Georgia Banking School - Georgia Bankers Association

GEORGIA

BANKERS

ASSOCIATION

Georgia Banking School

Asset/Liability Management II 2017 Georgia Banking School

May 10, 2017

Joel Updegraff Managing Director, ALM

SunTrust Robinson Humphrey


Important Disclosure

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This presentation is for informational purposes only and is being furnished on a confidential basis. By accepting this information, the

recipient agrees that it will use the information only to evaluate its potential interest in the strategies described herein and for no other

purpose and will not divulge any such information to any other party.

This presentation does not constitute a commitment to lend money, underwrite any proposed transaction, purchase securities or other

assets, provide financing, arrange financing, or provide any other services. SunTrust Robinson Humphrey, Inc. and its representatives

and affiliates make no representation and have given you no advice concerning the appropriate regulatory treatment, accounting

treatment, or possible tax consequences of the proposed transactions described herein. Prior to entering into any proposed transaction,

you should determine, without reliance upon SunTrust Robinson Humphrey, Inc. or its representatives or affiliates, the economic risks

and merits, as well as the legal, tax, and accounting characteristics and consequences, of the transaction, and that you are able to

assume these risks. These materials should not be relied upon for the maintenance of your books and records or for any tax,

accounting, legal or other purposes.

All materials, including proposed terms and conditions, are indicative and for discussion purposes only. Finalized terms and conditions

are subject to further discussion and negotiation and will be evidenced by a formal written agreement. Except as required by applicable

law, we make no representation or warranty, express or implied, to you or to any person as to the content of the information contained

herein. Opinions expressed herein are current opinions only as of the date indicated. Any historical price(s) or value(s) are also only as

of the date indicated. We are under no obligation to update opinions or other information.

In connection with Treasury Regulation Section 1.6011-4, it is our mutual intent that the tax structure and tax treatment of the

transactions contemplated by this presentation are not confidential and that notwithstanding anything herein to the contrary that each of

us (and our employees, representatives and agents) may disclose to any and all persons, without limitation of any kind, the tax

structure and tax treatment of the transactions contemplated herein. This presentation is for informational purposes only and is being

furnished on a confidential basis. By accepting this information, the recipient agrees that it will use the information only to evaluate its

potential interest in the strategies described herein and for no other purpose and will not divulge any such information to any other

party.


Class Agenda

Asset/Liability Management (ALM) Overview

• Definitions, goals & constraints, duties &

responsibilities, outputs/reports

Interest Rate Risk Management

• Definitions, risk contributors,

measurement methods, interpreting

results

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Asset/Liability Management is

not…

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Asset/Liability Management

Process of managing assets, liabilities, and

derivatives to obtain a risk/return trade-off

that is optimal for your institution.

What is optimal? Which side (risk vs. return)

and to what degree, drives the decisions?

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Goals of the ALM Process

• Earnings growth and stability

• Equity growth and stability

• Risk management

• Interest rate risk

• Credit risk

• Liquidity risk

• Leverage

• No surprises in performance

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Competing Goals

• ALCO goals can conflict with each other

• Desire higher earnings

• Need to control risk

• Trade-off between risk and return

• ALCO decisions involve balancing competing

objectives

• Continuous process of optimization

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Example: Optimization Challenges

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Management tries to achieve higher capital ratios by…

Result…

Lower risk based asset weightings

Typically lowers yields

Deleverage or contraction Typically lowers NII/NIM

Increasing book equity ($) Higher earnings only if institution is well run in other aspects


Constraints on ALM Process/Decisions • Economic, financial market conditions

• Local market conditions

• Institution’s characteristics

• Regulatory environment

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Constraints on ALM Process/Decisions:

Q1 2017 STRH Bank Survey

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ALM Decision Making

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ALM Decisions

• Balance sheet optimization

• Composition of assets

• Composition of liabilities

• Intensity of capital utilization

• Capital allocation to asset classes

• Pricing strategies

• Risk management strategies

• Should be taken in context of overall balance

sheet. These decisions and corresponding

actions should be interconnected at all levels of

operations.

