ncua irr policy
Post on 11-Jan-2016
29 Views
Preview:
DESCRIPTION
TRANSCRIPT
Presented By
NCUA IRR POLICYAugust 14, 2012
Cullen Coxe
Financial Advisor
Agenda
• Interest rate risk policy• Assumptions• Net interest income• Net economic value• Non-maturing deposit analysis• Prepayment sensitivity analysis• Spread / basis risk• Twisted yield curve
2
New IRR Policy
• NCUA passed a final ruling requiring federal credit unions to develop and adopt a written policy on interest rate risk management
• Effective date - 09/30/2012
• Required for CUs that meet one of the below criteria– More the $50mm in assets– Assets between $10-50mm only if “Supervisory Interest Rate
Risk Threshold Ratio” (SIRRT) is above 100%
Total Net Worth
3
SIRRT Ratio
Total first mortgages held + total investments with maturities greater than 5 years
IRR Policy Elements
4
IRR Policy Highlights
• Document responsible parties
• Set content and frequency of reporting
• Set IRR policy limits
• Test IRR impact on new business activities
• Document and regularly evaluate assumption and methodologies
• Separation of controls
• Action plan
5
ALCO
• Examining the impact of changing interest rates and economic conditions– Net economic value– Net interest income– Net income
• Monitoring the liquidity position
• Monitoring key ratios and statistics
• Reviewing and monitoring the credit union’s competitive position
6
Internal Guidelines
• The credit union is responsible for setting internal policy guidelines that best secure the stated goals and objectives of the institution
7
NCUA Risk Measurement
8
NCUA Risk Measurement
Low Moderate High
Cumulative gap
1 Year +/- 10% +/- 10% to -20% +/- 20%
Earnings at risk
Percent change in NII > -20% -20% to -30% < -30%
Percent change in NII > -40% -40% to -75% < -75%
Net economic value
NEV ratio < 6% 4% to 6% < 4%
Percent change in NEV < -25% -25% to -50% < -50%
NEV
• NEV ratio: must be above 4.00% in all environments between the shock down 300 scenario and the shock up 300 scenario
9
Interest Rate Shock
Status -300 Base 300
In Policy > 6% > 6% > 6%
In Policy, Approaching Limit 4% to 6% 4% to 6% 4% to 6%
Over Limit < 4% < 4% < 4%
NEV
• NEV Percent Change: must be within negative 40.00% in all environments between the shock down 300 scenario and the shock up 300 scenario
10
Interest Rate Shock
Status -300 Base 300
In Policy > -30% 0% > -30%
In Policy, Approaching Limit -30% to -40% 0% -30% to -40%
Over Limit -40% 0% -40%
NII
• NII Percent Change: must be within negative 20.00% in each of the four tested scenarios
11
Interest Rate Change
Status Declining Base Rising Shock 300
In Policy > -15% 0% > -15% > -15%
In Policy, Approaching Limit -15% to -20% 0% -15% to -20% -15% to -20%
Over Limit -20% 0% -20% -20%
IRR Measuring and Monitoring
• Model Sufficiency– The model used to assess the risks of the credit union must
employ sufficient techniques, analytical capabilities, and fundamental functionalities that properly capture the complexities of the balance sheet at hand
• Model Maintenance– A sufficient chart of accounts– An appropriate level of data aggregation– Inclusion and use of account level data
12
Assumptions
• Play an important role in classifying the risk of the balance sheet
• BOD must understand these assumptions and their impact on the model
• The credit union is responsible for:– Documenting all assumptions that have a substantial impact on
the credit union’s risk position and ensure that these assumptions are appropriate
– Monitoring these assumptions regularly– Ensuring any assumption changes are properly recorded and
fully disclosed in a transparent way
13
Different Types of Rates
• Weighted average book rate– Aggregate note rate as of a specific period of time
• Reinvestment rate– Used in earnings simulation to depict the current rate at
which cash flows will be reinvested
• Discount rate– Used in value simulation to determine the present value
