Bankers have been thinking and preparing for “rising rates” since December 2008. It has been a month since the first “baby step” toward higher rates was executed (Fed Funds and Prime moved up 25 basis points) and we have seen very little effect on the vast majority of the banks we work with.
In fact, only a few banks made the decision to raise rates approximately 25 basis points on their non-maturing deposits while leaving their time deposits alone. The rationale for immediate action was based on the notion that an increase now will hopefully allow them to stand pat for at least the next move, and maybe the next two increases. The greatest increase in the COF (cost of funds) we noticed was about three basis points. But, most community bankers shrugged their shoulders and took the wait and see approach. As it turns out, considering the current price of oil and the slowing Chinese economy, the next move may be much later than we anticipated. So, wait and see was a good choice.
The increase in the National Prime Rate (New York Prime if you like) of 25 basis points actually has a positive effect on some loan portfolios. For those bank’s with variable rate loans at or above their floors and not contractually locked out (i.e. they were immediately repriceable), a 25 basis rate increase hit the books increasing interest income. In banks with a large percent of their loans in this category the income received will be significant. Plus many banks improved their position for the next rate hike because many of the rates (index plus spread) moved closer to “piercing the floor!” Of course floors are a good thing when rates decline and remain low, but if the rates (index plus spread) are substantially below the floors there is a fair amount of “wheel spinning” before the floor is actually pierced, thereby delaying the increase in income.
In terms of fixed rate loans, very few banks have been able to increase rates they receive based solely on the Fed move. We monitor the “offering” rate on every single loan made (both fixed and variable) in every bank and to date we have seen no material rate increases. Unrelated to the Fed move however, many Ag banks have suggested that they may be increasing rates as loans renew because of cash flow issues related to cattle and grain prices. If you want to see what the market is saying how you should be pricing your fixed-rate loans, then use our Loan Builder to find out.
Many of the economic “gurus” have toned down their expectations of further rate hikes this year, but you should be prepared for the unexpected. Determine how an increase in deposit rates will impact the COF and thus the Spread and Margin. Know what the cost is before you make the move, and compare the income expected to be received (if any) from the variable loan portfolio.
In short, be prepared for “rising rates”, even if they may not be expected any time soon. You never know.
Tuesday, January 26, 2016
Friday, October 2, 2015
The days are getting shorter, the nights are getting cooler, and the leaves are changing color. This means that fall is here, and you have pulled out your favorite college or NFL team gear. This, also, means that it is time to start planning for next year. Most of our clients are experiencing better asset quality and improved earnings. However, earnings are only improving because of the decreased losses in the loan portfolio. The biggest challenge our customers are facing now is how they can improve their margins.
Before the Fed dropped rates to zero, banks were able manage the margin by either dropping deposit rates a little or increasing loan rates a little. With deposit pricing near zero and the highly competitive market for loans, banks need to be looking at their balance sheet a little differently than before to find a few more basis points to get that Earnings component back to a 1 or a 2. As a former examiner, I have seen many asset liability reports. Most of those reports use your general ledger data and aggregates the information to perform the analysis. While this method will often check the regulatory box for interest rate risk, this method doesn’t give you the specific detail of your balance sheet to find those few basis points of margin. To be able to find those opportunities within the balance sheet, you need to analyze each loan, investment, deposit, and borrowing. In addition, assumptions need to be developed based on accurate and timely data.
Here at AMG, we specialize in analyzing your specific information and returning it to you in a way to help you find those few basis points. We focus on data input and assumption development. The output is only as good as the input. Our reports have a built-in deposit study that gets updated with every run of the model. The results of this assumption development are also stress-tested to provide a range of results should you experience behaviors different than you are currently experiencing. In addition to the deposit information, we analyze your loan portfolio down to the loan number. This analysis allows us to give you reports about how you are pricing your loans to help show you if you are missing any opportunities in pricing. We also break down the variable loan portfolio to show you how and when you will be able reprice that segment of the portfolio. This information allows you to be more proactive in managing your balance sheet to start expanding your margins.
Because of how we gather your data, our BancPath® report is highly effective at managing interest rate risk. In addition, we are able to provide you reports that include the loan pricing, investment management, and deposit pricing. We also provide the sensitivity analysis of your assumptions. We do not break out these reports or charge more for them; they are all included in the same fee. Additionally, our reports “check” all the boxes in the interest rate risk guidance, with the exception of the independent review (which no model provider can include if they are generating your results). If you want to find out more about how we can help you start expanding your margins, email Aaron at firstname.lastname@example.org or call (800)226-1923.
Thursday, August 13, 2015
We have been receiving this request from many of our clients about an independent review of the interest rate risk management practices. We will continue to provide you with the resources you need to continue managing your bank efficiently while keeping regulatory scrutiny at bay.
