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Presented by:
Matthew Behar Assistant Vice President, ALM Consulting
Asset/Liability Management (ALM)
Principles, Uses and Expected Regulatory Changes
Objectives
I. Key Risk Measurements used in ALM
II. Uses of ALM
III. Preparing for New ALM and Interest-Rate Risk (IRR) Regulatory Expectations
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What is the definition of ALM? It depends on whom you ask…
• ALM is a comprehensive and dynamic framework for measuring, monitoring and managing market risk. The management of the balance sheet to maximize net interest income within the overall risk-preference of the institution. (allbankingsolutions.com)
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What is the definition of ALM? It depends on whom you ask…
• The practice of managing risks that arise due to mismatches between assets and liabilities. (wikipedia.org)
• A technique companies employ in coordinating the management of assets and liabilities so that an adequate return may be earned. (investopedia.org)
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What does all of that mean?
5
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A simple definition of ALM…
• A valuable tool for identifying and managing interest-rate risk and liquidity risk
• A process to help credit unions prepare for changes in market interest rates
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Key ALM Measurements
• If interest rates rise or fall over the next 12 months, what happens to net interest income?
• What are acceptable income changes in each interest rate scenario?
• Flat (no growth) balance sheet vs. growth forecast
Net Interest Income (NII) Sensitivity
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-300 -200 -100 FLAT +100 +200 +300
INVESTMENTS
Agency 178 180 201 222 243 265 287
Certificates of Deposit 109 126 158 189 220 241 260
FHLB Stock 0 0 1 3 4 5 6
Repo / Short Term 24 74 170 265 361 456 551
MBS 268 342 436 513 546 566 585
CMO 205 255 306 364 399 410 417
MCA 7 11 15 19 23 27 32
Funds Sold 1 1 7 14 22 30 38
Total Investments 792 990 1,294 1,589 1,819 1,999 2,176
LOANS
Mortgages 1,228 1,359 1,505 1,607 1,660 1,697 1,725
Home Equity Loans 384 445 507 558 600 640 680
Vehicle Loans 1,207 1,245 1,282 1,320 1,358 1,396 1,434
Secured Loans 62 64 66 68 70 73 75
Credit Cards 132 151 169 188 206 225 243
Unsecured Loans 98 100 103 105 108 111 113
Student Loans 0 0 0 0 0 0 0
Other Loans 83 95 108 120 133 145 158
Total Loans 3,193 3,458 3,740 3,967 4,135 4,287 4,429
TOTAL INT INCOME 3,985 4,449 5,034 5,556 5,954 6,286 6,605
MMDA Shares 456 488 568 648 728 809 889
Regular Shares 61 65 74 92 106 120 134
Share Draft 12 12 12 12 28 43 59
Escrow 0 0 0 0 0 0 0
IRA 216 234 260 286 312 338 365
CDs 1,265 1,427 1,624 1,822 2,020 2,218 2,415
TOTAL INT EXPENSE 2,009 2,225 2,538 2,860 3,194 3,528 3,862
NET INT INCOME 1,975 2,223 2,497 2,695 2,760 2,758 2,743
Provision for Loan Loss 53 53 53 53 53 53 53
Total Other Income 1,094 1,094 1,094 1,094 1,094 1,094 1,094
Total Other Expense 2,824 2,824 2,824 2,824 2,824 2,824 2,824
NET INCOME 193 441 715 913 978 976 961
INCOME / EXPENSE REPORT - SUMMARY
Sample FCU Change from
Guidelines Policy Limits Flat Scenario
Net Interest Income
< -30.00% < -25.00%
-20.00 to -30.00% -15.00 to -25.00%.
> -20.00% > -15.00%
-300 -26.71%
-200 -17.53%
-100 -7.37%
+100 2.39%
+200 2.32%
+300 1.76%
Net Income
< -75.00% < -70.00%
-40.00% to -75.00% -35.00% to -70.00%
> -40.00% > -35.00%
-300 -78.87%
-200 -51.75%
-100 -21.76%
+100 7.06%
+200 6.84%
+300 5.20%
Key ALM Measurements
• The fair market value of assets minus the fair market value of liabilities equals Net Economic Value.
• NEV includes only existing balances and contracts as of the analysis date. It does not include projected new volumes.
Net Economic Value (NEV)
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Key ALM Measurements
• If interest rates rise or fall, what happens to the NEV of your credit union?
• Focus is on determination of NEV
• What are acceptable changes in NEV in each interest rate shock scenario?
