Bill Nayda Assessing Second Pillar Consulting interest rate and Liquidity risk · 2016-07-26 · Bill Nayda, Ph.D., is the Principal and founder of Second Pillar Consulting.Bill and

Assessing interest rate and Liquidity risk Analyst Training in the Banking Sector July 25-29, 2016

Bill Nayda Second Pillar Consulting

Session Learning Objectives

• Review the fundamental concepts of balance sheet behavior and asset liability management

• Evaluate floating versus fixed rate exposures

• Analyze bank and thrift interest rate data to predict changes in income and equity

• Examine significant interest rate influences including embedded options and core deposits

• Assess strategies for hedging balance sheet risk

• Synthesize interest rate disclosures to asses an institution’s earnings quality and outlook

Copyright © 2016 S&P Global. The Knowledge Center, a part of S&P Global Market Intelligence, a division of S&P Global Inc. 2

About Second Pillar Bill Nayda, Ph.D., is the Principal and founder of Second Pillar Consulting. Bill and his team assist banks with risk management initiatives including: Enterprise Risk Management, stress testing, regulatory exams and relations, capital planning and adequacy, Basel, interest rate risk, liquidity, anti money laundering, risk based profitability, and model validation. During the crisis the firm was instrumental in working with several of the newly formed BHC’s to become regulated banks. Clients include top 10 banks, to regional and community banks. The firm has a focus on education working with boards and management to help them better understand and own the banks risk. The firm developed and teaches for the RMA the courses ERM for Community Banks and Stress Testing Boot Camp. For S&P Global Bill teaches Bank Credit Analysis and Bank Enterprise Risk Management. SPC consultants frequently publish in the area of risk management and are interviewed and quoted in many banking periodicals. Bill’s 20 years of banking and insurance experience is focused on risk management, regulatory compliance, quantitative analysis, and corporate governance. Prior to founding Second Pillar Consulting, Bill spent ten years at Capital One overseeing balance sheet strategy, economic capital, regulatory relations and pricing models. Bill has also helped model and manage enterprise risk at Travelers companies and Allied Irish Bank's U.S. subsidiary. Bill received his Ph.D. in Economics from Texas A&M University and his B.S. in Economics from Rutgers University. While at Texas A&M Bill conducted economic research into the impacts of global warming under Bruce McCarl who was a recipient of the Nobel Peace Prize for his research on global warming.


What is risk? risk \ˈrisk\ n Definition of RISK 1: possibility of loss or injury : peril 2: someone or something that creates or suggests a hazard 3a : the chance of loss or the perils to the subject matter of an insurance contract; also : the degree of probability of such loss b : a person or thing that is a specified hazard to an insurer c : an insurance hazard from a specified cause or source <war risk> 4: the chance that an investment (as a stock or commodity) will lose value Source: Merriam-Webster online dictionary http://www.merriam-webster.com/dictionary/risk


http://www.merriam-webster.com/dictionary/peril

There are two aspects of risk: frequency and severity

Frequency

• What are the odds an event will happen?

• Also called the Probability of Default or PD

• Think of it as the number of bad outcomes out of all outcomes. Normally expressed as a percentage 1 in 750,000 is the odds of getting struck by lightning or 1 in 195,249,054 is the odds of winning the Powerball lottery

Severity

• When a loss event happens how much do I lose?

• Also called the Loss Given Default or LGD

• Another way to look at it is gross loss net of any recoveries

• Normally expressed as a percent total loss is 100% or I lost 75% of the value of the investment

Expected Loss

• Frequency and severity combine to generate expected loss

• This is the amount one expects to lose from taking on a particular action or investment


What risks do banks face?