The 1996 Policy Statement on Interest Rate Risk(IRR) says that banks not only need to measure the risk that changing rates have on earnings and capital, but that the process to measure this risk needs to be reviewed by someone independent of the ALM process. This generally means that ALCO members are not eligible to be reviewers. Additionally, the independent review needs to be more than just a back-test of results and getting the validation certificate from your model provider. The FDIC released a Supervisory Insight in the winter of 2014 addressing how a community bank can address the Independent Review requirement for the IRR management process. The document provides some specific direction has to how to accomplish this with someone within the bank. It does point out that if there isn’t someone that is qualified to perform such a review, then the bank should consider looking to an outside source. Here is a direct link to the pdf.
Here at AMG, we take pride in the reports that provide our clients. Not only do our reports provide detailed analysis of your balance sheet, the BancPath® report follows what is expected from the 1996 Policy Statement and 2010 Advisory. We even brought a former examiner on staff to keep ahead of the regulatory pressure as it relates to your ALM process. If you are looking for a partner in your ALM process, we are looking forward to be there for you. For more information, call 800-226-1923 or email any of our contacts on the left of this page.
Thursday, July 16, 2015
Recently, we discussed the growing importance of not only developing institutionally relevant assumptions derived from your bank’s own historical data, but also the importance of stress testing these assumptions to isolate the impact a movement in a single assumption can have on a bank’s interest rate risk.
In light of increased examiner scrutiny on bank assumptions, and subsequently stressing those assumptions, we here at AMG have added 2 new stress tests. These 2 new tests will focus on loan and deposit prepayment factors in order to give the BancPath user a clear understanding of the affect these assumptions can have on the bank’s interest rate risk profile.
The first test we call the Prepayment Stress Factor. This test uses a Prepayment Stress Factor on loan prepayment speeds. This will generally have a NEGATIVE impact on the Interest Rate Risk Profile as rates decline (more dollars are repriced at lower rates) and as rates increase (fewer dollars are available to be repriced at higher rates). An example of this test is below where you can see the impact on Net Interest Income:
The second new stress test uses a Deposit Prepayment Stress Factor in conjunction with a Defined Prepayment Rate (either a default value or User Defined) to increase the expected forfeiture of Time Deposits in a rising rate environment. This will generally have a NEGATIVE impact on the Interest Rate Risk Profile as the probability for early withdrawals of time deposits increases. This is a simple test that applies an "across the board" prepayment rate. We would expect that actual prepayments would be much less severe as the likelihood of early withdrawals would ONLY occur on longer time deposits. See the effect on Net Interest Income below:
If you have any questions about this process, please don’t hesitate to contact us at Asset Management Group.
Friday, June 26, 2015
Since March 31, 2015, the 10-year Treasury has moved from 1.934 percent to 2.478 percent on June 10, 2015. During this time, most banks have experienced a decrease in market value of their securities portfolio. Additionally, the Fed continues to debate on when the time is right to start increasing the Fed Funds rate. With news of consumer sentiment up, unemployment numbers down, and housing up, it is only a matter of time before we see our first increase. What this all seems to be doing is causing some examiners to have anxiety about your investment portfolio and what is going to happen to your capital, liquidity, and earnings when rates rise.
Some of our clients have been asked by regulators to set policy parameters around the percent change of the investment portfolio as it relates to capital and earnings. The basis for this recommendation comes from the OCC Bulletin 2004-29, or the FDICFIL-46-2013. It looks as if the message behind this bulletin or FIL is to make sure bank management understands the risks within the portfolio as it relates to capital, liquidity, and earnings. Given the way the investment portfolio works, it is very challenging to set parameters specifically on the investment portfolio as it relates to capital without also looking at what is happening on the liability side of the balance sheet. This practice would place a bigger risk to the bank because when rates go up, you could be selling at the worst possible time, ultimately affecting capital, liquidity, and earnings. In this bulletin, the OCC talks about the importance of monitoring depreciation within the investment portfolio and it does talk about the importance of measuring the overall EVE, or MVE for BancPath®, position, but it doesn’t say that there needs to be a policy parameter for the amount of depreciation in the portfolio as it relates to capital. It warns of extending the duration of the portfolio to chase yields, and that management should be aware of what that practice might do to the overall position of the balance sheet in changing rates.
If you haven’t taken a look at your policy parameters as it relates to the condition of your bank or the position of your balance sheet, then it might be time for a revisit to reconfirm them or adjust them accordingly. Additionally, to show to regulators that this has been thoroughly thought out, if your liquidity contingency funding policy doesn’t include the depreciation of the investment portfolio in a rising rate environment and how management would handle the change in liquidity from that impact, then I would recommend adding that scenario. By taking these steps, regulators should get the impression of a comprehensive approach to managing the balance sheet and overall ALM. Also, don’t be afraid to document in the minutes the discussion within ALCO about the steps you are taking to control the duration of the portfolio.
