Evaluating interest rate risk and creating a risk management strategy

April 18, 2024

Conducting a review of a company’s debt obligations and interest rate exposures can help any commercial borrower better understand their risks. A company can then establish an interest rate risk management strategy to guide it through the evaluation and define any financing related or hedging actions that are needed.

The aggressive actions of the Federal Reserve have significantly impacted floating rate borrowers. This raises the question of when was the last time you took stock of all the company’s various exposures to interest rates?

Regularly reviewing your debt structure is a crucial step for understanding the potential risks and avoiding unexpected issues. Every loan should be assessed on its own terms, but a structured approach to risk management streamlines the evaluation process.

As a borrower, have you utilized interest rate hedging tools in the past? If so, are those hedges you put in place still aligned with your current goals and the market environment or should those hedges be restructured?  Finally, does the company have a defined strategy for managing floating interest rate risk that can help drive consistent and objective decisioning?

Get started by downloading the commercial debt organizer.

5 step framework for evaluating a commercial borrower’s interest rate exposure

Developing an approach to risk management can be a valuable exercise for any company with floating interest rate exposure, without needing to be overly complex. Below is a basic framework that can get any company through the steps of risk management.

 

1. Understand your risk tolerance

The first step for any company begins with establishing a philosophy around interest rate risk. There are a number of considerations that will influence this philosophy. It begins with understanding the existing company culture around risk taking and risk management. It is important to note that this may be different for risks such as interest rates, than it would be for risks that relate to a company’s core competency or area of expertise.

Ability to take risk also plays a role, with factors to consider such as leverage or a potential adverse impact on future business decisions. The perspective of key stakeholders is another consideration. Do they see greater value in an expense that fluctuates along with interest rates or one that is predictable over the long-term? It can also be helpful to understand what decisions are being made by companies with a similar profile, or how peer companies manage similar risks. Significant market changes could also put the company at an advantage or disadvantage to its competition.

 

2. Identify your exposure

A company can start identifying exposure with its most obvious one, existing floating rate bank debt. First you can identify the basic features such as current amount, amortization, maturity, and lender(s).  Note that unless a loan fully amortizes by maturity, its maturity date does not represent an end to rate risk.  It may even introduce additional risks that need to be evaluated. Next, attention can go to more detailed aspects like the benchmark index, day count, and payment dates.  Once debt instruments have been reviewed, your analysis can broaden out to include the entire capital structure, even potentially expanding beyond current obligations, to include future anticipated financing needs.

 

3. Define your goals

Once a company is comfortable with the evaluation of its interest rate exposures and prioritizes these risks it can then begin to establish defined goals. This can be as simple as determining a desired fixed/floating mix or fixing the rate on debt associated with specific long-term assets.  Some of these goals will likely be near-term, while others more long-term in nature.  Near-term could be to respond opportunistically to rates attractive to the company, by increasing the amount of fixed rate debt.  Long-term goals, like reducing the risk of exceeding borrowing cost targets or project cost budgets, may require a more detailed look at internal financial forecasts and interest rate assumptions.

 

4. Evaluate your options

Once the assessment is complete, evaluate the various hedging tools available to minimize risk. Consideration can be given to any natural hedges, such as cash on balance sheet that offsets floating rate borrowings or the ability to pass along rising interest rate costs through price increases. This can be tricky because the natural hedge needs to be in place not just now, but also in situations when it would be most needed.

Hedging tools may include the structure through which a company sources funds, such as a debt instrument that has a fixed rate. In some cases, the use of derivative products, such as interest rate swaps, caps or collars, may be the most efficient hedging tool. Being properly educated on the risks and benefits associated with any of these tools is an important part of evaluating them correctly. This step may conclude with documenting a formal or informal risk management strategy/policy.

 

5. Take action

The final step would be taking any actions needed to fully implement the risk management strategy. This may include reviewing the existing financing structure with the banking team. If the plan is to use derivative products, then it would include putting in place any documentation that would be needed in connection with executing a hedge.

Once a company’s risk management strategy is fully executed it is critical to note that the actions related to interest rate risk management are not done. It is important to continue with a periodic review, evaluating whether a company’s risks, philosophy around risk, or goals have changed. An assessment of any existing hedging tools should be done periodically to make sure they are performing as expected. Finally, it is necessary to remain informed on the latest tools available and developments in market conditions that may warrant a change.

