Asset/Liability Management (ALM) Principles, Uses and...

Presented by:

Matthew Behar Assistant Vice President, ALM Consulting

[email protected]

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)


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)


What does all of that mean?

5


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


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


-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%


• 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)



• 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


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!



• 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


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!


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


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


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


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


• 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


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


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


Proposed Supervisory Test


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



NCUA plans to adopt CAMELS rating system. Adding “S” for interest rate sensitivity testing.


C - Capital A - Asset Quality M - Management E - Earnings L - Liquidity S - Sensitivity (to Market Risk)

CAMELS Exam Rating System



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)



• 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


• 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


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


Questions?


All information contained in this document is the confidential property of Balance Sheet Solutions, LLC.

Distribution outside of the credit union is strictly prohibited.

The information contained herein is prepared for general circulation and is distributed for general information only. This information does not consider the specific investment objectives, financial situations or particular needs of any specific individual or organization that may receive this report. Neither the information nor any opinion expressed constitutes an offer, or an invitation to make an offer, to buy or sell any securities. All opinions, prices, and yields contained herein are subject to change without notice. Investors should understand that statements regarding future prospects might not be realized. Please contact Balance Sheet Solutions to discuss your specific situation and objectives.

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Date post:	02-Aug-2020
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Asset/Liability Management (ALM) Principles, Uses and...

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