The BancPath® reports have the capability to handle these recommendations in an easy-to-use format. The ALM world is continually evolving into more complexity, and we continue to strive to stay ahead of the curve. If you are feeling the pressure from examiners, concerned about how you are positioned for a rising rate environment, or just want to know more, then you can reach us at (800) 226-1923.
Monday, June 22, 2015
A President of a $300 million dollar community bank recently asked about adding long-term advances to “lock in” some spread to current book yields on earning assets. This is obviously a seeming reasonable question regarding a commonly used strategy. The answer to this simple question, however, requires a deep understanding of the balance sheet and specifically a thorough understanding of the nature of Non Maturing Deposits (NMD) as well as a “rate call”, and almost some clairvoyance regarding the likelihood of asset prepayments. In this analysis, however, let’s assume the banker thinks rates will increase and also thinks prepayments on both loans and investments will decrease as rates move up. So, it is just a matter of picking out some proper advances and pulling the trigger, right? What about those NMD on the balance sheet? Do they provide enough protection against rising rates, or, do we really need to add advances?
The specifics the banker laid out included a 10 million dollar advance in the five to 10 year range. At the time of the discussion the five year advance was in the neighborhood of 2.15% which increased the bank’s COF 6 basis points. This would increase the bank’s interest expense $180,000 a year, without raising the Interest Income a bit. Rate calls and insurance is expensive, even in today’s world of low rates. Can you afford and are you willing to take on this expense? Remember, when rates rise you can lag interest expense (Betas define rate sensitivity) and new assets will hit the books a higher rate increasing interest income.
First, before you dive headlong into extending your liabilities make sure have a clear picture of the current deposits on the balance sheet. In particular, get your arms around the nature and likely duration of NIB DDAs and the other transaction accounts (MM Savings and NOW). Even though it flies in the face of current wisdom, there may be more “protection” against increasing rates in these deposits than you think.
Even though the majority of community banks are funded with core deposits, more specifically non-maturity deposits (NMD) they get little respect when upward rate movement is discussed. The good news is that NMD create the greatest value of any funding source and are generally the most stable. The bad news is that they create the biggest headache when it comes to determining the value they place on the bank’s balance sheet and are the most scrutinized by examiners. Unlike all other assets and liabilities that have stated pricing structures and maturities, NMDs are considered to be immediately reprice-able by management and to be immediately callable by the customer. Since history has taught us that NMDs don’t immediately reprice or get called, we have to make assumptions to determine how these rate-sensitive deposits reprice and how long they will be around.
Additionally, NMD have grown in recent years as opposed to “decaying”. At least in the last five years or so, pricing has become practically irrelevant as NMD have increased. If you are just looking at the volumes in your NMD accounts to create an assumption about their life expectancy, you might be getting misleading information. In addition to this growing assumption dilemma, regulators are pushing to make sure those assumptions are accurate. How do you know those assumptions are accurate when there hasn’t been an increase in rates since June 2006?
But, recent history should not obscure the stable nature of NMD over a long period of time. It is obvious that balances may be larger than would be “normally” expected, thereby perhaps “temporarily” decreasing your COF (and perhaps increasing MVE), but the expected duration (time remaining on the books) of these accounts is probably far longer than the values we see in many current ALM Models.
So, back to our original premise, that when properly measured, NMD are probably less rate sensitive and most likely have more staying power than is often assumed. If your ALM model is telling you that NMD will run off as soon as rates rise and that they will be extremely rate sensitive (very high betas) you might want to closely examine these results. What assumptions are driving these conclusions, and do they make sense? Keep in mind the balance sheet may be less liability sensitive than your model says it is.
No one knows the future of rates, but if you do not properly value and measure the current balance sheet, then your COF may surge far more than necessary. The AMG BancPath® model incorporates a deposit study within the context of the model to give you the information you need to use your bank’s specific assumptions. If you have questions or want to know more, you can reach us at (800) 226-1923.
Wednesday, June 3, 2015
Do you have questions about how the new Basel III rules are going to affect your bank? You’re not alone. The OCC, FRB, and FDIC have issued an FAQ to help get you started. This FAQ covers issues various issues that other community banks have encountered when applying the new capital rules. The following is a list of topics that the FAQ addresses:
· Definition of Capital
· High Volatility Commercial Real Estate (HVCRE) Exposures
· Other Real Estate and Off-Balance Sheet Exposures
· Separate Account and Equity Exposures to Investment Funds
· Qualifying Central Counterparty (QCCP)
· Credit Valuation Adjustment (CVA)
· And a couple of other questions not covered by the above categories.