of future cash flows
14
NII Assumptions
• Reinvestment rates should be product and term specific
• Reinvestment rates– Loans: offering rates– Investments: market yields– Non-maturity deposits & certificates: offering rates– Borrowings: FHLB fixed-rate term advance rates
• Reinvestment rates will be adjusted depending on the interest rate scenario – Base, rising, declining and shock up 300
15
NEV Assumptions
• Determine appropriate discount rate– Present value of projected future cash flows
• Primary versus secondary market rates– Primary: current offering rate– Secondary: observable market rate
16
NEV Assumptions
Sources for discount rates•Offering rates for accounts without an actively traded secondary market
– Unique loan types– Signature loans
•Secondary market spread over an index for accounts with an actively traded secondary market
– Auto loans– Credit card loans
•Observable market rates – Home equity loans: closed-end second liens and HELOCs– Mortgage loans: fixed and adjustable
17
Spread Relationships
• Asset-backed securities (ABS)– Auto loans– Credit card loans
• LIBOR / swap curve plus additional spread– Servicing – New versus used auto loans– Liquidity
• Final spread is based on the average spread of observable ABS as published by multiple brokers
18
Spread Relationships
• Home equity– Bankrate represents comprehensive and objective
average rate obtained in the primary market for home equity loans
• Rate specific based on fixed versus floating• Example: 1/31/12 discount rates
– Fixed 6.00%– Floating 4.71%
– Discounting over a curve
• 1st lien residential mortgage– FHLMC servicing retained, 30-day mandatory delivery
price– Post-settlement delivery fees (loan-level pricing
adjustments)
19
NEV Assumptions - Investments
• Obtain base prices from third-party pricing source– IDC, Reuters
• Collect all security information– Bloomberg
• Retrieve structured product cash flows– Moody’s, Intex
20
21
Assumptions
21
Reinvestment Discount Prepayment SpeedsRate Source Rate Index Source
AssetsConsumer Loans
Visa 7.20 7.20 Offer 7.34 1M LIBOR + 7.12 Broker Avg.
MasterCard 7.09 7.09 Offer 7.34 1M LIBOR + 7.12 Broker Avg.
Direct Auto Loans 5.15 4.58 - 5.27 Offer 2.18 - 4.13 Swaps + 1.94 to 2.40 Broker Avg.
Indirect Auto Loans 5.30 4.03 - 4.31 Offer 2.18 - 4.13 Swaps + 1.94 to 2.40 Broker Avg.
HELOCs 4.16 3.06 - 6.00 Offer 4.60 National Average Bankrate
Wtd. Avg. Book Rate
Reinvestment Discount Prepayment SpeedsRate Source Rate Index Source
Business Loans
Business Loans Fixed 4.73 4.25 - 6.25 Offer 4.94 - 6.43 Swaps + 4.70 Broker Avg./Offer
Business Loans Adjustable 5.49 6.75 - 9.81 Offer 7.74 - 9.23 Swaps + 7.50 Broker Avg./Offer
Wtd. Avg. Book Rate
22
Assumptions
22
Reinvestment Discount Prepayment SpeedsRate Source Rate Index Source
Mortgage Loans
15-Year Fixed Rate Mortgages 4.22 2.88 Offer 30-Day Price Table FHLMC
15-Year Fixed Rate Mortgages, Jumbo 4.06 2.88 Offer 30-Day Price + Spread FHLMC
30-Year Fixed Rate Mortgages 5.00 3.63 Offer 30-Day Price Table FHLMC
30-Year Fixed Rate Mortgages, Jumbo 5.26 3.63 Offer 30-Day Price + Spread FHLMC
1-Year ARMs 2.87 1.38 Offer 30-Day Price Table FHLMC
3-Year ARMs 2.78 1.63 Offer 30-Day Price Table FHLMC
5-Year ARMs 3.50 2.38 Offer 30-Day Price Table FHLMC
5 Year ARM Jumbo 5.13 2.38 Offer 30-Day Price + Spread FHLMC
Wtd. Avg. Book Rate
Reinvestment Discount Prepayment SpeedsRate Source Rate Index Source
Total Investments Agency Notes, Fixed 1.80 0.55 IDC 0.55 NA IDC Agency Notes, Callable 1.40 0.59 IDC 0.59 NA IDC MBSs, Fixed 2.87 0.87 IDC 0.87 NA IDC MBSs, Variable 2.72 2.03 IDC 2.03 NA IDC CMOs Fixed 2.31 1.48 IDC 1.48 NA IDC
Wtd. Avg. Book Rate
NEV Assumptions - Liabilities
• Share certificates– Federal Home Loan Bank fixed-rate term advance curve– Early redemption
• Borrowings– Federal Home Loan Bank fixed-rate term advance curve– Call / put features modeled in ZMdesk