• Credit/Underwriting Risk • Interest Rate Risk • Price (Market Risk) • Liquidity Risk • Foreign Exchange Risk • Transaction (Operational Risk) • Compliance (Legal) Risk • Strategic Risk • Reputational Risk • Earnings Risk


Interest Rate Risk


According to OCC’s Fall 2015 Semiannual Risk Perspective Report released December 16, 2015 interest rate risk is one of the OCC’s top supervisory concerns The ongoing low interest rate environment poses additional concerns as banks reach for yield by extending asset duration trends. Deposit stability, a significant component of IRR modeling, is difficult to assess because of recent deposit inflows and the potential for increased competition for retail deposits. The low interest rate environment continues to pressure net interest margins as asset yields decline and the cost of funds has stabilized at historic lows.

Interest Rate Risk is a concern


How do changes in interest rates impact you?

You invest in a 5 year CD at 3%. Over the course of a year, the 5-year CD rate increases to 5%. • Has the income on your CD changed? • Has the value of your CD changed?

You take out a 30 year mortgage at 4%. Over the course of a year the mortgage rate rises to 6% • Do you refinance? • What if rates dropped to 2%?

Suppose you lend money at a variable rate of LIBOR+5%. Over the course of a year, LIBOR rises 5% • Are you better- or worse-off? • Does your answer change if rates increase 30%?


Banks face the same risks from changes in interest rates

• Rising interest rates increase income when assets re-price faster than liabilities.

• Rising interest rates decrease income when liabilities re-price faster than assets.

• Falling rates have effects opposite from those listed above.

Impact to Income

• Rising interest rates decrease the value of assets, with longer-dated assets suffering the most

• Rising interest rates increase the value of liabilities, with longer-dated liabilities gaining the most.

• Overall impact is determined by the net asset and liability values

Impact to Equity

• On some products, such as mortgages and C&I loans, customers have an option to pre-pay, extend, or draw as rates change

• On some products, such as C&I and credit card, the bank has an option to reduce exposures as rates change

Costumer and bank options


Current One Year Later Rates Rise 3%

Assets Liabilities Assets Liabilities

Fixed Rate Loans 1,000,000$ 900,000$ Floating Rate Deposits Fixed Rate Loans 1,000,000$ 900,000$ Floating Rate DepositsRate 5% Rate 2% Rate 5% Rate 5%

100,000$ Equity 100,000$ Equity

1,000,000$ 1,000,000$ 1,000,000$ 1,000,000$

Interest Income 50,000$ Interest Income 50,000$ Interest Expense 18,000$ Interest Expense 45,000$

Net Interest Income 32,000$ Net Interest Income 5,000$

Current One Year Later Rates Rise 3%Assets Liabilities Assets Liabilities

Floating Rate Loans 1,000,000$ 900,000$ Fixed Rate CD's Floating Rate Loans 1,000,000$ 900,000$ Fixed Rate CD'sRate 5% Rate 3% Rate 8% Rate 3%

100,000$ Equity 100,000$ Equity

1,000,000$ 1,000,000$ 1,000,000$ 1,000,000$

Interest Income 50,000$ Interest Income 80,000$ Interest Expense 27,000$ Interest Expense 27,000$

Net Interest Income 23,000$ Net Interest Income 53,000$

Impact on Net Income

What might happen to these deposits if rates

rise?


Impact to the value of assets and liabilities

Bank purchases $1,000,000 30 year bond at 6% coupon

Rates rise what

happens to the value of the bond?

Rates fall what

happens to the value of the bond?

Because rates have fallen the bond is now

worth more if I were to sell it

Because rates have risen the

value of the bond is worth

less if I were to sell it

Assets

Equity

Liabilities $900,000 $1,050,000

$150,000

$1,050,000 $1,050,000

Assets

Equity

Liabilities $900,000 $950,000

$50,000

$950,000 $950,000

Assets

Equity

Liabilities $900,000 $1,000,000

$100,000

$1,000,000 $1,000,000


Repricing Risk

•When there are timing differences in the maturity of assets and liabilities •Because banks are financial intermediaries this is one of the most common risks and most discussed of the types of interest rate risk

•These repricing differences cause the banks income and underlying economic value to change due to changes in interest rates

Description

•The bank has a long term mortgages that are funded with short term deposits. Example

•Banks typically take their balance sheet and bucket assets and liabilities by term to maturity. Then they compare what the amounts in the overall buckets.

