Liquidity Risk Management What is the FDIC’s Guidance?

Karl NelsonDirector of Industry and Governmental

RelationsSilverton Bank

What Is Liquidity Risk?

Sources of funds• Retail Deposit Inflows• Wholesale Funding• Cash Flows From Loans

and Investments• Sale of Loans and

Investments

Uses of funds• Deposit Outflows• Loan Commitments• Loan and Other Asset

Growth• Mortgage put-backs

The risk that sources of funds will be unable to meet the institution’s needs for outflow of funds.

What are Your Liquidity Risks?

• Reduced borrowing capacity• Increased collateral haircuts• Off-balance sheet exposure• PCA downgrade• Reduced mortgage prepayments• Asset quality affecting cash flows• Bad publicity, rumors• Available-for-sale accounting

Past Regulatory Oversight

• Examiners focused on balance sheet position more than liquidity management

• Liquidity measures focused on assets as the liquidity source– Investments liquid, loans were not– Deposits only stable source of funding

• Skepticism related to other sources of funding

Modern Perspective

Traditional sources are still well regarded, but:

• Diversified funding is a positive

• Management is at least as important as position

• “What if ?” planning is essential

Liquidity Guidance (Financial Institution Letter 84-2008)

Recent disruptions in the credit and capital markets have exposed weaknesses in

liquidity risk measurement and management systems.

Liquidity GuidanceMajor Highlights:

• Banks using liability-based or off-balance sheet funding strategies, or that have other complex liquidity risk exposures, should measure liquidity risk using pro forma cash flows/scenario analysis, and should have contingency funding plans.

• Contingency funding plans should stress testing that could rapidly affect an institution's 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.

Liquidity Guidance

• Contingency funding plans should outline practical and realistic funding alternatives that can be implemented as access to funding is reduced.

• Institutions that use volatile, credit sensitive, or concentrated funding sources are generally expected to hold capital above regulatory minimum levels to compensate for this risk.

• Examiners will continue to evaluate an institution's ability to maintain access to funds and liquidate assets in a reasonable and cost-efficient manner in both normal and stressed markets.

Tools to Measure Liquidity Risk

• Ratios– Net non-core funding dependence– Large depositors to total deposits– Loans to deposits– Pledged to Total Securities– Loans to Assets

Contingency Funding Plan

Ratios Have Limitations

• Definitions Differ From Reality• Not Forward Looking• Does Not Include Market Access and

Borrowing Capacity• Limited Ability to Measure

– Funding Concentrations– Contingency Funding Options– Management Strength and Planning

• CFP is a Written Plan of Action for Various Adverse or Stress Scenarios

• Monitor and Stress Test Scenarios

• Review Scenario Assumptions and Triggering Events

• Report Scenario Results

• Test Strategies and Stress Events

Contingency Funding Plan (CFP)

A Good CFP Should…

• Be customized to the liquidity risk profile of the bank

• Identify the types of stress events which may be faced

• Define responsibilities and decision making

• Detail how management will monitor liquidity events

A Good CFP Should…

• Consider triggering restrictions limiting access brokered/high-cost deposits

• Identify and assess contingent funding sources

• Consider any legal, financial and logistical constraints that might influence availability of back-up lines

Brokered and High Rate Deposits

Brokered Deposits to Total Assets at FDIC-Insured Institutions

0.0%

0.5%

1.0%

1.5%

2.0%

2.5%

3.0%

3.5%

4.0%

4.5%

5.0%

Per

cen

t

Interest Rate Restrictions 12 U.S.C. § 1831f 12 C.F.R. § 337.6

Basic Concept: Restrictions depend upon bank’s capital level. As condition deteriorates, restrictions become more severe.

• Well capitalized institutions may pay rates w/no restrictions• Adequately capitalized institutions with waivers to accept

brokered deposits• Adequately capitalized institutions without waivers to accept

brokered deposits• Undercapitalized institutions

Adequately Capitalized With Waivers to Accept Brokered Deposits

Rule: May not pay a rate of interest that “significantly exceeds” applicable market rate.

• For deposits accepted within institution’s “normal market area,” the applicable market rate is the prevailing rate or “effective yield” on deposits of comparable size and maturity in that area.

• For deposits accepted outside the institution’s “normal market area,” the applicable market rate is the “national rate.”

• “Significantly exceeds” means more than 75 basis points.

Definitions

market area is defined as “any readily defined geographical area in which the rates offered by any one insured depository institution soliciting deposits in that area may affect the rates offered by other insured depository institutions operating in the same area.”

effective yields in the relevant markets are the average of effective yields offered by all other insured depository institutions in the market area in which deposits are being solicited.

Definitions cont…

An effective yield on a deposit with an odd maturity violates [these rules] . . . if it is more than 75 basis points higher than the yield calculated by interpolating between the yields offered by other insured depository institutions on deposits of the next longer and shorter maturities offered in the market.”

“National Rate” Is defined as “(1) 120 percent of the current yield on similar maturity U.S. Treasury obligations; or (2) in the case of any deposit at least half of which is uninsured, 130 percent of such applicable yield.”

Adequately Capitalized Without Waivers to Accept Brokered Deposits

Rule: May not pay a rate of interest that significantly exceeds prevailing rate in institution’s normal market area. Thus:

• For deposits accepted within the institution’s normal market area, the institution may not pay a rate that significantly exceeds the prevailing rate in the institution’s normal market area.

