Lecture Materials BANK PERFORMANCE ANALYSIS AND CAPITAL PLANNING

Transcription

1 Lecture Materials BANK PERFORMANCE ANALYSIS AND CAPITAL PLANNING David Koch President & CEO FARIN Financial Risk Management Madison, Wisconsin August 11, 2017

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3 BANK PERFORMANCE ANALYSIS SESSION 4: UBPR, CAPITAL PLANNING & ALM David Koch President\CEO

4 What Is Asset/Liability Management? Asset/liability management (ALM) is the process of planning, controlling and monitoring risks to reach financial goals while remaining safe & sound. Primary risks measured to determine if plan can be met reasonably: Credit risks Interest rate movements Changes in liquidity position

5 Asset/Liability Defined More Practically Asset-liability management The decision making process used to select & price assets & liabilities in order to meet financial performance goals When done right, it is NOT simply a regulatory appeasement tool! Constraints: Managing risks to board established acceptable levels Meeting regulatory expectations Capital Earnings Concentrations While meeting financial targets

6 6 Components of the ALM Process 1. Setting achievable financial goals 2. Identifying levels of financial risk 3. Developing appropriate risk measurement systems 4. Integrating measurements into management process (the ALCO process) 5. Evaluating new ideas before implementation to determine risk 6. Implementing & tracking new strategies\ideas to maximize performance

7 Financial Goals Earnings (ROE, ROA, Net Interest Margin) No earnings, no survival. Earnings provide engine to grow Capital (Real and Regulatory) Measure of solvency Balancing act between regulatory need and shareholder return Too little in reserve may cause failure in unforeseen events Too much in reserve costs shareholders money Managing goals requires the ability to project cash flows and future plans for assets and liabilities. Financial risks develop from changes in actual versus expected cash flows

8 Understanding Financial Risks What financial risks impact core earnings? Credit risk: will the borrower of funds repay the committed amount? Liquidity risk: will we have enough funds to meet the demands for loans or deposit withdrawals? Interest rate risk: to what extent will the core earnings change if market interest rates change? Factors in measuring risks Must be able to project cash flows principal & interest Must understand what may cause changes in flows Embedded options Pricing/customer behavior

9 Fundamental risks in Banking : Credit risk Liquidity risk Market risk Operational risk Capital or solvency risk Legal risk Reputational risk

10 Finding Financial Ratios in the UBPR Interest income composition rate & volume ratios Rate: asset yields pg 3 Memo: Avg yield / average earning assets pg 1 Adjusts for difference in size of liabilities and assets Volume: Ttl. Earning assets \ total assets page 1 Mix and cost of components Page 3 has all cost info by individual funding source Page 6 has all the mix of funding data by source Categories of earning assets Gross loans & leases Total Investments Yield is sum of sub parts Fed funds sold Investment securities Int. bearing bank balances

11 Profitability Ratios Summary Ratios Page

12 Profitability Ratios Summary Ratios Page

13 Credit risk the potential variation in net income and market value of equity resulting from nonpayment or delayed payment. Three question need to be addressed: What has been the bank s loss experience? What is the amount of loss we are expecting? How prepared is the bank if we have the losses we expect, or more?

14 Credit ratios to consider What has been the bank s loss experience? Net loss to average total LN&LS Gross losses to average total LN&LS Recoveries to avg tot LN&LS Recoveries to prior period losses. Net losses by type of LN&LS What amount of losses are we expecting? Non current LN&LS to tot loans Total P/D LN&LS incl nonaccural Non curr restruc LN&LS / GR LN&LS Curr Non curr restruct / GR LN&LS Past due by loan type

15 Credit ratios to consider (continued) How prepared are we to handle the planned losses or more? Loss Provision to: average assets and avg tot LN&LS LN&LS Allowance to: net losses and total LN&LS Earnings coverage of net loss

16 Credit risk ratios - Page

17 Credit risk ratios - Page 8a

18 Credit risk ratios - Page 8b

19 Liquidity risk Banks can acquire liquidity in two distinct ways: By liquidation of assets. Composition of investments Maturity of investments By borrowing. Core deposits Volatile deposits the variation in net income and market value of equity caused by a bank's difficulty in obtaining cash at a reasonable cost from either the sale of assets or new borrowings

20 Liquidity risk ratios: Page 10 How much do you rely on core funding vs. more volatile sources? Net non core funding dependence Core deposits\ttl deposits How much coverage do you have for potential loss of funds? ST Investments\ST non core funds ST Assets\ST Liabilities How far have you leveraged deposits to loans? Net loans & leases\ttl deposits Net loans & leases\core deposits

21 Liquidity risk ratios: Page 11 Note that 67% of the securities portfolio is in MBS 16% in Mutual funds\other marketable securities\stock FHLB Impact on future liquidity if rates rise? 87.79% of securities are pledged what does that mean?

22 Market risk Market risk arises from changes in: Interest rates Foreign exchange rates Equity and security prices. the risk to a financial institution s condition resulting from adverse movements in market rates or prices

23 Interest rate risk Example: $30,000 5 Yr car loan at 3.0% 1 year CD at 1.0% Spread 2.0% But for How long? What happens when interest rates rise in the next year? What if the rates were to fall?. the potential variability in a bank's net interest income and market value of equity due to changes in the level of market interest rates

24 Foreign exchange risk Foreign exchange risk arises from changes in foreign exchange rates that affect the values of assets, liabilities, and off-balance sheet activities denominated in currencies different from the bank s domestic (home) currency. This risk is often found in off-balance sheet loan commitments and guarantees denominated in foreign currencies; foreign currency translation risk. the risk to a financial institution s condition resulting from adverse movements in foreign exchange rates

25 Equity and security price risk Large banks must conduct value-at-risk analysis to assess the risk of loss with their trading account portfolios. change in market prices, interest rates and foreign exchange rates affect the market values of equities, fixed income securities, foreign currency holdings, and associated derivative and other off-balance sheet contracts

26 Operational risk Typical ratios focus on: total assets per employee total personnel expense per employee noninterest expense ratio There is no meaningful way to estimate the likelihood of fraud or other contingencies from published data A bank s operating risk is closely related to its operating policies and processes and whether it has adequate controls measures the cost efficiency of the bank's activities; i.e., expense control or productivity

27 Operational risk ratios: Pg.. 3 Total Assets/ # of employees Personnel Exp / # of employees Efficiency ratio Overhead less non int income / Avg Assets

28 Legal risk Legal risk include: Compliance risks Strategic risks General liability issues the potential that unenforceable contracts, lawsuits, or adverse judgments can disrupt or otherwise negatively affect the operations or condition of banking organization

29 Reputational risk Reputational risk is the potential that negative publicity regarding an institution s business practices, whether true or not, will cause a decline in the customer base, costly litigation, or revenue reductions