Net Economic Value (NEV) Sensitivity
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Book Value -300 -200 -100 FLAT +100 +200 +300
Cash 902 902 902 902 902 902 902 902
INVESTMENTS
Treasury 0 0 0 0 0 0 0 0
Agency 4,661 4,865 4,865 4,829 4,792 4,755 4,720 4,419
Certificates of Deposit 5,059 5,294 5,262 5,183 5,128 5,076 4,960 4,866
FHLB Stock 102 102 102 102 102 102 102 102
Repo / Short Term 8,828 8,828 8,828 8,828 8,828 8,828 8,828 8,828
MBS 8,715 8,818 8,794 8,790 8,743 8,357 7,879 7,434
CMO 6,539 6,649 6,627 6,607 6,538 6,269 6,016 5,783
MCA 411 411 411 411 411 411 411 411
Total Investments 34,315 34,967 34,889 34,749 34,542 33,798 32,916 31,843
LOANS
Mortgages 26,678 27,414 27,194 27,039 26,797 26,042 25,083 24,142
Home Equity Loans 8,373 8,544 8,517 8,515 8,476 8,341 8,185 8,033
Vehicle Loans 20,112 21,960 21,495 21,054 20,634 20,234 19,852 19,486
Secured Loans 896 986 967 949 931 914 897 881
Credit Cards 1,841 1,841 1,841 1,841 1,841 1,841 1,841 1,841
Unsecured Loans 929 963 952 941 931 921 911 901
Other Loans 1,628 1,670 1,644 1,620 1,598 1,578 1,559 1,542
Loan Loss Reserve -83 -83 -83 -83 -83 -83 -83 -83
Total Loans 60,374 63,295 62,527 61,875 61,125 59,788 58,246 56,743
Other Assets 4,409 4,409 4,409 4,409 4,409 4,409 4,409 4,409
TOTAL ASSETS 100,000 103,573 102,727 101,936 100,979 98,897 96,473 93,897
MMDA Shares 23,522 24,309 24,175 23,844 23,522 23,209 22,905 22,609
Regular Shares 6,564 6,651 6,651 6,630 6,564 6,521 6,478 6,436
Share Draft 9,222 9,222 9,222 9,222 9,222 9,158 9,095 9,033
IRA 6,904 7,262 7,199 7,107 7,027 6,949 6,874 6,800
CDs 41,668 43,175 42,847 42,530 42,170 41,817 41,471 41,132
Other Liabilities 959 959 959 959 959 959 959 959
TOTAL LIABILITIES 88,840 91,578 91,052 90,292 89,464 88,613 87,782 86,969
EQUITY 11,160 11,995 11,675 11,643 11,515 10,284 8,692 6,928
TOT EQUITY & LIABS 100,000 103,573 102,727 101,936 100,979 98,897 96,473 93,897
MARKET VALUE REPORT - SUMMARY
Sample FCU Change from
Guidelines Policy Limits Flat Scenario
Net Economic Value
< -50.00%
-25.00% to -50.00%
> -25.00%
-300 4.17%
-200 1.39%
-100 1.11%
+100 -10.69%
+200 -24.52%
+300 -39.84%
Start with book value equity and understand
assumptions for flat and shock scenarios!
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Key ALM Measurements
• If interest rates rise or fall, what happens to the value of your credit union?
• Market value of equity divided by market value of assets
• What are acceptable NEV ratios in each rate shock scenario?
NEV Ratio
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Sample FCU
Guidelines Policy Limits Actual
NEV Ratio
< 4.00%
4.00% to 6.00%
> 6.00%
-300 12.00%
-200 11.68%
-100 11.64%
FLAT 11.51%
+100 10.28%
+200 8.69%
+300 6.93%
Start with book value capital ratio and understand
assumptions for flat and shock scenarios!
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Uses of ALM
• Determine if current balance sheet composition and ALM results are acceptable
• Establish limits that are acceptable to regulators
• Limits should be in alignment with current ALM results
Setting Policy Limits
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Uses of ALM
• Improve income/expense, while monitoring risk
• Can balance sheet changes (new products, asset growth, etc.) occur without adding significant risk?
• Apply forecasted growth to ALM reports
Budgeting
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Uses of ALM
• Investment purchases
• Rate specials
• New product offering
• Expected growth of specific loan type
• Interest-rate curve changes
• Modeling assumption changes (prepayment speeds, non-maturities, etc.)