• For deposits accepted outside the institution’s normal market area, the institution may not pay a rate that significantly exceeds the prevailing rate in the institution’s normal market area.

Undercapitalized Institutions

Rule: May not pay a rate of interest that significantly exceeds applicable market rate.

• For deposits accepted within the institution’s own normal market area, the applicable market rate is the prevailing rate in the institution’s own normal market area.

• For deposits accepted outside the institution’s own normal market area, the applicable market rate is the lesser of the following: (1) the prevailing rate in the institution’s own normal market area; or (2) the prevailing rate in the market area from which the deposit is being accepted.

Temporary Liquidity Guarantee Program (TLGP)

Overview

• Systemic risk exception invoked October 13, 2008.

• FDIC announced and implemented TLGP October 14, 2008.

• On November 2, 2008, FDIC extended the opt-out deadline to December 5, 2008 with the disclosure provision of the rule extended to December 19, 2008.

• Purpose of TLGP is to strengthen confidence and encourage liquidity in the banking system.

• TLGP consists of two components: debt guarantee program and the transaction account guarantee program.

TLGP – Debt Guarantee Program

• Coverage– All senior unsecured debt issued October 14, 2008 thru June 30, 2009,

with guarantees expiring no later than June 30, 2012.

– May be denominated in foreign currency.

• Guarantee limits– 125% senior unsecured debt on books as of September 30, 2008 that is

scheduled to mature before June 30, 2009.

– Debt cannot be guaranteed if proceeds are used to prepay outstanding debt or if the debt is extended to an insider of the eligibility entity or an affiliated entity or to the affiliated entity itself.

TLGP – Debt Guarantee Program

Includes Excludes Exceptions

• Promissory notes• Commercial paper• Unsubordinated unsecured notes• Certificates of deposit and Eurodollar deposits standing to the credit of a bank• Bank deposits in an international banking facility of insured depository institution

• Obligations from guarantees or other contingent liabilities• Derivatives• Derivative-linked products• Debt paired with any other security• Convertible debt• Capital notes• Negotiable certificates of deposit• Deposits in foreign currency• Eurodollar deposits that represent funds swept from individual, partnership or corporate accounts held at insured depository institutions

• FDIC may, in consultation with primary federal regulator, grant alternative threshold determination, if:

–either zero balance or not reflective of normal practices, or –if eligible entity wishes to temporarily exceed 125% cap

TLGP – Non-Guaranteed Long Term Debt

• Once the participating entity has reached its 125% limit, it can issue debt that is not guaranteed, but it must disclose that such debt is not guaranteed.

• If the entity wants to issue non-guaranteed debt before issuing the maximum amount of guaranteed debt, it must elect to do so on or before November 12, 2008.

– This requires the entity to pay a nonrefundable fee equal to 75 basis points (annualized) of the entity’s senior unsecured debt (other than debt owed to affiliates) outstanding September 30, 2008 with a maturity date on or before June 30, 2009.

TLGP – Debt Guarantee Program

Major Changes (as of 11/21/08):

• The debt guarantee will be triggered by payment default rather than bankruptcy or receivership.

• Short-term debt issued for one month or less will not be included in the TLGP, consistent with the objective of the program to facilitate longer term lending.

• Altered Fees: Shorter-term debt will have a lower fee structure and longer-term debt will have a higher fee. The range will be 50 basis points on debt of 180 days or less, and a maximum of 100 basis points for debt with maturities of one year or longer annualized).

TLGP – Transaction Account Guarantee Program

• Coverage

– 100% guarantee of noninterest-bearing transaction accounts held by FDIC-insured depository institutions (DIs) until December 31, 2009

– In addition to and separate from the coverage provided under the FDIC’s general deposit insurance regulations at 12 CFR Part 330

• Noninterest-bearing transaction account

– Transaction account on which insured DI pays no interest and

– Does not reserve the right to require advance notice of intended withdrawals

– Exception: The FDIC Board voted to include NOW accounts with interest rates of 0.5% or less and IOLTAs (lawyer trust accounts) in the transaction account program.

• Deposits in the noninterest-bearing savings account will be covered in compliance with the FDIC’s general deposit insurance regulations at 12 CFR Part 330.

TLGP – Transaction Account Guarantee Program

• Includes– Traditional checking accounts that allow:

• for an unlimited number of deposits and• withdrawals at any time

– Official checks issued by an insured depository institution

• Excludes– Negotiable order of withdrawal (“NOW”) accounts with interest rates of 0.5% or

more– Money market deposit accounts (“MMDAs”)– Any funds in an account swept into an interest-bearing account

• Exception– Funds swept from noninterest-bearing transaction account to a noninterest-

bearing savings account

• Fees: 10 basis points (annualized) until the end of 2009. After that date, these accounts will be subject to the basic insurance amount.

TLGP – Reporting Requirements

• Leverage existing reporting mechanisms (i.e. FDICConnect) and other primary federal regulators.

• Limited changes to the December Call Report.

• Separate reporting will likely be necessary related to the FDIC-guarantee of senior unsecured debt and we will make those requirements known as soon as they are available.

TLGP - Communication

• A dedicated website, www.fdic.gov/tlgp, houses current information, including – Federal Register notices, – FAQs, – press releases, – financial institution letters, and – technical briefings.

• Email Updates via FDIC’s subscription service.

Time For A Time For A Break!Break!