Presented By:

August 16, 2016

CHANGE IS IN THE AIR: WHAT’S NEW AT ALM FIRST

ALM First Executive Management Team

Agenda

• ALM First – the Company

• Emerging Themes

• Investment & ALM Strategy Groups

• Mortgage pipeline management

• Maximizing member benefit

• Credit

• What is new in marketing, webinars, and speaking engagements

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About Us

• Established in 1995• Headquartered in Dallas, TX• SEC registered investment

advisor (not a broker / dealer)• 200+ financial institution clients• Average asset size of $1.2

billion • $20 billion assets under

management• ~20 M&A deals annually across

all financial institution verticals• Work with 10 of 15 largest CUs

including capital planning stress test engagements

• Quantitative risk modeling, trading, hedging, and management consulting are core competencies

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Thought Leaders

• Partner with, publish for, and educate– Auditors

– Management and Boards

– Regulators

• FDIC

• FFIEC

• FHLB

• NCUA

• State Banking Commissions

– Trade Associations

• AICPA

• AmericanBanker

• CUNA

• FMS

• Western Independent Bankers

• State Credit Union and Banking Associations

– Trade Publications

• SNL Financial, a division of S&P

• Credit Union Journal

• Credit Union Business

• Credit Union Times4

History of ALM First

• Founded in 1995, firm’s foundation is rooted in risk management.

• Previously engaged mainly for outsourced ALM reporting, and ability to obtain better trade execution through the use of primary broker-dealers.

• As firm evolved, moved into a far more strategic role. AUM have doubled since 2008.

• ALM still fundamental to what firm does, focused on driving returns from spread management rather than betting on interest rates or trying to pick the best bond.

• Over 95% of returns come from sector allocation and duration accuracy than solely security selection.

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The ALM First Difference

• Thoughtful, quantitative research oriented organization.

• Clearly communicate themes and opportunities in markets on a regular basis.

• In the credit union business for over 20 years. We understand credit unions, we understand regulators, and communicate frequently with both.

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Assets Under Management

Agency $4.6 Billion

CMO $5.2 Billion

MBS $5.9 Billion

Credit $0.4 Billion

Other $3.9 Billion

TOTAL $20.0 Billion

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*Market Value as of June 30, 2016

Agency23.18%

CMO25.98%

MBS29.51%

Credit1.85%

Other19.48%

Organizational Structure

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CEO

(Emily Hollis)

Principal, Advisory Services

(Travis Goodman)

Principal, Marketing and Client Relations

(Mike Ensweiler)

Principal, Strategic Solutions Group

(Kevin Kirksey)

Operations, Financial Modeling

Group, IT, Technology

Merger Valuations & Validations

Capital Stress Testing

Principal, ALM & Investment Strategy

(Robert Perry)

Trading & Investment Strategy ALM Strategy

Leadership

• Emily Moré Hollis, CFA, Chief Executive Officer– Served as a principal since the company was established in 1995

– Under her leadership, organization has grown to manage over $220 billion in assets under management

– Well-known figure in the investment community and a renowned expert in asset liability management as well as in executing and managing risk management programs

• Kevin Kirksey, Principal, Strategic Solutions Group– Oversees merger valuation, ALM validation, and many hedging strategy relationships

– Oversees the Financial Modeling Group, which is responsible for all non-investment financial reporting and valuation

– Serves as the Chief Compliance Officer for the firm while overseeing office management, collateral management, software engineering, and firm profitability

• Robert Perry, Principal, ALM & Investment Strategy– Responsible for the development of asset liability and investment portfolio themes for the firm

– Provides strategic focus for financial institution client portfolios that are primarily invested in the high credit quality sectors

– Instrumental in balance sheet hedging strategy development

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Leadership

• Travis Goodman, CFA, Principal, Advisory Services– Oversees Advisory Department, which is responsible for implementing actionable and

effective ALM and investment strategies for client financial institutions

– Assists large, complex financial institutions in achieving optimal performance within policy & risk tolerances