What If Analyses
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Uses of ALM
• Educate ALCO / Board about credit union’s risk position
• Are results compliant with policy limits and examiner expectations?
• Have prior examiner issues been addressed?
Prepare for Exam
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• Proposed Supervisory Test to Determine Exam Scope
• Add “S” to CAMEL (in the near future)
New ALM and IRR Expectations NCUA June Board Briefing Highlights
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New ALM and IRR Expectations
Risk Classification Post-shock NEV Ratio NEV Sensitivity (from Base)
Extreme Below 2% Above 85%
High 2% - 4% 65% - 85%
Moderate 4% - 7% 40% - 65%
Low Above 7% Below 40%
New NCUA NEV Supervisory Test - Risk Matrix
Proposed Supervisory Test
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Non-Maturity Liabilities Valuation Used for Risk Classification
Rate Shock Scenario Market Value Change
Base Case (Flat) -1% from Book Value
+300bp -4% from Base Case
New ALM and IRR Expectations
Proposed Supervisory Test
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Book Value FLAT +300
Cash 1,021 1,021 1,021
INVESTMENTS
Certificates of Deposit 29,363 29,722 28,366
Interest-Bearing Cash 1,276 1,276 1,276
Member Capital 619 359 445
Total Investments 31,258 31,357 30,087
LOANS
Mortgage Loans 12,497 12,606 11,205
Home Equity Loans 2,580 2,532 2,508
Vehicle Loans 19,257 19,428 18,710
Secured Loans 62 61 58
Credit Cards 1,897 1,881 1,836
Unsecured Loans 1,654 1,655 1,596
Other Loans 7 7 7
Total Loans 37,955 38,171 35,920
Loan Loss Reserve -241 -241 -241
Other Assets 5,007 5,007 5,007
TOTAL ASSETS 75,000 75,315 71,794
Zero Rate Shares 8,744 8,656 8,310
MMDA Shares 10,709 10,602 10,178
Regular Shares 26,289 26,026 24,985
Share Draft 4,881 4,832 4,639
Escrow 29 29 28
IRA Shares 3,397 3,363 3,228
CDs 13,701 13,714 13,346
Other Liabilities 154 154 154
TOTAL LIABILITIES 67,903 67,376 64,868
EQUITY 7,097 7,939 6,926
TOT EQUITY & LIABS 75,000 75,315 71,794
Post-shock NEV Ratio 10.54% 9.65%
NEV Sensitivity -12.76%
MARKET VALUE REPORT - Supervisory Test
99% of Book Value
96% of Flat (Base)
Examination Scope Total Assets
<$50MM $50MM - $500MM > $500MM
IRR Workbook Steps No Steps 15 Steps
35 Steps for 1st Exam
Cycle, 15 Steps
thereafter
IRR Workbook Steps, if "High" or "Extreme"
N/A 25 Steps 25 Steps
New ALM and IRR Expectations Proposed Supervisory Test
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New ALM and IRR Expectations
NCUA plans to adopt CAMELS rating system. Adding “S” for interest rate sensitivity testing.
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C - Capital A - Asset Quality M - Management E - Earnings L - Liquidity S - Sensitivity (to Market Risk)
CAMELS Exam Rating System
New ALM and IRR Expectations
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CAMELS Exam Rating System History
• In 1979, the Uniform Financial Institutions Rating System
(UFIRS) was adopted by Federal Financial Institutions Examination Council (FFIEC)
• FFIEC consists of: • Consumer Financial Protection Bureau (CFPB) • Federal Deposit Insurance Corporate (FDIC) • Federal Reserve Board of Governors (FRB) • National Credit Union Administration (NCUA) • Office of Comptroller of Currency (OCC)
New ALM and IRR Expectations
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• In 1997, FFIEC added (S) to CAMEL to separate sensitivity to market risk from Liquidity (L) to improve assessment of exposure to interest-rate risk.
• Since then, most of the other FFIEC agencies, as well as several state regulators, have already added (S).
New ALM and IRR Expectations CAMELS Exam Rating System History
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• An expected change
• Consistent with other FFIEC agencies • Enhanced analysis of liquidity and IRR
• Improved monitoring and focus for IRR
New ALM and IRR Expectations Adding “S” to CAMEL
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Summary
ALM is a tool for helping CUs manage IRR: NII sensitivity, NEV sensitivity and NEV ratios
Many uses of ALM: Policy Limits, Budgeting, What Ifs, Exam Preparation
New ALM and IRR Expectations: Supervisory Test, CAMELS
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Questions?
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