Frequently Asked Questions – Derivative Hedging Services

Derivative Hedging FAQs

• What is derivative hedging?

  Derivative hedging, as it applies to credit unions, is the practice of executing a contract with a third party to provide payment to the credit union if the events outlined in the contract are met.  Credit unions use derivatives to mitigate interest rate risk. 

• Why does Catalyst Strategic Services offer derivative hedging services?

  NCUA authorized certain federal credit unions to enhance their interest rate risk mitigation strategies by purchasing derivatives. While credit unions have had access to derivative instruments for some time, using them to hedge risk is unchartered territory for most.  Catalyst Strategic Solutions offers derivative hedging services as an interest rate risk management solution for credit unions. 

• Why use derivatives?

  Derivative hedging may allow credit unions to hold a greater concentration of longer-term higher-yielding assets – most commonly mortgages – without the associated interest rate risk. These instruments also are used to stabilize a credit union’s cost of funds, for hedging mortgage pipelines, and to provide an alternative to selling an asset or taking out a borrowing, with the added benefit of not diluting capital ratios.

• What derivative hedging services is Catalyst Strategic Solutions offering?

  Services include in-depth training and education throughout the process, assistance with NCUA derivative applications, development of derivative policies and procedures, interest rate risk modeling, legal review of all derivative documentation, counterparty credit analysis, derivative hedging strategies, trade execution and transaction management, daily monitoring of derivative pricing and collateral management, among other services. 

• How long does it take to implement a derivative hedging program?

  It takes approximately six months to institute a program. 

• What are the steps to implementing a derivative hedging program?

  The first month includes board education and pre-approval.  Month two involves the development of derivative policies and a hedging strategy, plus the submission of an application letter to the NCUA or state authority. Months four through six include International Swaps and Derivatives Association (ISDA) agreements and derivative analytics, performing ALM analytics, setting up accounting functions, obtaining hedge counterparties, legal review, and hedge execution and strategy implementation.

• How long has Catalyst Corporate managed the execution of derivative transactions?

  Catalyst Corporate has managed derivative transactions for interest rate risk mitigation for more than 20 years and was an approved derivative vendor under the NCUA’s investment pilot program.

• How long has Catalyst Strategic Solutions worked with hedging strategies?

  Approved for the NCUA’s pilot program 10 years ago, Catalyst Strategic Solutions’ team of experts has tailored a solution to support the needs of credit unions seeking to take advantage of the benefits of the new derivatives regulation.

• How long has Catalyst Strategic Solutions served credit unions?

  For more than 25 years, Catalyst Strategic Solutions’ advisors have identified and deployed strategies that optimize the performance of credit union assets, while protecting their earnings streams and equity capital.  

• What types of derivatives are credit unions allowed to utilize?

  While there is a wide array of derivative structures, the new regulation only allows for specific interest rate derivative instruments, including:  interest rate swap, basis swap, interest rate cap, interest rate floor and U.S. Treasury note futures. 

• What are interest rate derivatives?

  Interest rate derivatives are financial contracts executed between two parties, designed to protect the balance sheet from exposure to changing interest rates.

• What maximum forward date can be used?

  Derivative strategies can utilize forward dates of up to 90 days.  These include plain vanilla swaps, amortizing swaps, interest rate caps and interest rate floors.

• How do I get started?

  The Catalyst Strategic Solutions team will guide credit unions through the entire process – from an initial meeting to discuss objectives through compliance follow-up. Just contact a Catalyst Strategic Solutions team member at 800.301.6196.