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 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 To identify where potential risk lies within the balance sheet under different rate and economic scenarios 5 To create an investment and loan strategy to generate positive cash flows and minimize the loss of earnings Ensure the credit union has adequate capital and liquidity across the different rate environments 6 3

4 The use of investments, loans, and deposits to create a balance sheet that generates positive cash flows and minimizes the loss of earnings in various economic environments 7 You want to optimize the balance sheet composition To earn a positive spread some risk must be accepted to obtain a positive net income 8 4

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 The potential to lose earnings as a result of changes in interest rates that adversely impact the performance of investments, loans, or deposits. Two types: Price Risk Reinvestment Risk 10 5

6 Price risk is risk that the value of an instrument will change as a result of changes in interest rates» Decrease in value is a risk for assets» Increase in value is a risk 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 is a risk for assets» Higher rates is a risk for liabilities 11 To help identify these risks, there are several useful tools: Gap Ratio (short term) Income Simulation (intermediate term) Net Economic Value (long term) 12 6

7 Each measure s outlook is for a different time horizons Each event does NOT affect the three measures in the same way!

8 All else held constant, a way for you to measure what happens to your return on assets (ROA) if rates move 15 Short Term Risk Measure (normally less than 1 Year) Captures Asset & Liability Term Structure or Repricing Mismatch Proxy for Short Term Change in Gross Spread 16 8

9 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 17 Dividend rate sensitives Cash IRA/Share certificates Investment maturity Borrowings 18 9

10 Positives: Best for credit unions with non complex balance sheet Negatives: Limited ability to incorporate loan prepayments and calculate the risk exposure of individual accounts

11 The income projections for the credit union over the next few years Indicates how much income can change if market rates move 21 Intermediate term risk measurement (1 3 Years) Illustrates impact of changing interest rates on net interest income (NII) and net income (NI) Indicates how earnings are projected to change in various interest rate scenarios 22 11

12 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 volatility in projected NII or NI Volatility is the size of the change in the various interest rate environments 23 Dividend rate sensitivities Loans Adjustable vs Fixed Maturity Cash 24 12

13 Positives: Measures risk in the current and projected balance sheet by incorporating new business and optionality Increases the value of strategic planning by allowing you to see your cash flows over time to plan for liquidity issues Negatives: The longer the time horizon the harder it is to ensure accuracy of projections. 25 NEV tells a credit union the fair value of your total capital If you have an instrument earning more than the current market rate, you will have a fair value that is greater than 100% All else held constant, results in fair value of capital exceed book value of capital We use the market rate because it is the replacement rate of a like product It is the present value of assets minus the present value of liabilities 26 13

14 Long term risk measurement (> 5 Years) Calculates the market value of equity under current market conditions Estimates the NEV volatility by measuring the change in market value of equity under various rate shock scenarios 27 Dividend rate sensitivities Loans Adjustable vs Fixed Maturity Cash 28 14

15 Positives: Evaluates the current balance sheet over its entire term Incorporates optionality Negatives: Complex theory and calculations

16 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. 31 Gap Ratio Analysis All else held constant, your Gap ratio allows you to measure what happens to ROA if rates move Income Simulation Analysis How much your projected income can change if the market rates move Net Economic Value Analysis The fair value of your total capital 32 16

17 Sasha Khandoker ALM Analyst ext