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.


Cash & Loan Portfolio Protection For Regional Bank


  • 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.


  • 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 DerivativeEDGE, 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.