 

U.S. Bank’s Derivative Products Group is a team of professionals whose resources and expertise in interest rate risk management can be accessed by contacting your U.S. Bank Relationship Manager.

 

 

The information in this article and any accompanying materials (the "Materials") are provided for your informational purposes only. The Materials do not constitute an offer, a commitment or solicitation to engage in any products or transactions. The Materials are derived from internal and external sources that we believe are reliable, but we do not warrant their completeness or accuracy. The Materials describe products and services available through U.S. Bank National Association and are not bank deposits or insured by the FDIC. Derivative products and services are generally restricted to “eligible contract participants” as defined in the Commodity Exchange Act and Commodity Futures Trading Commission regulations, and other legal requirements and restrictions apply. Before entering into any transaction, you, along with your own financial, legal, tax, accounting and other professionals, should conduct a thorough evaluation of any proposed transaction and determine whether or not any transaction is right for you.

Related content

6 questions to ask before buying a new home

8 steps to take before you buy a home

What to know when buying a home with your significant other

How you can take advantage of low mortgage rates

5 financial goals for the new year

Allowance basics for parents and kids

What’s your financial IQ? Game-night edition

Tips for realtors to help clients get their homeownership goals back on track

Common unexpected expenses and three ways to pay for them

Myths vs. facts about savings account interest rates

How to build and maintain a solid credit history and score

How do interest rates work?

7 steps to keep your personal and business finances separate

At your service: outsourcing loan agency work

30-day adulting challenge: Financial wellness tasks to complete in a month

High-yield bond issuance: 5 traits lawyers should look for in a service provider

What you need to know before buying a new or used car

What is a home equity line of credit (HELOC) and what can it be used for?

Year-end financial checklist

Putting home ownership within reach for a diverse workforce

Housing market trends and relocation impact

Administrator accountability: 5 questions to evaluate outsourcing risks

An investor’s guide to marketplace lending

What is a CLO?

Beyond Mars, AeroVironment’s earthly expansion fueled by U.S. Bank

Refinancing your practice loans: What to know

ABL mythbusters: The truth about asset-based lending

What type of loan is right for your business?

Collateral options for ABL: What’s eligible, what’s not?

Can ABL options fuel your business — and keep it running?

Luxembourg's thriving private debt market

Easier onboarding: What to look for in an administrator

Maximizing your infrastructure finance project with a full suite trustee and agent

3 tips to maintain flexibility in supply chain management

Top 3 considerations when selecting an IPA partner

Insource or outsource? 10 considerations

4 questions you should ask about your custodian

Refining your search for an insurance custodian

Service provider due diligence and selection best practices

Webinar: CRE technology trends

Complying with changes in fund regulations

Business risk management for owners of small companies

Evaluating interest rate risk creating risk management strategy

Webinar: CSM corporation re-thinks AP

Tech tools to keep your restaurant operations running smoothly

Webinar: AP automation for commercial real estate

Addressing financial uncertainty in international business

5 winning strategies for managing liquidity in volatile times

The future of financial leadership: More strategy, fewer spreadsheets

Employee benefit plan management: trustee vs. custodian

Choosing your M&A escrow partner

Tech lifecycle refresh: A tale of two philosophies

Changes in credit reporting and what it means for homebuyers

High-cost housing and down payment options in relocation

Why retail merchandise returns will be a differentiator in 2022

4 benefits of independent loan agents

Middle-market direct lending: Obstacles and opportunities

Crypto + Relo: Mobility industry impacts

For today's relocating home buyers, time and money are everything

Webinar: CRE Digital Transformation – Balancing Digitization with cybersecurity risk

Empowering team members

10 tips on how to run a successful family business

Streamline operations with all-in-one small business financial support

Business tips and advice for Black entrepreneurs

Tools that can streamline staffing and employee management

How to identify what technology is needed for your small business

Planning for restaurant startup costs and when to expect them

How to fund your business without using 401(k) savings

Costs to consider when starting a business

How to test new business ideas

The role of ethics in the hiring process

8 ways to increase employee engagement

How to reward employees and teams who perform well

How to hire employees: Employee referral vs. external hiring

Give a prepaid rewards card for employee recognition

Checklist: Increase lead generation with website optimization

Is your restaurant Google-friendly?

