By Annmarie Novotney, CPA, Audit Director at Blue & Co.

Over the past few years, not-for-profits have faced heightened interest rate volatility. In 2022 and 2023, the Federal Reserve raised interest rates aggressively to combat inflation, pushing policy rates to levels not seen in decades. As inflation pressures eased, the Fed shifted to periods of holding rates steady and then gradually cutting them through 2024 and into 2025.

For organizations financing building campaigns, affordable housing, or large campus projects, these shifts have contributed to uncertainty in borrowing costs and debt-service planning. With rate risk heightened, many not-for-profits are exploring tools such as interest rate swaps as hedging strategies to help stabilize interest costs, support more reliable budgeting, and protect long-term financial health.

What Is an Interest Rate Swap?

At its core, an interest rate swap is a contract between two parties to exchange interest payments on a notional principal amount (the principal itself is not exchanged). In a common structure, one party pays a fixed interest rate while receiving a variable (or “floating”) rate from the other, effectively converting variable-rate debt into a fixed-rate payment stream, or vice versa.

If a not-for-profit expects variable interest rates to rise or remain volatile, a swap can provide greater predictability by locking in consistent payments over time.

Why Not-For-Profits Might Consider Swaps

• Mitigate interest rate risk. For not-for-profits with floating-rate debt tied to benchmarks such as SOFR (Secured Overnight Financing Rate), swaps can help secure more predictable interest costs, reducing uncertainty in cash flow and budgeting.
• Potential cost savings. In certain market conditions, the net cost of a floating-rate loan combined with a swap can be lower than a traditional fixed-rate loan; though this depends on pricing, market expectations, and credit spreads.
• Customizable risk management. Swaps can be structured to align with the size, timing, and duration of debt, which is useful for phased construction projects or amortizing loans.

Potential Drawbacks for Not-For-Profits

• Counterparty credit risk. Swaps are typically executed over the counter (OTC), meaning not-for-profits assume some exposure to the financial health of the swap dealer. Credit support or collateral arrangements can help mitigate this risk.
• Complexity and governance burden. Swaps introduce additional accounting and internal control requirements. Not-for-profits must thoughtfully document risk management policies and ensure appropriate oversight.
• Cash flow unpredictability in adverse scenarios. If interest rates move in an unexpected direction or a swap is unwound early, organizations may face significant termination or make-whole payments.
• Accounting volatility without hedge designation. If a swap is not designated and accounted for as a hedge under U.S. GAAP, changes in its fair value flow through operations, which can create fluctuations in reported results.

GAAP Accounting 101 (With or Without Hedge Accounting)

Under U.S. Generally Accepted Accounting Principles (U.S. GAAP) Accounting Standards Codification 815, all derivatives, including interest rate swaps, must be recorded on the balance sheet (statement of financial position) at fair value. From there, nonprofits have two compliant reporting paths – and either can be appropriate, depending on resources, governance capacity, and desired financial statement presentation.

Big picture differences:

• Hedge accounting = timing alignment and smoothing.
• No hedge accounting = immediate swings and simplicity.

Option 1: Apply Hedge Accounting

Some organizations elect hedge accounting to align the swap’s financial reporting with its economic purpose (stabilizing interest costs).

If hedge accounting is applied:

• The hedge relationship is documented at inception,
• Effectiveness is evaluated at least quarterly,
• Changes in fair value are recorded outside of operating activities on the income statement (statement of activities) on a timing basis that matches the hedged item, typically within the non-operating section of the statement of activities as a change in net assets without donor restrictions.

Option 1 reduces volatility in reported results and keeps any swap valuation changes from distorting performance measures that boards, lenders, and stakeholders monitor for mission activities.

Option 2: Do Not Apply Hedge Accounting

Some not-for-profits choose not to apply hedge accounting, and that can still be a compliant and practical approach under U.S. GAAP. This may be appropriate when organizational capacity, materiality, or governance structure makes ongoing effectiveness testing burdensome.

If hedge accounting is not applied:

• The swap still appears at fair value on the balance sheet (statement of financial position),
• Fair value changes are recognized immediately in the non-operating section of the statement of activities each reporting period, even if the timing doesn’t align with the underlying debt.
• Reported results may fluctuate with market movements.

Option 2 can create more ups and downs in financial reporting, but there is no misapplication of GAAP. Clear disclosure and board awareness make this approach workable for many organizations.

There is not a “right” or “wrong” path – the choice should reflect mission, materiality, internal capacity, and how the organization communicates financial results to stakeholders.

Making Swaps Work for Your Organization

• Assess risk tolerance. Determine whether the benefits of greater rate stability outweigh the increased complexity and cost.
• Partner wisely. Work with established financial institutions that offer transparent terms and strong credit support practices.
• Engage accounting and audit teams early. Early collaboration can help determine whether hedge accounting is appropriate and ensure systems are in place for ongoing monitoring and effectiveness testing.
• Plan for disclosure. Be prepared to clearly explain your strategy, risks, and financial statement impacts to auditors, your board, and users of your audited financials, including in IRS Form 990 footnotes where relevant.

Swaps aren’t giveaways; they’re a business tool. Banks offer them because swaps help manage the bank’s own interest rate exposure, generate fee income, and strengthen long-term lending relationships. Not-for-profits consider them because, in exchange for that structure, they gain predictability in budgeting, cash flow, and long-term debt planning.

Bringing Strategy, Risk, and Accounting Together

Interest rate swaps can be useful tools for not-for-profits managing debt-financed capital projects – offering a potential path to rate stability, cost efficiency, and budgeting confidence. However, they come with important complexities: counterparty risk, U.S. GAAP accounting and disclosure requirements, potential termination costs, and heightened governance needs. Before incorporating a swap into your debt strategy, conduct a thorough assessment – blending financial strategy with accounting diligence – to ensure the approach aligns with your mission, risk profile, and long-term stewardship objectives.

If you’re considering interest rate hedging or have questions about how swaps may affect your organization’s financial reporting, reach out to your Blue & Co. service team and your banking partners for tailored guidance.