  Interest rate swaps allow banks to trade fixed rate debt for floating and vice versa.

•  Interest rate caps pay when the interest rate on an agreed-upon index exceeds a certain level, protecting a liability-sensitive bank.

•  Interest rate floors pay when interest rates go below a particular level, which might be of particular interest to an asset-sensitive bank.

Some institutions, though, expect their customers to manage interest rate risk. At LaSalle Bank, NA, most loan assets are initially at floating rates. Many clients convert those loans into fixed-rate debt using the swap market, says John Falb, a senior vice president and regional manager at LaSalle’s Minneapolis office.