Asset/Liability Management Series Session 1 Presenter: Sasha Khandoker ALM Analyst

Transcription

1 Asset/Liability Management Series Session 1 Presenter: Sasha Khandoker ALM Analyst 1 2 1

2 What is ALM? Why are we asked to perform ALM? What is the goal of ALM? How can we use it? 3 *The process of evaluating balance sheet risk (interest rate and liquidity risk) and making prudent decisions, which enables a credit union to remain financially viable as economic conditions change. *Source: NCUA Examiner s Guide Stated differently, this means: Creating and managing a balance sheet composition that promotes consistent earnings and adequate capital levels across a variety of interest rate and economic environments. 4 2

3 Essential for: Consistent Earnings Adequate Capital Poor composition leads to: Inconsistent Earnings Volatile Capital Levels 5 ALM helps credit unions be proactive rather than reactive by identifying areas of: Interest Rate Risk Credit Risk Liquidity Risk As such, ALM helps decrease the potential for insolvency and inadequate earnings! 6 3

4 To establish a risk management program that: Identifies, Measures, Monitors, and Reports the interest rate risk exposure. So decisions can be made to control that risk exposure as needed

5 Process of identifying and assessing current risk exposures and then choosing whether to accept or mitigate that risk exposure. ALM enables the identification and assessment of risk 9 Help strike a difficult balance to manage risk and return Determine how much risk to accept in order to realize a positive spread Know your credit union s risk appetite Know examiner s limits 10 5

6 The risk that changes in interest rates will adversely impact the performance of investments, loans, or deposits. Two types: Price Risk Reinvestment Risk 11 Price risk is risk that the value of an instrument will change as a result of changes in interest rates.» Decrease in value for assets» Increase in value for liabilities Price risk is greater for instruments that have longer terms to maturity (e.g. Mortgages) Reinvestment risk is risk that funds will need to be redeployed at different rates than received on the original instruments.» Lower rates for assets» Higher rates for liabilities Commonly associated with the exercise of embedded options such as Call Options or Prepayment Options. 12 6

7 To help identify these risks, there are several useful tools: Gap Ratio (short term) Income Simulation (intermediate term) Net Economic Value (long term) 13 Forward looking! Short Term Events Intermediate Term Events Long Term Events Each event does NOT affect the three measures in the same way! 14 7

8 Short Term Risk Measure (normally less than 1 Year) Captures Asset & Liability Maturity or Repricing Mismatch Proxy for Short Term Change in Gross Spread 15 Important Concepts: Positive Gap Ratio Asset Sensitive Rising Rate Environments: No Risk Falling Rate Environments: Risk Negative Gap Ratio Liability Sensitive Rising Rate Environments: Risk Falling Rate Environments: No Risk Risk Measurement Risk is measured by the size and direction of the resulting Gap ratio 16 8

9 Positives: Identifies short term mismatches Sufficient for non complex balance sheet Simple to understand and calculate Negatives: Limited ability to incorporate loan prepayments Does not identify the risk exposure of individual accounts 17 If rates rise Decline in cash Increase in longer term investments Increase in shorter term share certificates High Non Term share dividend rate sensitivities If rates fall Increase in cash Increase in shorter term investments Increase in longer term share certificates Lower Non term share dividend rate sensitivities 18 9

10 19 Intermediate term risk measurement (1 3 Years) Illustrates impact of changing interest rates on net interest income (NII) and net income (NI) Indicates the amount of earnings and earnings volatility over time 20 10

11 Important Concepts: Change in NII and/or NI Positive change in NII and/or NI Increase in income Negative change in NII and/or NI Decrease in income Risk Measurement Risk is measured by the size of the change (volatility) in projected NII or NI 21 Positives: Incorporates prepayments Measures risk in the current and projected balance sheet incorporating new business Increases the value of strategic planning Negatives: Assumptions have a material impact on results Longer time horizons increase the impact of assumptions 22 11

12 If rates rise Decrease in cash Increase in fixed rate assets (2 years or longer) Decrease in share certificates (2 years or shorter) Increase in balance of more sensitive NTS accounts, such as money market accounts If rates fall Increase in cash Increase in adjustable rate assets Increase in share certificates Decrease in balance of more sensitive NTS accounts, such as money market accounts

13 Long term risk measurement (> 5 Years) Estimates the market value of equity under rate shock scenarios Determines the volatility of equity due to the relationship between current coupon rates and market discount rates for assets of liabilities 25 Important Terms Market Value of Assets (MVA) Net present value of all interest earning assets Market Value of Liabilities (MVL) Net present value of all cost bearing liabilities Net Economic Value (NEV) NEV = MVA MVL 26 13

14 Important Concepts: Present Value The current worth or value of a future stream of cash flows. The future cash flows are discounted at a discount rate, and the higher the discount rate, the lower the present value of the future cash flows. The discount rate is often determined as the current rate offered on a like product that can be obtained today. Weighted Average Life (WAL) The average number of years for which each dollar of unpaid principal remains outstanding. Tells how many years it will take to receive (or pay) half of the outstanding principal. Effective Duration The approximate percentage change in price for a 100 basis point change in rates. 27 Important Concepts: Positive change in NEV The market value of equity increases as the market value of assets increases relative to the market value of liabilities. Negative change in NEV The market value of equity decreases as the market value of liabilities increases relative to the market value of assets

15 Positives: Evaluates the current balance sheet over its entire term Results easy to understand; change in equity Incorporates optionality Negatives: Complex theory and calculations Assumptions can have a material impact on results 29 If rates rise Decline in cash Increase in longer term fixed rate products (mortgages and MBS) Increase in more sensitive non term shares (money markets) Decrease in fixed rate borrowings If rates fall Increase in cash Increase in adjustable rate assets Increase in longer term share certificates Lower Non term share dividend rate sensitivities 30 15

16 31 The goal of ALM: Ensure consistent earnings and sufficient equity capital» Identify potential risks» Measure potential risks» Monitor potential risks» Report potential risks As a result, more informed decisions about balance sheet composition can be made in order to control potential risks

17 Gap Ratio Analysis Short term measure that identifies mismatch risk and approximates the near term impact on gross spread. Income Simulation Analysis Intermediate term measure that projects earnings over multiple rate environments to determine earnings volatility. Net Economic Value Analysis Long term measure that evaluates risk to capital by evaluating the current market value of products on the balance sheet 33 To ease the ALM portion of the examination process, credit unions should: Know what ALM is and why we use it Be familiar with the risk limits contained in your ALM policy Understand the basics of ALM modeling and risk measures Know and be able to defend assumptions ALM provides significant information in helping manage balance sheet composition Be proactive! 34 17

18 Sasha Khandoker ALM Analyst ext