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Effective Risk Management Process

• Must be able to evaluate risk-return trade-offs on a regular basis

• Must adjust asset, liability balances, pricing, and hedging for appropriate trade-off

• Must be an on-going process with board and senior management

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ALCO Reports

• Market Overview

• Balance Sheet Composition • Change from prior, current, projected

• Earnings Performance • Current, trends, projected

• Risk Reports • IRR

• Liquidity

• Credit

• Other

• Peer Comparison

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Rates/Market Overview

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Rates/Market Overview

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Balance Sheet Composition

• Loan composition and growth

• Securities portfolio, composition and role

• Deposit composition and growth

• Wholesale funding

• Yields on assets, rates on liabilities

• Capital ratios

• Trend, current level, and projections

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Earnings Performance Reports

• Current earnings

• Earnings ratios

• ROE, ROA, NIM

• Earnings, expenses as pct of assets

• Trends, peer comparison

• Yields on assets, rates on liabilities

• Competitor’s rates

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System of Internal Controls

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System of Internal Controls

• Maintain strong control environment

• Internal controls should promote effective

operations, reliable reporting, and compliance

with laws, regulations, and policies

• Internal audit should evaluate:

• Effectiveness of controls

• Compliance with limits

• Reliability, timeliness of management reports

• Independence of risk management process

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Interest Rate Risk

• What is interest rate risk? What causes it?

• Why should we be concerned about it?

• How do we evaluate our exposure to it?

• How do we reduce exposure if it’s too high?

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What is Interest Rate Risk?

• Interest Rate Risk (IRR) is the risk that changes in interest rates can adversely effect the bank’s earnings or economic value of equity.

• Economic value of equity (EVE) is

the economic value of assets less the

economic value of liabilities. EVE

provides a long-term look at our

interest rate risk exposure.

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What causes IRR for banks?

• Loans & investments = earning assets

• Core deposits & other funding = funding

liabilities

The degree to which earning assets and funding

liabilities create cash flow mismatch over time

and as rates change primarily drive a bank’s

interest rate risk exposure.

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Interest Rate Risk

Primary Types:

Repricing risk

Options risk

Basis risk

Yield curve risk

Risk types were focus of the ALM 1 course. Risk

models quantify the degree of exposure to future

earnings and/or capital from these risks. ALM 2

will focus on developing a basic understanding of

modeled IRR exposures.

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Why should we be concerned about it?

• Risk management is about preparing for what

might happen in the future.

• The bank must be willing to live with changes in

interest rates.

• Once rates move, the impact can not be avoided.

• The bank must make adjustments before interest

rates change to avoid adverse impact to earnings

and/or capital.

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Interest Rate Risk Models

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Risk Measurement Models

• Income Simulation

• Economic Value Analysis

• GAP Analysis

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What is income simulation?

• A short-term (e.g.12 months) forward

assessment (projection) of how changes in

interest rates may impact a bank’s net interest

income and net income.

• The projection incorporates all earning assets

and funding liabilities.

• Must incorporate: • Mathematical relationships

• Behavioral reactions

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Measuring Risk with Income Simulation • Step 1: project next 12 months net interest

income (NII) under base case scenario

• NII = interest income on earning assets less interest expense on funding liabilities

• Base case scenario = market rates as of the scenario date

• Step 2: project next 12 months NII for shocked scenarios

• Shocked scenario: base case market rates are shocked up/down +- 300 basis points

• Step 3: Change in projected income from base case is measure of risk

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Measuring Risk with Income Simulation

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What does this information tell us?

Step 1

Step 2 Step 3


How does it compare to the average risk

profile of 150 banks?

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What would an unfavorable income

simulation result look like?

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What would an unfavorable income

simulation result look like?

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Disadvantages of Income Simulations

• Short-term focus misses impact of longer

term cash flow mismatches

• Does not fully capture option-related risk

*May not provide a sufficiently robust picture

of the bank’s interest rate risk exposure if

used in isolation

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Risk Measurement Systems



• GAP Analysis

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What is Economic Value analysis?

• A long-term assessment (projection) of how

changes in interest rates may impact a bank’s

economic value of equity.

• Long term means the longest dated cash flow of

any earning asset or funding liability on the balance

sheet

• Must incorporate: • Mathematical relationships

• Behavioral reactions

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Economic Value of Equity (Defined) • EVE = present value of the bank’s assets

less the present value of its liabilities

• Present value = the current worth of a future

stream of cash flows given a specified rate of

return

• EVE analysis includes present value estimates

on the entire balance sheet and represents

theoretical present value of the bank’s capital

position

• EVE changes as rates change

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Net Present Value

Changing interest rates affect economic value:

• By changing the discount rate

• For items with variable rates, by changing the

interest payments

• With embedded options, by changing the cash

flows

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t

r

C

)1(NPV


Measuring Risk with EVE • Step 1: Project EVE under base case scenario

• Calculate present value of earning assets, deduct present value of funding liabilities

• Base case scenario = market rates as of the scenario date

• Step 2: Project EVE for shocked scenarios

• Shocked scenario: base case market rates are shocked up/down +- 300 basis points

• Step 3: Change in projected EVE from base case is measure of risk

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Measuring Risk with EVE

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What does this information tell us?