• Non-maturity deposits– Federal Home Loan Bank fixed-rate term advance curve– X-coefficient, effective maturity, decay rate– Net non-interest costs
23
24
Assumptions
24
Reinvestment Discount Prepayment SpeedsRate Source Rate Index Source
Funding
Regular Shares 0.25 0.25 Offer 0.26 - 2.54 Term Advances FHLB Atlanta
Share Drafts 0.25 0.25 Offer 0.26 - 2.54 Term Advances FHLB Atlanta
IRA Shares 0.35 0.35 Offer 0.26 - 2.54 Term Advances FHLB Atlanta
Money Market 0.37 0.37 Offer 0.26 - 2.54 Term Advances FHLB Atlanta
Regular Certificates 1.09 0.40 - 1.44 Offer 0.26 - 2.54 Term Advances FHLB Atlanta
Jumbo Certificates 1.52 0.40 - 1.44 Offer 0.26 - 2.54 Term Advances FHLB Atlanta
IRA Certificates 2.39 0.60 - 1.44 Offer 0.26 - 2.54 Term Advances FHLB Atlanta
FHLB Borrowing 3.61 0.26 - 2.54 FHLB Atlanta 0.26 - 2.54 Term Advances FHLB Atlanta
Wtd. Avg. Book Rate
Net Interest Income Analysis
• It is important to remember the purpose of any analysis
• In the case of NII, the purpose is not budgetary– That is, the primary goal is not to determine the projected
income for the institution over a given time period• To do so would require balance and rate projections
• The goal is to project the volatility of earnings in changing (rising / declining) interest rate environments– NII is then compared in alternative scenarios in order to evaluate
interest rate risk
25
26
NII Assumptions
26
NII Scenarios
• Possible scenarios include:– Base scenario - rates are held constant– Declining scenario - rates decrease 25 basis points per month
for 12 months (resulting in a down 300 over 1 year)– Rising scenario - rates increase 25 basis points per month for 12
months (resulting in an up 300 over 1 year)– Shock up 300 scenario - rates shock immediately 300 basis
points and hold at that level indefinitely– A non-parallel shift in rates (a “twisted yield curve”)
27
Reinvestment Rates
• Should be product and term specific• Reinvestment rates
– Loans: offering rates– Investments: market yields– Non-maturity deposits & certificates: offering rates– Borrowings: FHLB fixed-rate term advance rates
• Reinvestment rates will be adjusted depending on the interest rate scenario – Base, rising, declining and shock up 300
28
NII Projected Outputs
• Projected interest income
• Projected interest expense
• Projected NII and net income
• Percent change from base model
• Asset yields and costs of funding
• Net interest spread
• Net interest margin
• Return on assets
29
30
Reinvestment of Cashflows – ExampleCurrent Offering Rate = 3.00%
30
Month 1 Month 2 Month 3
$600K Principal
$400K Principal
$375K Principal
Net Interest Income Output – Nominal Values
Declining Base Rising Shock Up 300
Total Consumer Loans 11,688 12,129 12,790 13,878
Total Real Estate Loans 19,275 21,229 23,248 24,950
Total Business Loans 4,585 4,890 5,091 5,606
Total Investments 3,171 4,283 6,634 8,439
Total Interest Income 38,719 42,531 47,763 52,873
Total Interest Expense 7,026 8,242 13,844 19,895
Net Interest Income 31,693 34,289 33,919 32,978
31
32
NII Output – Interpreting Interest Rate Risk
32
Declining Base RisingShock
Up 300
Interest Income $ 39,719 $ 42,532 $ 47,764 $ 52,873 % Change from Base -6.61% 0.00% 12.30% 24.31%
Interest Expense $ 5,026 $ 8,242 $ 13,844 $ 19,895 % Change from Base -39.02% 0.00% 67.97% 141.38% Net Interest Income $ 34,693 $ 34,289 $ 33,919 $ 32,978 % Change from Base 1.18% 0.00% -1.08% -3.83% Provision for loan losses $ 3,000 $ 3,000 $ 3,000 $ 3,000 Other Income $ 13,000 $ 13,000 $ 13,000 $ 13,000 Other Expense $ 35,000 $ 35,000 $ 35,000 $ 35,000 Net Income $ 9,693 $ 9,289 $ 8,919 $ 7,978
% Change from Base 4.34% 0.00% -3.98% -14.12% Yield on Earning Assets 3.28% 3.60% 4.04% 4.48% Cost of Paying Liabilities 0.65% 0.77% 1.29% 1.85% Net Interest Spread 2.62% 2.83% 2.75% 2.62% Net Interest Margin 2.68% 2.90% 2.87% 2.79%
Return on Assets 0.35% 0.32% 0.29% 0.25%
What do NII Results Provide?