•Further, banks may shock rates by a predetermined amount say 100bp and see how the net interest income may change

•These can be found in the banks maturity gap and duration reports

Measurement

•Banks can use several strategies to manage an imbalance. If the bank is primarily a mortgage lender then odds are they are not going to change the type of lending. However, they may be able to change funding to prevent the mismatch. For instance marketing 5 and 10 year fixed rate and fixed term CD’s. These longer term CD’s will help address the mismatch.

•Another alternative is banks may enter into an interest rate swap where they pay a fee to pay a floating rate and receive fixed rate payments. That way the floating rate payment coincides with their shorter term floating rate deposits but they fix payments in equal to their interest income on the fixed rate loans

Strategies


Yield Curve Risk

• When changes in the slope or shape of the yield curve cause adverse effects on the banks net interest income and economic value Description

• Assume the bank has a position in 10 year government bonds funded by 5 year government notes. If there was a parallel shift they might be hedged however a steepening in the yield curve would adversely effect the economic value of this position

Example

• Banks can run various curve steepening, or inverted curve scenarios as well as yield curve twists to determine the potential impact on net interest income and net interest expense.

Measurement

• The portfolio manager with advance notice can start to realign the portfolio to make it less sensitive to steepening. This is why in many ALCO reports you will see a discussion about the current shape of the curve and any anticipated movements.

Strategies


Basis Risk

• This is the phenomenon that while two instruments appear to have similar pricing characteristics their repricing rates may not be perfectly correlated

• Net result is when the pricing of these instruments change there can be gaps and unexpected changes in the cash flows

Description

• Let’s assume a bank has a floating rate credit card that prices off of the Prime rate and has floating rate funding that is priced off of LIBOR. Both are floating rates however, both may not move in lock step.

Example

• Run shocks on the portfolio examining the 99th worst case spreads between these products to determine the impact on net income Measurement

• Price assets and liabilities using the same underlying characteristics • If that is not possible then explore derivatives to hedge away the basis

risk. Strategies


Optionality

• Risk occurring from the options embedded in the balance sheet. An option gives the holder the right but not the obligation to buy, sell or in some manner alter the initial cash flow of the instrument. This alteration of the cash flows can come at an inappropriate time for the bank and cause adverse changes to net interest income or economic value.

Description

• A bank may have explicit options such as exchange traded options • Banks can also have bond investments with call or put provisions which are

tied to changes in interest rates. • Mortgages have embedded options as if rates change in the borrowers favor

they will refinance the loan

Example

• The measurement of optionality requires running numerous what if scenarios to determine how the assets and liabilities will perform. This takes sophisticated Asset Liability Management modelling software that has term structure methodologies and simulation capabilities to model the outcomes.

Measurement

• After a bank better understands the optionality they can either change the terms of their products to eliminate or reduce the optionality

• In addition, banks can purchase derivative products to hedge the optionality Strategies


Example of Basis Risk between 1 month LIBOR and Prime Rate

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Rat

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Prime Bank Rate and 1 Month LIBOR

1 MonthLIBOR

PRIMEBank Rate

Note how both are floating rates however they don’t always move in lock step. Thus the spread between the Prime Rate and LIBOR can expand and compress creating changes in net interest income.


Banks can measure interest rate risk using stress testing


After the shock they can determine the impact on net income


Banks will also examine the change in their equity value from changes in interest rates


IR terms

• A rise in rates increases net interest income.

• As rates rise, interest income from assets rises faster than liability interest expense.

• As rates fall, interest income falls faster than the reduction in interest expense.

Asset sensitivity

• A rise in rates decreases net interest income

• As rates rise, liability interest expense rises faster than interest income from assets.

• As rates fall, interest expense falls faster than the reduction in interest income.