The majority of the questions help answer the issues in identifying and accounting for HVCRE. The following link goes directly to the FAQ and supporting information.
If the question isn’t answered with this FAQ about the new Basel III regulations, the page provides a list of contact information for your regional FDIC contact.
Friday, May 22, 2015
As we noted in late March Regulators are focusing on Liquidity, or more appropriately stated, they are sharply focusing on stressed liquidity and the adequacy of Contingency Funding Policies. The presence of an acceptable policy is not an option, regardless of the present liquidity on the balance sheet. In the past few weeks we have received request from bankers to help shape an acceptable policy “ASAP” in response to examinations.
Liquidity is always a more pressing issue in a highly loaned bank with little on balance sheet liquidity. Also, even in a bank with fewer loans coupled with a “long” investment portfolio with significant interest rate risk liquidity might be a concern. But, in recent weeks, a couple of banks with loan to deposit ratios of less than 55%; at least 45% on balance sheet liquidity; portfolios with less than 3.5 years duration; and above all else excellent asset quality, were scrambling to create an adequate policy.
The point of citing these examples is to drive home the point that every bank, regardless of its current risk or liquidity profile, should spend the time to create a good contingency funding policy. The policy should include an inclusive list of various scenarios that might lead to liquidity “stress” or a varying degree of “crises”. Then, it should systematically list the steps that could be taken to meet the emergency.
Keep in mind, there are three “stress events” related to the loss of deposits that should be covered. The first is a “Severe Stress Event” that reduces deposits by 20% while reducing borrowings and lasts one year. The second is a “Moderate Stress event” that reduces deposits by 10% and ability to borrow and last three months. The third is a “Mild Stress Event” that merely reduces deposits by 5% and lasts for a couple of weeks.
At one point it seemed that the “Severe Stress Event” was most scrutinized and at the end of the day if the Cumulative Net Surplus in the 181-365 days period was NEGATIVE or marginally positive, it was time to trot out the Contingency Funding Policy! But now, even if your numbers are solidly positive in the last time bucket, it is still imperative that the policy be updated, accurate, reasonable, comprehensive, and most importantly, an effective tool to provide the liquidity needed.Every AMG report contains all three Liquidity Stress Tests, and, we have sample Contingency Funding Polices and the experience to help meet current expectations. Call AMG at 800.226.1923 if you need help with any of these issues.
Thursday, April 9, 2015
Banking regulators seem to be increasingly focused on liquidity, or more appropriately stated, they seem to be increasingly focused on stressed liquidity. Stressed liquidity, of course, is when the balance sheet is stressed by an immediate decrease in deposits coupled with a reduction in the capacity to borrow. The concept of stressed liquidity was extremely important during the early years of the credit crisis beginning in 2007 and continuing until banks either failed or worked-out their credit issues. This was followed by a “lull” in regulatory scrutiny, but recent increases in the ratio of loans-to-deposits have brought renewed interest in the concept.
There are three “stress scenarios” that are “triggered” by the loss of deposits:
There are three “stress scenarios” that are “triggered” by the loss of deposits:
- The first is a “Mild Stress Event” that merely reduces deposits by 5% over a period of a couple of weeks.
- The second is a “Moderate Stress event” that reduces deposits by 10% and ability to borrow over a three month period.
- The third is a “Severe Stress Event” that reduces deposits by 20% and the ability to borrow over a one-year time frame.
Tuesday, February 24, 2015
Now that we have established defensible, institutionally relevant assumptions for your bank, it is necessary that your bank periodically stress tests each assumption. This is critical to understanding how sensitive the bank's balance sheet is relative to a change in a certain assumption.
Referring back to the last Supervisory Insights issued by the FDIC (Winter 2014), here is how they view this process:
"The objective of sensitivity analysis is to isolate the impact a single assumption may have on the results of the IRR measurement system. This is accomplished by changing one assumption (e.g., increasing the decay rate or the beta factor by X percent) and re-running the analysis to compare results.)"
Since 2008-2009, the traditional deposit mix of banks has changed. Time deposits have fell out of favor to non maturing Money Market and NOW accounts. In response to regulators concerns on this topic, BancPath has included a new report titled "Assumption Stress Tests". In this section of the report, we use four tests to gauge the sensitivity of changes in assumptions to the balance sheet.
The four tests are:
1) change in net interest income due to a change in deposit mix (back to pre 2008 mix)
2) dynamic market value of equity in response to a change in deposit mix
3) interest rate risk profile in response to changes in deposit betas
4) shortening the duration of non-maturing deposits and the effect on Market Value of Equity
We continue to look for ways we can serve our clients better. If you would like to learn more about what we do, contact us.