Step 1

Step 2 Step 3


How does it compare to 150 banks?

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What would unfavorable EVE results look

like?

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Ouch…


Advantages of Economic Value Analysis

• Most complete measure of interest rate

risk (captures all cash flows)

• Captures repricing, basis, and options risk

• Regulators increasingly rely on economic

value analysis

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How do banks reduce their IRR exposure?

• On balance sheet actions:

• Investment portfolio decisions

• Loan products, terms, and conditions

• Funding products, terms and conditions

• Off balance sheet management:

• Interest rate swaps

• Other derivative products and strategies

• Risk reduction is most effectively

performed before interest rates change

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Risk Measurement Systems



• GAP Analysis

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What is a GAP analysis?

• Short term earnings exposure tool based on

cumulative repricing differences between earning

assets and funding liabilities

• The difference between the volume of earning

assets and funding liabilities that reprice within

one year (12 months gap) is the common

evaluation benchmark.

• General application: if interest rates rise by 100

basis points, change in income should

approximate 1% times the 12 month gap.

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Advantages of GAP Analysis

• Quick, simple to construct

• Comparatively easy to understand and

interpret

• Gives a big picture assessment of risk

• May be adequate in very small institutions

with very simple balance sheets

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Disadvantages of GAP Analysis

• Lack of precision in risk estimate

• Static model, does not capture behavior

• Options, prepayments, deposits

• Limited in output’s application

• Usually not comprehensive or accurate

enough for most institutions

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Summary

• Asset/liability management requires an on-

going process of risk/return optimization

• Process should strive to minimize surprises in

operating performance while effectively

communicating goals/objectives throughout

the bank.

• Interest rate risk can adversely impact a

bank’s earnings and/or capital.

• Risk measures must incorporate both short term

(earnings) and long term (EVE) assessments

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Summary (continued)

• Earnings simulation is the common tool for

measuring short-term interest rate risk while

EVE is the common long-term risk measure.

• Gap analysis is a limited scope risk metric and

should be used only in a support capacity.

• IRR management should entail a proactive,

ongoing process. Mitigating risk after rates

change can be costly and prohibitive.

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Questions?

Joel Updegraff

Managing Director, ALM

SunTrust Robinson Humphrey

[email protected]

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Sample GAP report

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Total Investments 17,899,416 44,021,501 118,953,109 71,860,086 38,379,788 7,726,566 1,222,933 300,063,399

Total Loans 212,625,789 61,051,556 82,748,649 43,588,583 30,069,772 16,086,043 569,003 446,739,395

Total Earning Assets 230,525,205 105,073,057 201,701,758 115,448,669 68,449,560 23,812,609 1,791,936 746,802,794

Total Cost of Funds 93,093,290 128,041,480 165,422,340 78,434,794 77,299,220 - - 542,291,124

Interest Sensitive Assets 230,525,205 105,073,057 201,701,758 115,448,669 68,449,560 23,812,609 1,791,936 746,802,794

Interest Sensitive Liabilities 93,093,290 128,041,480 165,422,340 78,434,794 77,299,220 - - 542,291,124

GAP 137,431,915 (22,968,423) 36,279,418 37,013,875 (8,849,660) 23,812,609 1,791,936 204,511,670

Cumulative GAP 137,431,915 114,463,492 150,742,910 187,756,785 178,907,125 202,719,734 204,511,670 204,511,670

GAP Ratio 2.48 0.82 1.22 1.47 0.89 1.38

Cumulative GAP Ratio 2.48 1.52 1.39 1.40 1.33 1.37 1.37 1.38

Gap as % of Total Assets 16.38 (2.74) 4.32 4.41 (1.05) 2.84 0.21 24.37

Cumulative GAP as % of TA 16.38 13.64 17.97 22.38 21.32 24.16 24.37 24.37

Gap as % of Earning Assets 18.40 (3.08) 4.86 4.96 (1.18) 3.19 0.24 27.38

Cumulative GAP as % of EA 18.40 15.33 20.19 25.14 23.96 27.15 27.38 27.38

Demand Deposits 5,617,689 16,853,067 112,353,744 44,941,512 44,941,500 224,707,512

DescriptionTotal

Up to 3

Mos.

>3 Mos.

<1 Year

>1 Year

<3 Years

>3 Years

<5 Years

>10 Years

<20 Years

>5 Years

<10 Years>20 Years

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