Liability/ Deposit sensitive


Advanced IR terms

• the price sensitivity of a bond to changes in interest rates

Duration

• how fast the price of a bond changes in relation to small changes in interest rates

Convexity

Price

Yield

P*

Y*

Duration is the measure of price changes given small

changes in yield

Convexity is a measure of the amount of smile for

instance negative convexity would be a frown

Each asset or liability has a duration and

convexity. These define the price of the bond

given changes in yield. They are determined by the performance of the underlying cash flows .

For instance if rates move by a prescribed

amount a bond may be retired or “called away”


Banks try to minimize interest rate risk by changing product terms or hedging

Maturity of assets is much longer than liabilities

Run a 5 year term CD special

Maturity of assets is much shorter than liabilities

Run a special on a money market fund to bring in short duration liabilities

Fixed rate funding but variable rate

loans Hedge by buying a fixed

to floating rate swap

Floating rate funding but fixed

rate loans Hedge by buying a

floating to fixed rate swap


Previous Interest Rate Risk Disasters

Asset Backed Commercial Paper

• ABCP became a popular funding vehicle leading up to the banking crisis.

• ABCP were long term assets funded using short term commercial paper. When the financial markets seized in 2009 it was impossible to reissue the short term commercial paper and the asset funding dried up having to come back on banks balance sheets.

S&L Crisis

• A contributing factor of the S&L crisis was a mismatch in the duration of assets and liabilities that when rates moved exacerbated the impact of credit defaults


Refining the Management of Interest Rate Risk

Ensure that all sources of interest rate risk are accounted for • Repricing risk -- mismatching maturities of assets and liabilities • Yield curve risk -- exposure to yield curve twists • Basis risk -- pegging floating rate assets and liabilities to different

base rates • Optionality -- changes in prepayment/extension behavior as rates

move

Define the metrics of interest • Economic value of equity / duration of equity • Income sensitivity

Building the suite of appropriate reports • Maturity gap analysis • Duration reports • Yield curve twists • Stress tests and scenarios analysis


Example: Managing the key assumptions that drive interest rate risk

• Non-maturity deposits • Non-maturity loans (HELOC, card) • Freely pre-payable loans (residential mortgage) • Loans with lax prepayment penalty enforcement (CRE, C&I)

Assets and liabilities lacking definite maturity contribute to

interest rate risk

• How will balances change as rates move? • How should I fund card receivables? • How much leeway should I give loan officers to waive fees?

• How should I price mortgages? • How much value is my deposit franchise creating? • How much interest rate risk am I exposed to?

Assumptions about the effective maturity and sensitivity of

extension/pre-payment help answer important questions

about rate risk

• If commercial loan officers pledge to limit waivers, how should overage be handled?

• If the prepayment rate on mortgages exceeds plan, how should this “convexity” be charged?

The originators of rate risk should have clear accountability

for rate risk assumptions


Banks measure interest rate risk centrally but charge business lines individually • Because banks must look at loans and deposits holistically

when determining their interest rate risk position it is at times difficult to determine the IR implications of the next product.

• However, to examine profitability at a business unit or product level banks have come up with methods to price for the interest rate risk internally

• This is known as Funds Transfer Pricing (FTP) • FTP is basically the price at which the bank is willing to

borrow or lend funds internally


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Funding Curve

Treasury Yield Curve

Bank Yield Curve

How FTP works

Deposits • Loans money to

Central Treasury • Paid based upon

the maturity of the deposit and type (fixed or floating rate)

Central Treasury

Loans •Borrows money from Central Treasury

•The cost of funds depends upon the maturity of the loan and type (fixed or floating rate)

A 3 year loan would have a cost of funds roughly equal

to 2%

Because the bank cannot borrow at the

current treasury rate the internal

cost of funds curve is at a

spread above treasuries


Prepayments on Commercial Loans and Residential Mortgages lead to interest rate risk

Assume a bank has a 5 year bullet commercial loan

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Funding Curve


Bank Yield Curve

Term


Bank Yield Curve

3-Month 0.13 1.2216-Month 0.16 1.27212-Month 0.2 1.342-Year 0.37 1.6293-Year 0.59 2.0035-Year 1.17 2.9897-Year 1.81 4.07710-Year 2.49 5.23330-Year 3.91 7.647

• What is the cost of funds of 5 year money? • What would happen if the borrower decided to prepay the

loan in year 2? • Is there a real cost? If so who should pay for it?