• Breakdown of interest income and interest expense by category type
• Projected earnings on a static balance sheet
• Earnings at risk due to constant, rising or declining interest rates
• Potential balance sheet problems prior to interest rate shifts
33
What is NEV?
• Evaluate interest rate risk from a value perspective
• Economic value is calculated at a single point in time
• Net economic value– The present value (PV) of the balance sheet
Economic Value of Assets
- Economic Value of Liabilities
= NEV
34
Purposes of NEV
35
Why Calculate NEV?
• Superior to cost accounting information
• Captures interest and principal cash flows
• Provides an analysis of options risk
• Allows for comparisons between different scenarios
• More complete than the income simulation
• Properly managing NEV can reduce the volatility of earnings and net worth
36
NEV Measurements
• NEV percent change– The projected net gain or loss of net economic value assuming
changes in interest rates, relative to the starting value– The sensitivity of capital to changes in interest rates
• NEV ratio– A measurement of capital adequacy from an IRR perspective– Calculated as the NEV of equity / NEV of total assets
37
Price Examples
• There is an asset and it has a fixed rate of 3%, with a maturity of 5 years
Current Market Rate3%
Current Market Rate2%
Current Market Rate4%
PricePar100
PricePremium
>100
PriceDiscount
<100
38
Calculating Prices
• Example 30-year mortgage portfolio– Book value $30,000,000– Book rate 4.55%– Market (discount) rate 3.96%– Market value $31,102,800– Gain / (loss) $1,102,800– Price 103.68
39
Net Economic Value (Micro)
Selected asset prices:Interest Rate Scenario
Assets Book Value (200) (100) Base 100 200 300 400
Visa Platinum $22,526 97.63 97.59 96.48 95.11 93.77 92.46 91.17
New Auto $65,000 103.17 103.12 102.64 101.05 99.78 98.63 97.51
Used Auto $44,269 102.70 102.65 101.64 100.32 99.10 97.81 96.59
Share Secured $11,229 104.16 101.97 99.86 97.83 95.87 93.98 92.16
Signature Loans $14,801 100.00 100.00 99.74 98.70 97.68 96.67 95.68
Home Equity LOC $32,405 99.90 99.88 99.85 99.83 99.81 99.78 99.76
First Mortgage Loans $30,000 104.91 104.67 103.68 99.85 94.90 90.16 85.51
Second Mortgage Loans $26,457 100.99 100.03 97.32 94.58 91.98 89.50 87.14
Agency Fixed $2,000 100.03 100.03 100.02 98.84 97.32 95.78 94.26
Agency Callables $9,994 100.31 100.31 100.03 98.56 96.76 94.93 93.14
Bank CDs $5,475 101.24 101.05 99.93 98.47 97.04 95.64 94.27
Corporate CDs $1,000 100.01 100.01 100.01 100.00 99.98 99.96 99.95
CMO Fixed $15,996 100.05 100.34 100.08 98.88 97.04 94.83 92.47
CMO Variable $3,870 100.32 100.21 99.81 98.99 97.65 95.84 93.63
ARMs $2,688 105.85 106.09 105.64 104.36 102.58 100.38 97.87
MBS Fixed $36,588 102.83 102.89 101.07 97.57 93.31 88.92 84.68
40
Interest Rate Scenario
Assets Book Value (200) (100) Base 100 200 300 400
Visa Platinum $22,526 (534) (542) (793) (1,102) (1,403) (1,699) (1,989)
New Auto $65,000 2,063 2,026 1,719 683 (145) (893) (1,621)
Used Auto $44,269 1,195 1,172 724 143 (398) (969) (1,509)
Share Secured $11,229 467 221 (16) (244) (464) (676) (880)
Signature Loans $14,801 (0) (0) (38) (192) (344) (493) (639)
Home Equity LOC $32,405 (31) (39) (47) (55) (63) (71) (79)
First Mortgage Loans $30,000 1,473 1,401 1,103 (45) (1,530) (2,951) (4,347)