– Leads ALM First’s efforts in the development and implementation of interactive client reporting tools

• Mike Ensweiler, Principal, Marketing & Client Relations– Oversees the firm’s sales and growth strategies

– Manages all areas of marketing and client relations

– Has extensive financial services background, with success in helping financial institutions increase their productivity and strengthen their bottom lines

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EMERGING THEMES

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Emerging Themes

• Margin compression

• Asset liability management trends

• Mortgage pipeline management

• Liquidity management & stress testing

• Capital planning & stress testing (CPST)

• FASB’s proposed Current Expected Credit Loss (CECL) model

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ALM AND INVESTMENT STRATEGY GROUP

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Strategic Management – ASG / IMG Org Chart

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Robert Perry

(Principal)

ALM Strategy Group

Alec Hollis (Associate)

John Hopkins (Senior Analyst)

Investment Management Group

Jason Haley (Managing Director)

Ryan Bridges (Associate)

Hafizan Hamzah (Director) Chris Eckhoff (Analyst)

Investment Management Group

• Firm-wide communication of investment themes– Daily trading package

– Weekly analytics

– Bi-weekly market update and monthly ALM strategy update webinars

– Monthly commentary and portfolio returns

– Current market themes• Rates, vol and spreads

• Sector and strategy performance

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Investment Management Approach

• Not broker / dealer, but an asset manager

• Strong commitment to market research

• Focus on risk-adjusted return– Risk versus reward

– Excess-return in high credit quality

• Management approach is two-pronged– Investment philosophy (firm-wide)

– Investment strategy (institution-specific)

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Investment Philosophy

• Tenets of ALM investment philosophy– Duration (i.e. get the durations right, no rate-betting!)

– Sector and security selection to outperform

– Accurate and timely data leads to better decision-making• Frequency of iteration augments better decision-making capabilities

• Shorter feedback loops enable more effective adapting and learning

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Ex‐Ante

Ex‐Post

Man

agem

ent

Effe

ctiv

enes

s

Feedback Loop Time

Investment Strategy

• Risk targeting:– Target duration based on the ALM framework

• LDI

– Risk tolerance

– Strategy preference• Core MBS

• Enhanced liquidity

• Diversified exposure

• Relative value in the marketplace may not equate to most valuable for a balance sheet– LDI

– Example: floaters versus fixed CMBS

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ALM Strategy Group

• Development and communication of ALM themes and strategies– ROE calculator

– Monthly webinar series

– Capital management

– ALM (risk management) process

• Industry research– Peer and profitability analysis

– Modeling assumptions and procedures

• Secondary market services– Pipeline management

• Middle-office responsibilities– ISDA / accounting valuations / risk reporting

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Asset-Liability Management Philosophy

• ALM: maximize profitability through risk reduction– The ALM framework seeks to maximize the firm’s probability-

weighted net worth

• Philosophy: focus on the ALM process as a whole, viewing the firm at the enterprise-level

• Three main characteristics of a high-quality ALM program– Timeliness

– Accuracy

– Comprehensiveness

• ALM decision-making process enhanced through enhancing these characteristics– Get out of the granular, and focus on the process!

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Asset-Liability Management Process

• Much like the investment management process, the ALM process is improved through frequency of iteration and accuracy of modeling

• Shorter feedback loops allow for a better ability to adapt and adjust strategy

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Set and Define: Policies, procedures and risk

tolerances

Set and Define: Policies, procedures and risk

tolerances

Risk Measurement: Quantification and

monitoring

Risk Measurement: Quantification and

monitoring

Risk Adjustment: Management and strategy

implementation

Risk Adjustment: Management and strategy

implementation

Ex-Post Analysis: Assess performance

Ex-Post Analysis: Assess performance

Asset-Liability Management Strategy

• Strategy is set at the enterprise-level• Enterprise-level ALM involves:

– Market risk, most notably: interest rate risk– Liquidity– Capital management

• Risk-based capital• Risk-budgeting (e.g. capital allocation between business lines)

– Credit risk

• ALM strategy also involves enhancing the ALM process– Delivered information becomes more valuable– Could involve improving:

• Information expediency, accuracy or comprehensiveness

• ALM strategy focuses on the highest value-add areas to deliver competitive advantage to the firm

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MAXIMIZING MEMBER BENEFIT

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Return on Equity

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DuPont Model for Financial Institutions

Return on Assets Financial Leverage

ProfitMargin AssetUtilization

NetIncome

AverageEquity

NetIncomeRevenue

Revenue

Average Assets

AverageAverage Equity

• Industry average ROE weighted by asset size– Credit union industry: 7.32%– Community banking (<$10m in assets): 9.61%

• Small CUs and community banks generally underperform their larger peers– Size efficiency

• ROE can be done on a marginal basis, and be market-based to help select assets by determining relative value– Economic ROE

Marginal Economic ROE Calculator: Example

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Capital Constraints and Equity Returns

• Managing balance sheets based on expected returns on capital under a dual capital mandate (leverage and risk based) can be a mathematically complex process– Optimization methods are typically used where the objective

function is the following:• Maximize ROE

• Subject to:– ∑ W1+W2+W3 etc = 100%

– Capital / Total Assets

– Capital / Risk Weighted Assets ≥ 8%• Risk-based requirement

– All Weights (Ws) ≥ 0 • No short selling

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Risk Budgeting – Where Do You Spend Your Risk?

• Two balance sheets with equal capital levels can have very different constructions

• Examples:

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Balance Sheet BExposure Balance  Risk Weighting

Retail 50,000,000  100%

Auto 100,000,000  75%

1st Mortgage 250,000,000  50%

Other RE 25,000,000  100%

Business 225,000,000  100%

Total Loans 650,000,000  77%

Total Investments 275,000,000  20%

Overnight Cash 40,000,000  0%

Non‐Interest Cash 10,000,000  0%

Cash & Cash Equivalents 50,000,000  0%

Total Other Assets 25,000,000  0%

Total Assets 1,000,000,000  56%

Total Liabilities 950,000,000 

Equity 75,000,000  14%

Total Liabilities & Equity 1,000,000,000 

Balance Sheet AExposure Balance  Risk Weighting

Retail 50,000,000  100%

Auto 250,000,000  75%

1st Mortgage 300,000,000  50%

Other RE 50,000,000  100%

Business 75,000,000  100%

Total Loans 725,000,000  71%

Total Investments 200,000,000  20%

Overnight Cash 40,000,000  0%

Non‐Interest Cash 10,000,000  0%

Cash & Cash Equivalents 50,000,000  0%

Total Other Assets 25,000,000  0%

Total Assets 1,000,000,000  55%

Total Liabilities 950,000,000 

Equity 75,000,000  14%

Total Liabilities & Equity 1,000,000,000 

MORTGAGE PIPELINE MANAGEMENT

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Mortgage Banking Business

• The mortgage banking business involves:

• Commitments made to potential borrowers are firmfor the financial institution, but flexible for the borrower

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Originate New Loans

PipelineManagement

Service Sold Loans

(MSR)

Mortgage Pipeline Risk

• Mortgage originators sell conforming mortgage loans to the agencies (GNMA, FNMA or FHLMC)

• This sale process exposes the originator to pricing risks from the time of the initial commitment to the borrower until the time that the mortgage is committed for sale to the agencies

• Originators manage this pipeline risk in one of three ways:– Best efforts forward sale commitments

– Mandatory forward sale commitments

– Hedging their pipeline with capital market instruments like TBA MBS and other interest rate related futures contracts

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Pipeline Management

• Best efforts commitments: – Loans are committed or “locked in”