Banks should charge lines breakage fees

• The cost to the bank is real • That is why it is important not

to waive prepayment fees


Mortgage Servicing Rights

• Servicers receive fees for processing the loan receipts each month. This service has value to the bank. MSR

• If there is a flurry of refinance activity due to lower rates and the loans are pulled away from the servicer their income will be diminished. Hence in falling rate environments current servicing rights are worth less

• The converse is true as rates rise the value of existing serviced loans increases as the prepayment rates will be lower and the income stream more dependable

Value depends

upon interest rates

It’s not just loans but other instruments may be impacted by changes in interest rates


Questions for Bank Management Are you targeting a particular level of NII (net interest income) sensitivity? Are you targeting a particular level of EVE (economic value of equity) sensitivity? What kinds of interest rate scenarios are you using? How was your last interest rate risk regulatory exam? Do you have an interest rate risk policy? How do you manage your IRR assumptions for assets and liabilities? With what frequency do you run IRR models? Is the modeling done internally or through a third-party vendor? Are you satisfied with the output and recommendations from your asset/liability management software? Do they have an ability to test planned future assets and liabilities or are they restricted to the “run-off” portfolio? Is the Board getting the right interest rate risk information? Do you have the right tools to understand the interest rate risk performance of your current and future portfolio?


Liquidity Risk


What is liquidity?

The state of having cash or cash like investments on hand that could be quickly sold in the market with little reduction in price to meet near term payments or withdrawals

Liquid investments • Cash • Deposits in a bank • CD’s • Treasury bills or bonds • Corporate Bonds or paper

that are heavily traded • Highly liquid stocks

Illiquid Investments • Real Estate • Thinly traded Stocks • Thinly traded Bonds • Preferred stock • Physical Assets • Collectables


What are other sources of personal liquidity?

Credit cards

Home Equity Lines of Credit

Unsecured Loans – pay day lender

Pawn Shops

Parents, Rich Uncle, Relatives, Friends


Regulatory Definition of Liquidity and Liquidity Risk

Cash Balances due from

depository institutions

Treasury securities

US government

agency securities

Lines of Credit

Discount Window

Pledging mortgage to FHLB

Liquidity

A financial institution’s capacity to meet its cash and collateral obligations at a

reasonable cost

Liquidity Risk The risk that an institution’s financial

condition or overall safety and soundness is adversely affected by an inability (or perceived inability) to meet obligations

Source: SR 10-6 “interagency Policy Statement on Funding and Liquidity Risk Management”


A liquidity crisis happens when short term cash out flows exceed available cash and liquid securities on hand

Systemic event • Economic shock • Total market disruption such as default of

Lehman, Bear Stearns, and AIG • Disasters such as Y2K, 9/11, or avian or wide

spread flu could cause liquidity events

Bank Specific • Fraud or bad press can cause a lack of

confidence in depositors and a run • Loss of a major depositor • Draws on lines of credit • Being shut out of whole sale markets • Sometimes snowstorms or mail disruptions

can cause liquidity events

In each instance events cause extreme outflows of cash


Just like a recession, when you examine a liquidity crisis the question is how deep and how long

Depth

• Is the event isolated to one type of funding or all types?

• The degree to which asset prices have declined? Is it possible to sell at any price?

• Are additional credit lines available to obtain cash?

• Can assets be pledged to gain additional short term funding?

Length

• Is this a one day, one week, or protracted event?

• How long before asset prices return to normal levels?

• What levers are available to be pulled on a daily, weekly, or longer basis to avert the crisis?

• Can I quickly head off a reputational event with an effective response plan?


