CUNA CFO Council
May 2015
Charles N. McQueen
McQueen Financial Advisors
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SEC Registered Investment Advisor
Asset Liability Management
Merger Valuations
Mortgage Servicing Rights Valuations
Municipal and Corporate Credit Review
Core Deposit Studies
Assumption Sensitivity Analysis
Prepayment Speed Analysis
Page 2
Purpose of ALM
• Basic – What happens to our earnings and
value as interest rates change?
• Advanced – How do I position my Credit Union
to maximize income within risk parameters?
Page 3
Today’s Agenda – ALM 101:
Goals: Discussion on ALM and supporting activities
Basic ALM – Management of the Net Interest
Margin in changing interest rates
Assumption Support
• Core Deposit Studies
• Prepay Speed Analysis
Results
• Income Simulations
• Net Economic Value of Equity Analysis
Additional Reports
• Assumption Sensitivity Analysis
• 3rd Party ALM Validations
Page 4
Purpose of ALM
• ALM – is best thought of as managing the
balance sheet to maximize income while
maintaining risk within established Board
parameters
• Key output relates to:
– Net Interest Margin
– Income Sensitivity
– Net Economic Value of Equity
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Net Interest Margin
• Net Interest Margin (NIM) is projected for
each interest rate scenario
• Key components of NIM:
– Asset mix and interest income
– Liability mix and interest expense
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Net Interest Margin
All CU’s 4.15
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NIM – Yield on Assets
All CU’s 4.69
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ALM Model Inputs: Assets
• Asset Mix
– Loans
– Investments
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ALM Model Inputs: Loans
• Data and assumptions:
– Maturity Dates
• Prepayment Speed Assumptions for all scenarios
• ARM and Variable Rate Reset Dates
– Yield
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Current Yield
Replacement Yield
Index (Prime, LIBOR)
Index Spread
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ALM Model Inputs: Loans
• Loans
– Unique characteristics must be captured
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Caps
Floors
Reset Dates
Index (Prime, LIBOR)
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ALM Model Inputs: Investments
• Data and assumptions:
– Maturity Dates
• Call Structure
• MBS Prepayment Assumptions
• Step Up Dates and Rates
– Yield
• Replacement Yield Assumptions
• Reset Dates (variable)
• Index & Spread
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ALM Model Inputs: Investments
• Potentially Complex Investments
– Across all rate scenarios:
• Will a bond get called?
• Will a step-up bond get called?
• Will Mortgage Backed Securities cash flow change?
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NIM - Liability Cost
CU’s 0.54
FDIC 12/31/14Page
QGB
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ALM Model Inputs: Liabilities
• Liabilities
– Mix
• Non Maturity Deposits
• Certificates of Deposit
• Borrowings
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ALM Model Inputs: Liabilities
• Data and assumptions
– Non Maturity
• Replacement rates (beta) in each scenario
• Assumptions may differ for each type
– CD’s
• Yield
• Maturity & potential for early withdrawal
– Borrowings
• Yield
• Term
• Advances with put features may be complex
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NIM – Sample Build Up - Assets
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NIM – Sample Build Up - Liabilities
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NIM – Sample Build Up - Summation
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NIM - Scenarios
• Analysis projects forward NIM based on
current holdings and model assumptions
• NIM is projected in multiple scenarios
– Gradual Change
– Shock Change
– +/- 100, 200, 300, 400 and 500 basis points and
unchanged rate environment
– 6 different non-parallel scenarios each quarter
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ALM
• Assumptions and support
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Assumption Support: Non-Maturity Deposits
• What is the likely retention term of my nonmaturity deposits?
– Study looks back over 5 years to determine
historical retention
– Limitation on data due to the last 5 years
– Can you get longer data?
– Forward-looking ALM Model assumptions are
based on historical analysis
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Assumption Support: Core Deposit Analysis
In this example, thousands of accounts were closed. The balance of
remaining accounts was significantly higher.
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Assumption Support: Core Deposit Analysis
Non maturity deposit retention rates were in the mid 80% range to over 90%.
The results are incorporated into future ALM Model runs.
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Assumption Support: Core Deposit Analysis
• Core Deposit Analysis Goals:
– Sensitivity: Analysis of deposit pricing during a
prior period of rapidly rising rates (2004 – 2006)
– Retention: How long can we retain all these low
cost deposits?