Second Mortgage Loans $26,457 261 7 (709) (1,434) (2,123) (2,778) (3,402)
Agency Fixed $2,000 1 1 0 (23) (54) (84) (115)
Agency Callables $9,994 31 31 3 (144) (324) (507) (686)
Bank CDs $5,475 68 57 (4) (84) (162) (239) (314)
Corporate CDs $1,000 0 0 0 (0) (0) (0) (1)
CMO Fixed $15,996 9 54 12 (180) (474) (827) (1,204)
CMO Variable $3,870 12 8 (7) (39) (91) (161) (247)
ARMs $2,688 157 164 152 117 69 10 (57)
MBS Fixed $36,588 1,034 1,058 393 (887) (2,446) (4,055) (5,604)
Net Economic Value (Micro)
Selected asset gains / (losses):
41
Interest Rate Scenario
Liabilities Book Value (200) (100) Base 100 200 300 400
Regular Shares $93,296 107.56 103.90 100.93 98.21 95.71 93.41 91.51
Share Draft $71,794 107.85 103.44 99.46 95.81 92.53 89.60 86.96
Money Market $82,567 104.71 102.42 100.33 98.44 96.84 95.67 94.74
IRA Shares $12,376 108.21 104.78 101.77 99.01 96.48 94.16 92.21
Share Certificates $52,666 102.53 102.36 101.34 100.09 98.87 97.69 96.53
IRA Certificates $24,083 103.22 103.05 101.96 100.61 99.28 97.99 96.74
Total Other Liabilities $11,206 100.00 100.00 100.00 100.00 100.00 100.00 100.00
Net Economic Value (Micro)
Selected liability prices:
We can see that the regular shares are priced above par in the base case (which is a detriment to the credit union as it reduces capital), whereas the share drafts are priced below par in the base case (which benefits the credit union by increasing capital)
42
Interest Rate Scenario
Liabilities Book Value (200) (100) Base 100 200 300 400
Regular Shares $93,296 7,055 3,639 867 (1,674) (4,005) (6,144) (7,921)
Share Draft $71,794 5,635 2,472 (389) (3,010) (5,360) (7,469) (9,363)
Money Market $82,567 3,887 2,001 276 (1,289) (2,611) (3,577) (4,341)
IRA Shares $12,376 1,016 592 219 (122) (435) (723) (964)
Share Certificates $52,666 1,334 1,243 704 46 (595) (1,218) (1,825)
IRA Certificates $24,083 776 734 473 146 (173) (483) (786)
Total Other Liabilities $11,206 - - - - - - -
Net Economic Value (Micro)
Selected liability gains / (losses):
The gains and losses, based on the prices, are shown
43
44
NEV- Macro
44
($,000 omitted)(200) (100) Base 100 200 300 400
Change in Economic Value of Assets 7,560 7,479 3,002 -3,686 -10,553 -17,251 -23,853
Minus Change in Economic Value of Liabilities 7,235 3,932 -271 -4,785 -9,208 -13,542 -17,789
Equals Cumulative Change in Economic Value 325 3,547 3,273 1,099 -1,345 -3,710 -6,064
Plus Book Capital 31,267 31,267 31,267 31,267 31,267 31,267 31,267
Equals Economic Values of Book Capital 31,592 34,814 34,540 32,366 29,922 27,557 25,203
NEV Dollar Change (2,948) 274 - (2,174) (4,618) (6,983) (9,337)
NEV Percent Change -8.54% 0.79% 0.00% -6.30% -13.37% -20.22% -27.03%
NEV Ratio 7.79% 8.59% 8.62% 8.21% 7.72% 7.24% 6.74%
Interest Rate Scenario
Purpose of an NEV Analysis
• Measure interest rate risk
• Understand trade-offs between long term risk and short term return
• Conduct “what-ifs”
45
Break
46
Non-Maturity Deposit Analysis
Consists of two regression analyses• Financial institution’s dividend rate sensitivity
– How does the financial institution’s dividend rate change with a given change in market rates
– X-coefficient
• Membership sensitivity– Calculate an effective final maturity for each deposit
account– 10-year maximum maturity
47
Non-Maturity Deposit Analysis