Firm specific liquidity crises

Enron •What finally killed Enron was a lack of liquidity that exposed the fraud

Long Term Capital Management •LTCM did not have enough liquidity to ride out a turn in the market when their uncorrelated positions moved in the same direction because of a lack of liquidity in the market

WAMU •A lack of confidence led to a slow walk of deposits out of the bank

Indy Mac •The Schumer letter and leaking the letter to the press started a run on the bank due to lack of confidence

All of these had problems but their ultimate demise was due to a liquidity crisis


Recent Systemic Liquidity Crises

The Liquidity Crisis of 2009

• A fear of counterparty credit risk after Lehman and Bear failed locked the liquidity markets. At the same time AIG a AAA rated company was insolvent

• On this fear commercial borrowers started to tap their lines of credit with the banks to ensure their liquidity

• The resulting deleveraging that took place completely locked the markets forcing the Fed to pump in liquidity through programs like TARP and TALF as well as making it acceptable for banks to borrow from the discount window

• ABCP and other securitization funding vehicles dried up during the crisis as investors became fearful of counterparty credit risk

• In some instances depositors took cash out of banks and bought gold

The Perfect Storm

•Without injections from TALF and TARP things may have gotten worse

•Central banks across the world began injecting massive amounts of liquidity to mitigate the crisis


A liquidity crisis is a downward spiral unless the government or investors step in to break the chain

Nervous customers draw increasing amounts of cash

Banks sell liquid assets in the market

to generate additional cash reserves

All of the banks dumping assets at the same time lowers asset prices and instills fear in the market

Asset sales combined with lower asset prices lowers

the value of the banks equity

Market concerns cause corporations to draw their credit lines

lowering the cash available and requiring

additional equity

If equity ratios fall below preset

covenants banks trading partners will not trade or provide lines of credit e.g.

additional cash

At the same time customers become increasingly worried about lower levels of

bank equity


Principles for the Management of Liquidity Risk

• Establish and articulate a firm-wide liquidity risk tolerance Governance

• Be sure to capture off-balance sheet exposures, securitization activities, and other contingent liquidity risks Measurement

• Incentives of individual business units should be aligned with the liquidity risk exposures their activities create for the bank , remember that the undrawn portions of a Line of Credit take up balance sheet and are usually drawn at the worst time

Alignment

• Develop tests that cover a variety of institution-specific and market-wide scenarios, with a link to the development of effective contingency funding plans Stress test

• Strong management of intraday liquidity risks and collateral positions Management

• Keep a robust cushion of unencumbered, high quality liquid assets to be in a position to survive protracted periods of liquidity stress Maintenance

• Regular public disclosures, both quantitative and qualitative, of a bank’s liquidity risk profile and management

Public Disclosure

• Understanding the linkages between liquidity risk and other risk types Correlation

When examining a bank determine if they are following these best practices


Evaluating Liquidity

Need to evaluate* • Volatility of deposits • Reliance on interest-sensitive funds and frequency and level of borrowings • Unused borrowing capacity • The capability of management to properly identify, measure, monitor, and control the

institution's liquidity position, including the effectiveness of funds management strategies, liquidity policies, management information systems, and contingency funding plans

• Level of diversification of funding sources • Ability to securitize assets • Availability of assets readily convertible into cash • Ability to pledge assets • Impact of holding company and affiliates • Access to money markets • The institution's earnings performance • The institution's capital position • The nature, volume, and anticipated usage of the institution's credit commitments

Source: FDIC Examination Manual


Evaluating liquidity: liquid relative to what?

Asset liquidity • Examine

composition of bank’s assets

• Evaluate true liquidity of nominal liquid and quasi-liquid assets

ALM: Assess maturity or repricing

schedule for assets and liabilities

Funding composition • Analyze structure

of a bank’s sources of funds: • Core deposits • Purchased, or

“hot” funds

Liquidity management: • Evaluate

management’s “contingency planning”

• What is a “liquid” asset? • How liquid are ostensibly liquid assets? Limitations

Principal approaches to liquidity evaluation


FDIC Guidance on Liquidity • “The FDIC limits the use of brokered deposits by insured institutions that

are less than well capitalized, and also limits the effective yield that these institutions may offer on all their deposits. These limits are set forth in Part 337.6 of the FDIC Rules and Regulations and should be incorporated in contingency funding plans.”