– If the loan does not close, delivery is not required

– Least favorable pricing

• Mandatory forward whole loan or cash sales:– Mandatory delivery

– If delivery cannot be made, there is a “pair off” fee

• Hedging the pipeline with capital market instruments like TBA MBS

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Pipeline Management

• Choosing the technique to employ involves cost-benefit analysis

• Performance evaluation should consider not only mitigation of risk, but cost effectiveness of doing so

• High quality pipeline management should:– Effectively mitigate risk

– Be cost efficient

– Be transparent

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Performance

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CREDIT

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CreditCredit

Capital PlanningCapital

Planning

Concentration Risk

Concentration Risk

More…More…

CECLCECL

Credit

• Robust record-level modeling capabilities allow for more effective evaluation of credit risk

• Once a solid credit modeling framework has been established, applications of results increase substantially

• All credit outputs have similar foundations, but assumptions are modified to fit desired output

• Increased data requirements to receive meaningful outputs

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Credit Risk Modeling

• ALM First has been valuing whole loans and non-agency securities since its inception

• Process for projecting loan losses under a variety of macroeconomic scenarios is part of our regular business

• Spend significant resources on developing models to evaluate voluntary prepayments, default probabilities, loss severities, and recovery lags across even the most esoteric collateral

• Key differentiators– Utilize information so clients can make better strategic decisions

(not SaaS or “blackbox” deliverable)– Bottom-up approach with proxy data as needed– Quantitative defensibility of capital plan, concentration risk

policy, and ERM parameters– Considerable sensitivity analysis and documentation– Substantial credit union experience and perspective

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Implementing Credit Analyses

• Credit unions can employ the results for risk management and strategic planning processes

• The board of directors and senior management can rely on stress testing model results and documented capital plan to:– Clarify position to the regulators

– Diagnose areas needing strategic and operational improvement

– Examine the risk appetite statement and ERM framework

– Evaluate lending concentrations at the portfolio level

– Assess the adequacy of capital and the allowance for loan and lease losses (CECL)

– Increase effective challenge across multiple models and departments

– Reconcile with the member experience and philosophy

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Credit Data Action Items

• Identify and document data constraints proactively

• Refresh data dictionary and regulatory mapping

• Refine ownership and security governance

• Optimize centralized datamart and warehouse architecture

• Improve data capture at origination

• Enhance loss mitigation practices

• Back-test and validate over full economic cycle

• Align business unit heads with flexible reporting tools

• Consider reputational issues, e.g. AML, cybersecurity, ATMs

• Enhance statistical relevance to idiosyncratic risk modeling

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CPST Services

• Credit unions < $10B assets– Multi-dimensional credit risk analysis at a point in time

– Forward-looking analysis in prescribed baseline, adverse, and severely adverse scenarios

– Idiosyncratic risk assessment

– Reverse stress testing

– Capital plan and ERM policy documentation and review

– Ongoing staff and board training and advisory

• Credit unions > $10B assets– Champion model development and outsourcing

– Challenger model

– Model aggregator

– Credit risk model development

– Data, systems, and process review

– Full CPST documentation ongoing or project basis

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CPST Service Competitive Analysis

• Strengths– Deep and focused industry experience and Street relationships

– Transparent and auditable results

– Relentless devotion to model development, data science, and scenario analysis

– Commitment to education and strategic advisory

• Areas of improvement– Technical writers for appendices required under DFAST

– Information technology outsourcing

– Client collaboration and utilization

– Regulatory acceptance of champion model

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WHAT’S NEW IN MARKETING AND EVENTS

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Marketing & Client relations

• Client relations

• Regional Roundtables

• Survey Q4

• Communication strategy going forward– Delivery channels

• Website

• Email

• Newsletter

• Social Media

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Events & Education

• Financial Institute– March 26-29, 2017, Four Seasons Resort and Club, Dallas

• Financial Forum• Best time to hold?

• How do we make more valuable?

– 2017 • Broadmoor Hotel, Colorado Springs, CO

• Date: TBD

• Webinars

• Certified Balance Sheet Manager Program

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