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Assumption Support: Core Deposit Analysis
• Between June 2004 & June 2006, the Fed Funds rate increased a total of 400
basis points. We compare actual deposit pricing during this period.
• Note that the rate paid on Shares and Share Drafts was cut.
• The Money Market rate rose a total of 79 basis points or 20 basis points for
each 100 basis point move in the Fed Funds rate.
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Assumption Support: Prepay Speeds
– Prepayment Speed Assumptions
– Guidance calls for incorporating historical prepay
speeds into the ALM Model
– How do we determine prepay speeds?
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Assumption Support: Prepay Speeds
• Prepayment Study
– Study the Credit Union actual prepayment history
by product type
– Within the ALM Model, use a mix of the actual
historic prepayment and market forward looking
rates
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Assumption Support: Prepay Speeds
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Assumption Support Summary
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ALM
• ALM Tests we run
– Income
– Equity
Page 31
Gradual Income Simulations
• Gradual Rate Change
– Increase all rates (loan, deposit and investments)
gradually over 12 months.
– Most models use 1/12 of the +100 beta per
month.
– Positive: This is historically what has happened
– Negative: Assumes the yield curve is held parallel
(normally this does not happen)
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Income Simulation
Gradual Rate Change Example
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Shock Income Simulations
• Shock
– Increase all rates (loan, deposit and investments)
immediately
– 100% of the +100 beta is implemented
– Deposit rates reset faster than other products
– Assumes all non maturity deposits reset at once
– Discussion point: non-maturity deposit duration
and repricing.
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Income Simulation
Shock Rate Change Example
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Income Simulations: Non-Parallel
• Non-Parallel
– Changes the shape of the yield curve
– Traditionally covers the following changes:
• Flattening yield curve
• Steepening yield curve
– Increase rates relative to the projected move of
the yield curve
– The beta is implemented in relative fashion
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Income Simulations: Non-Parallel Examples
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NEVE
• Economic Value of Equity
– Long-term view of IRR
– Values the balance sheet based on the following:
• Duration (term)
• Discount Rate
• Current yield
• Alternative NEVE
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Sample NEVE Report
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NEVE Analysis: Non-Parallel Examples
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Risk Report Output
• How do we improve our IRR and NEVE
position in a modeled rising rate
environment?
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Asset Duration
• Shorter the duration of our assets:
– Shorter term loans
– Shorter term investments
– Reduce optionality
• Effect – income may go down
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Liability Duration
• Lengthen the duration of our liabilities:
– FHLB Advances
– Brokered Deposits
– Term CD’s
• Effect – Costs may go up
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Other Options
• Utilize derivatives to enhance performance:
– Cap
– Floor
– Swaps
– FHLB Symmetrical advances
• Effect – Costs may go up
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ALM
• Assumption Sensitivity
• Third Party Validations
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Additional Reports:
Assumption Sensitivity Analysis
ALM Model is loaded with less favorable
assumptions to determine the impact on the
Credit Union’s risk profile
• Loan Beta (narrower)
• Investment Beta (Narrower)
• Deposit Beta (wider)
• Prepayment Assumptions (slower)
• Non Maturity Deposit Term Assumptions (shorter)
These changes will result in less-favorable income
and/or NEVE sensitivity
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Assumption Sensitivity Analysis
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Assumption Sensitivity Analysis
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Assumption Sensitivity Analysis
Results of using less favorable assumptions compared to standard ALM report
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Third Party Validations
We have performed ALM validation on over 20 different models.
3rd party validation considers:
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Appropriate Model Use
Chart of Accounts
Data Integrity
Loan Betas
Deposit Betas
Prepay Speeds
Non-Maturity Term Assumptions
Support for ALM Assumptions
Reasonableness of the Output
All Regulatory Guidance
Examiner Expectations
Conclusion
• Basic – What happens to our earnings and value as
interest rates change?
• Advanced – How do I position my Credit Union to
maximize income within risk parameters?
• Managing the NIM in changing rates
• Good assumptions make or break ALM
• Focus on the simplicity of the two reports
– Income
– Equity
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Questions?
McQueen Financial Advisors, Inc.
Charles N. McQueen
26676 Woodward Avenue
Royal Oak, MI 48067
248-548-8400
[email protected]