• • “Contingency funding plans should outline practical and realistic funding

alternatives that can be implemented as access to funding is reduced, including diversification of funding and capital raising initiatives.”

• • “Institutions that use volatile, credit sensitive, or concentrated funding

sources are generally expected to hold capital above regulatory minimum levels to compensate for the elevated levels of liquidity risk present in their operations.” Consider these when evaluating a banks liquidity. Think about the

relationship between liquidity and capital. Ask management direct questions.


Liquidity Ratios

• Measure of non-core deposits

Ratio Formula Purpose

Net Non-core Funding Dependence

Non-core liabilities less short term investments divided by

long term assets. Reflects the bank's

dependency on non-core deposits

Brokered Deposits / Deposits

Deposits acquired from brokers and dealers for the

account of others divided by total deposits.


Liquidity Ratios • Measure of immediate liquidity


Short Term Assets / Short Term Liabilities

Short term assets divided by short term liabilities.

Measures the extent the bank can quickly liquidate assets

(without any price discount) and cover short term liabilities.

Net Short Term Liabilities / Assets

Short term liabilities less short term assets divided by total

assets.

Liquidity Ratio

Liquid Assets (Cash & Bal Due Dep Inst + Securities + Fed Fund & Repos - Trading

Accounts -Pledged Secs)/ Total Liabilities


Liquidity Ratios Ratio Formula Purpose

Gross Loans / Total Deposits

Loans held for investment, before reserves, as a percent

of total insured deposits

Gives a rough picture of the relative balance of loans and

deposits.

Net Loans/ Total Deposits

Net loans, plus lease-financing receivables, divided by total

deposits.

Loans/Deposits

Total Loans & Leases (Net of Unearned Income & Gross of

Reserve)/ Total Deposits (Includes Domestic and

Foreign Deposits)


Liquidity Ratios • Some of the other common ratios that examiners use are:


Net Short-Term Non-Core Funding Dependence

Time deposits greater than $250,000, brokered deposits of less than or equal to $250,000, time deposits in foreign

offices, Federal Home Loan Bank advances, and other borrowed money

with a remaining maturity of one year or less, and securities sold under

agreements to repurchase and federal funds purchased divided by total assets*

Reflects the bank's dependency on non-core, short-term deposits

Net Loans and Leases to Total Assets

Net loans, plus lease-financing receivables, divided by total assets.

% of assets that are loans

Pledged Securities to Total Securities

The amortized cost of all held-to-maturity securities and the fair value of all available-for-sale securities that are pledged to secure deposits, repurchase

transactions, or other borrowings, as performance bonds under futures or forward contracts, or for any other

purpose as a percent of total securities

Pledged securities are “encumbered”, i.e. the bank has promised to hold them as collateral against liabilities , so can’t be sold in time of liquidity needs

Core Deposits to Total Assets

Deposits in domestic offices excluding time deposits over $250,000 and

brokered deposits of $250,000 or less divided by total assets

Shows how much of the bank’s assets are being funded by core deposits

* As defined by the UPBR Copyright © 2016 S&P Global. The Knowledge Center, a part of S&P Global Market Intelligence, a division of S&P Global Inc. 48

Liquidity Ratio Quintiles Liquidity & Funding

Brokered Deposts/ Deposits(%)

Percentile 2015Y 2014Y 2013Y 2012Y 2011Y 2010Y 2009Y 2008Y 2007Y 2006Y 2005Y80th 4.67 3.98 3.44 3.25 4.08 5.63 7.99 10.18 6.15 5.80 3.8960th 0.15 0.02 0.00 0.00 0.14 0.50 1.05 1.47 0.01 0.00 0.0040th 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.0020th 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00

