ALM Process & Strategies

Transcription

1 ALM Process & Strategies Requirements for a Solid Foundation Chad McKeithen, Managing Director Duncan-Williams Inc. Al Forrester, CEO FiCast Data Corp

2 Outline History of Interest Rate Risk Management How to Effectively Manage Risk Six Questions The Difference between Planning and Risk Management The Importance of Stress Testing Unpacking your Risk Profile

3 The History of IRR January was Pivotal FFIEC Issues an Advisory on Interest Rate Risk Interest Rate Risk Prior to the Advisory IRR, so what, who cares? After the advisory, You better care, OR ELSE!

4 What did the FFIEC Advisory Say Material weakness in risk management processes or high levels of IRR exposure relative to capital will require corrective action Such actions could include recommendations or directives to: Raise additional capital Reduce levels of IRR exposure Strengthen IRR management expertise Improve IRR management information and measurement systems

5 FFIEC Before 2010 Joint Agency Policy Statement: Interest Rate Risk (1996) Institutions that are found to have high levels of exposure and/or weak management practices will be directed by the agencies to take corrective action Such actions will include directives to: Raise additional capital Strengthen management expertise Improve management information systems Reduce levels of exposure, or a combination thereof

6 What Changed in 2010 In Principle Nothing Practically Speaking Everything Now the Board and Management have to: Understand IRR The Concern of the Regulators is: Capital - NEV

7 Understanding & Managing Risk Six Key Questions 1. What is my risk? 2. What is causing my risk? 3. What material assumptions I am making? 4. Where did I get those assumptions? 5. What happens if I am wrong about those assumptions? 6. What is my plan if I am wrong?

8 A Key Distinction Risk vs. Planning What is Planning? What I think is going to happen What I want to happen What I hope will happen What better happen if I want to keep my job!

9 A Key Distinction Risk vs. Planning What is Risk? What happens if I am wrong? What causes me to blow up? When does my institution collapse?

10 A Key Distinction Risk vs. Planning You have to do both: 1. Plan 2. Manage Risk Planning is Educated Guessing Risk Management is Stress Testing your Guessing

11 Stress vs. Guess What does the Advisory say about Stress Testing? should include a sensitivity analysis to help determine which assumptions have the most influence on model output can be used to determine the conditions under which key business assumptions and model parameters break down

12 Stress vs. Guess Stress Testing is the Heart of Risk Management Stress Testing Answers the 3 Questions 1. What happens if I am wrong? 2. What causes me to blow up? 3. When does my institution collapse?

13 How Do You Stress Test? There are 2 Ingredients in every Risk Model 1. Facts 2. Assumptions

14 How Do You Stress Test? What are the Facts? Balance Sheet and Market Facts Contractual Facts: Balance Rate Re-pricing characteristics Payment characteristics, etc.

15 How Do You Stress Test? What are the Assumptions? Things that are made up Rate scenarios Non maturity deposit behavior Prepayments

16 How Do You Stress Test? Assumptions: Are elements of the Planning Process because they are made up This means your Risk Profile is NOT a Scientific Fact Your Risk Profile is a Belief System

17 How Do You Stress Test? Determine which Assumptions are Most Critical Stress Test Critical Assumptions

18 What Do Regulators Want? Management and the Board should be able to: Understand and Explain your Risk

19 What Do You Want? The Regulators to go away If you want them to go away, see previous slide

20 What Should You Do? Demonstrate you Understand Cooperate and Graduate

21 Unpacking Your Risk NEV Volatility With No Options

22 Unpacking Your Risk NEV Volatility Adding Back Options

23 Unpacking Your Risk NEV Volatility Adding Back Prepayments

24 Unpacking Your Risk NEV Volatility Adding Back NMD Assumptions

25 Non Maturity Shares Stress Test

26 Unpacking Your Risk On the Balance Sheet What is Causing Risk

27 Unpacking Your Risk On the Balance Sheet What is Causing Risk

28 Unpacking Your Risk On the Balance Sheet What is Causing Risk

29 Unpacking Your Risk On the Balance Sheet What is Causing Risk

30 Earnings at Risk vs NEV Risk Earnings at Risk vs NEV at Risk are different things Sometimes the risk profiles can opposite views of risk Asset Sensitive with respect to Earnings? Liability Sensitive with respect to NEV?

31 A Tale of Two Credit Unions $100 million in Assets Bullet 30-Year UST $100 million in Capital Does this institution have interest rate risk?

32 A Tale of Two Credit Unions Earnings at Risk No! A Locked in Margin NEV at Risk? A LOT!

33 A Tale of Two Credit Unions $100 million in Assets Fed Funds Sold $100 million in Capital Does this CU have interest rate risk?

34 A Tale of Two Credit Unions NEV at Risk No! No Gains or Losses due to Changes in Rates Earnings at Risk? A LOT!

35 What are the Regulators Worried About? Asset Durations - Lengthening Liability Durations Shortening How the combination hurts earnings and capital in Rising Rates They are most concerned about NEV at Risk

36 What are the Regulators Worried About?

37 What are the Regulators Worried About?

38 What are the Regulators Worried About?

39 What are the Regulators Worried About?

40 Conclusion Regulators are Serious about the Risk Management Process You are Required to Understand your Risk Planning and Risk Management are Different A Risk Profile is a Belief System made up of Facts and Assumptions Assumptions are made up! But make the best guess you can Determine the Significance of each Critical Assumption Stress Test Critical Assumptions

41 Contact Information Chad McKeithen Al Forrester ext.159