What are Interest Sensitive Assets
Interest sensitive assets are assets held by a bank that are vulnerable to changes in interest rates. They are generally comprised of variable rate products which have interest rates that fluctuate with market changes however they can also include fixed-rate assets in times of rising rates. Interest sensitive assets can be identified as both interest earning variable rate products as well as variable rate investments.
BREAKING DOWN Interest Sensitive Assets
Interest sensitive assets can be analyzed in a variety of ways and from many different angles. Complex interest sensitive asset analysis is typically done by institutional lenders when analyzing the sensitivity of income from lending issuance. Lenders and all types of corporations will also generally analyze the interest rate sensitivity of investment assets in balance sheet reporting as well as general investment portfolios.
There are several types of assets which are flagged as interest sensitive. These assets can include adjustable rate mortgages (ARMs), variable rate consumer and commercial loans and variable rate credit card products. The indexed rate of these products is the key component that analysts follow when considering interest sensitivity since the fully indexed rate paid on variable rate products will only fluctuate with changes in the indexed rate. Benchmarks under close watch for interest rate sensitivity include the 6-month T-Bill rate, LIBOR and the prime rate. These rates are common indexes used as an indexed rate in variable rate products.
Analyzing Balance Sheet Interest Rate Sensitivity
Balance sheet interest rate sensitivity is a common type of analysis for institutional lenders. This analysis considers the lender’s loan issuance and cash flow from interest. In a rising rate environment, variable rate products will earn higher levels of interest for financial institutions. This will generally benefit line items pertaining to interest earning assets in the assets portion of a balance sheet. In times of rising rates variable rate products offer greater income from interest. A rising rate environment also makes fixed rate earning assets at a higher risk. Given this scenario lenders will often seek swap products that allow them to trade their fixed rate earning assets for variable rate earning assets providing for greater earned income. Adversely In a falling rate environment, variable rate earning assets would have greater sensitivity and banks would seek fixed rate swaps to protect against earned income losses. (See also: Analyzing a Bank's Financial Statements)
In the institutional market, swaps are a popular product that help institutions manage interest rate sensitivity. Swaps are traded through private deals and in the fourth market through institutional trading groups. They are commonly used to help increase income from interest sensitive assets. They can also be used to support expenses in the liability portion of a balance sheet when opportunities arise to offset higher required interest payments on variable rate liabilities or to make lower interest payments when rates are falling.
Analyzing Interest Rate Sensitivity in Investment Portfolios
Investment portfolios also require a great deal of analysis on interest sensitive assets in times when rates are fluctuating. Generally fixed income investment portfolios will seek to earn higher income from variable rate investments when rates are rising. When rates are falling they may seek to invest a greater portion of assets in fixed rate investments that provide higher coupons. Floating rate bonds are one type of product that investors can look to for reducing the risk of interest rate increases in their investment portfolios when rates are rising since these bonds pay market interest rates and thus have prices that are unaffected by increasing rates. When rates are falling investors will typically focus on earning the highest rate available which can be achieved from investing in high yield fixed rate bonds. As markets change fixed income investment managers must constantly analyze the interest sensitivity of assets in their investment portfolio to seek to mitigate against losses.