(Noncore Liabilities - Short Term Investments)/ Long Term Assets (%)********Percentile 2015Y 2014Y 2013Y 2012Y 2011Y 2010Y 2009Y 2008Y 2007Y 2006Y 2005Y80th 13.03 12.42 11.55 9.83 11.80 14.25 33.89 39.04 34.51 32.72 30.2860th 5.17 4.70 4.05 2.48 4.24 6.01 23.99 27.49 23.51 21.26 19.4440th -1.29 -1.62 -2.43 -4.52 -2.24 -0.65 15.52 18.29 14.18 12.20 10.9720th -10.45 -10.84 -12.03 -15.23 -11.96 -9.60 5.27 7.23 2.35 0.60 0.00[(Non-Core Liabilities) - (Short-term Investments)] / [(Long-term Assets)]. The net non-core funding dependence ratio indicates the degree of reliance on funds *FDIC changed its defintion of core deposits in March 2011. Core deposits include deposits <250K for periods including and after 2010Q1. Periods prior to 2010Q1 include deposits <100K.

Total Brokered Deposits in Domestic Offices/ Total Deposits (Includes Domestic and Foreign Deposits)

Source: S&P Global Market Intelligence, Data based on all U.S. commercial banks


Liquidity Ratio Quintiles Short Term Assets/ Short Term Liabilities (%)


(Short Term Liabilities - Short Term Assets)/ Total Assets (%)

Percentile 2015Y 2014Y 2013Y 2012Y 2011Y 2010Y 2009Y 2008Y 2007Y 2006Y 2005Y80th 6.94 7.56 8.49 8.14 11.70 14.02 17.70 19.74 17.86 16.61 13.2060th -0.63 0.42 1.16 0.60 3.93 6.01 9.66 11.37 8.96 7.56 4.7140th -7.11 -6.30 -5.65 -6.84 -3.06 -1.08 2.63 4.08 0.72 -0.91 -3.0020th -15.56 -14.83 -14.69 -15.74 -12.10 -10.17 -6.61 -5.49 -10.52 -11.82 -13.76

[(Short-term Liabilities) - (Short-term Assets)] / [Total Assets]. The ratio indicates the degree of exposure assumed by funding assets w ith short-term liabilities.



Liquidity Ratio Quintiles


On Hand Liquidity (%)


Loans/ Deposits (%)

Percentile 2015Y 2014Y 2013Y 2012Y 2011Y 2010Y 2009Y 2008Y 2007Y 2006Y 2005Y80th 92.86 91.21 88.44 86.54 87.28 89.79 93.72 100.58 99.89 96.86 96.0160th 82.59 80.53 77.67 75.74 77.79 80.99 84.66 90.71 89.08 86.69 85.9440th 71.81 69.96 67.73 66.27 68.52 71.97 75.94 80.52 78.85 76.98 75.7620th 57.43 55.58 54.27 53.79 56.26 59.60 62.88 65.95 64.83 63.52 61.96Total loans divided by total deposits

[(Interest-bearing Balances) + (Total Securities) + (Fed Funds Sold & Reverse Repos) - (Fed Funds Purch & Repos) - (Pledged Securities)] / [Total Liabilities].


Questions for bank management Do you have a contingent liquidity plan? Are you targeting particular short-term and long-term liquidity ratios? How was your last liquidity risk regulatory exam? Are you effectively measuring the cost of liquidity? How often do you test your liquidity position? Is the Board getting the right liquidity risk information and reporting? How do you manage and test your liquidity assumptions? How quickly can you respond to changes in the liquidity position? Do you have the right tools to understand your current and prospective liquidity position?


Questions


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Documents

Bill Nayda Assessing Second Pillar Consulting interest rate and Liquidity risk · 2016-07-26 · Bill Nayda, Ph.D., is the Principal and founder of Second Pillar Consulting.Bill and