How small businesses are growing sales with online ordering

How to expand your business: Does a new location make sense?

3 simple brand awareness tips for your business

How a small business owner is making the workplace work for women

The growing importance of a strong corporate culture

Business credit card 101

Meet your business credit card support team

How to apply for a business credit card

How jumbo loans can help home buyers and your builder business

When to consider switching banks for your business

5 tips to help you land a small business loan

5 questions business owners need to consider before taking out a loan

Leverage credit wisely to plug business cash flow gaps

How to establish your business credit score

How to make the most of your business loan

Do you need a business equipment loan?

Break free from cash flow management constraints

5 tips for managing your business cash flow

Improve online presence your business

How Shampoo’ed is transforming hair and inspiring entrepreneurs

The San Francisco bridal shop that’s been making memories for 30 years

How Al’s Breakfast is bringing people together

In a digital world, Liberty Puzzles embraces true connection

Celebrity Cake Studio’s two decades of growth and success

How a travel clothing retailer is staying true to its brand values

How to build a content team

Use this one simple email marketing tip to increase your reach

How (and why) to get your business supplier diversity certification

Good debt vs. bad debt: Know the difference

Student checklist: Preparing for college

The A to Z’s of college loan terms

Co-signing 101: Applying for a loan with co-borrower

Practical money skills and financial tips for college students

How I did it: Paid off student loans

5 myths about emergency funds

Tips to overcome three common savings hurdles

How having savings gives you peace of mind

Personal loans first-timer's guide: 7 questions to ask

Things to know about the Servicemembers Civil Relief Act

5 tips to use your credit card wisely and steer clear of debt

Travel for less: Smart (not cheap) ways to spend less on your next trip

Real world advice: How parents are teaching their kids about money

How to stop living paycheck to paycheck post-pay increase

Practical money tips we've learned from our dads

6 ways to spring clean your finances and save money year-round

How to cut mindless spending: real tips from real people

How to increase your savings

Your financial aid guide: What are your options?

Is a home equity loan for college the right choice for your student

Parent checklist: Preparing for college

How to apply for federal student aid through the FAFSA

What to consider before taking out a student loan

Are you ready to restart your federal student loan payments?

Consolidating debts: Pros and cons to keep in mind

Everything you need to know about consolidating debts

5 tips to use your credit card wisely and steer clear of debt

How to use debt to build wealth

What’s a subordination agreement, and why does it matter?

Understanding the true cost of borrowing: What is amortization, and why does it matter?

Know your debt-to-income ratio

How to pay off credit card debt

How to use credit cards wisely for a vacation budget

Your quick guide to loans and obtaining credit

Dear Money Mentor: How do I begin paying off credit card debt?

Dear Money Mentor: What is cash-out refinancing and is it right for you?

Overcoming high interest rates: Getting your homeownership goals back on track

What are conforming loan limits and why are they increasing

Money Moments: How to finance a home addition

How I did it: My house remodel

Is it the right time to refinance your mortgage?

These small home improvement projects offer big returns on investment

Should you get a home equity loan or a home equity line of credit?

Mortgage basics: What’s the difference between interest rate and annual percentage rate?

Is a home equity line of credit (HELOC) right for you?

How to use your home equity to finance home improvements

How do I prequalify for a mortgage?

Can you take advantage of the dead equity in your home?

4 questions to ask before you buy an investment property

10 uses for a home equity loan

How to spot a credit repair scam

5 unique ways to take your credit card benefits further

Test your loan savvy

U.S. Bank asks: What do you know about credit?

How to improve your credit score

Take the stress out of buying your teen a car

Questions to ask before buying a car

What you should know about buying a car

How to choose the best car loan for you

Disclosures

Start of disclosure content

Loan approval is subject to credit approval and program guidelines. Not all loan programs are available in all states for all loan amounts. Interest rate and program terms are subject to change without notice. Mortgage, Home Equity and Credit products are offered through U.S. Bank National Association. Deposit products are offered through U.S. Bank National Association. Member FDIC.