• Should be updated every year
• Regression analysis for final maturities
• Regression analysis for dividend payments
• Non-interest costs
• Run sensitivity analysis
• Discussion with ALCO on reasonableness of rate movements
• These scenarios test maturity and sensitivity assumptions
48
Non-Maturity Deposit Analysis
Regular Shares– Dividend rate 0.50%– Coefficient 0.27%– Non-interest cost 1.39%
Down 100 Base Up 100Non-interest cost 1.39% 1.39% 1.39%Dividend rate 0.23% 0.50% 0.77%Total cost 1.62% 1.89% 2.16%
49
Coefficient Materiality
Coefficient Model A Model BRegular Shares 0.27% 0.41% 0.54%Share Drafts 0.15% 0.23% 0.30%Money Market 0.45% 0.68% 0.90%
Initial Model A Model BNEV Ratio - Base 11.26% 10.92% 10.58%NEV Ratio - Up 300 9.03% 8.20% 7.37%NEV % Change Up 300 -23.04% -29.78% -34.82%Asset Duration - Up 300 2.77% 2.77% 2.77%Liability Duration - Up 300 1.16% 1.04% 0.91%
50
Maturity Materiality
Maturity Model ARegular Shares 8 4Share Drafts 10 5Money Market 6 3
Initial Model ANEV Ratio - Base 11.26% 9.84%NEV Ratio - Up 300 9.03% 7.14%NEV % Change Up 300 -23.04% -32.13%Asset Duration - Up 300 2.77% 2.77%Liability Duration - Up 300 1.16% 1.14%
51
NMD Price Materiality
Initial NMD @ parNEV Ratio - Base 11.26% 9.67%NEV Ratio - Up 300 9.03% 4.71%NEV % Change Up 300 -25.04% -54.45%Asset Duration - Up 300 2.77% 2.77%Liability Duration - Up 300 1.16% 0.44%
52
Prepayment Speeds
• Prepayments are early repayments of a loan• Prepayment risk results when cash flows contract or
extend more than expected– Leads to reinvestment risk– Increased / decreased volatility in net economic value
• Generally, if rates rise, all else equal, prepayments will slow
• Generally, if rates fall, all else equal, prepayments will rise
53
Prepayment Speeds
• Auto loans - based on historical prepayment speeds of
asset-backed securities• Residential mortgages - derived from prepayment
model which accounts for the following among many other factors:– Refinancing incentive– Seasoning– Burnout – Seasonality– Media effect
54
Prepayment Sensitivity
• Impact of slower prepayment speeds
• Extend mortgage loans and mortgage investments
• Run annually or more frequently depending on rates
• Most important when projected prepay speeds are fast
55
56
Prepayment Curve
Agency MBS prepayment “S” curve
Rates are ‘low’ relative to mortgage
coupon
Prepayment Incentive
Rates are ‘high’ relative to mortgage coupon
Low Prepayments
High Prepayments
CP
R
Rates
56
Two Sample Financial Institutions
Financial institution - Mortgage• Total Assets = $740 million
– 37% Fixed-rate mortgages– 18% Adjustable mortgages– 5% Auto loans
• Total Liabilities = $673 million– 50% Share certificates– 10% Money market
• Total Capital = $67 million
Financial institution - Auto• Total Assets = $500
million– 55% Auto loans– 10% Fixed-rate
mortgages– 5% Adjustable mortgages
• Total Liabilities = $455 million– 50% Share certificates– 10% Money market
• Total Capital = $45 million
57
Sample Economic Value Simulation
Financial Institution - Mortgage
(200) (100) Base 100 200 300 400 NEV Ratio 9.28% 10.45% 11.26% 11.29% 10.32% 9.03% 7.39%
NEV Percent Change -13.77% -6.49% 0.00% -1.26% -11.98% -23.04% -35.80%
Financial Institution - Auto
(200) (100) Base 100 200 300 400 NEV Ratio 7.65% 8.98% 9.25% 9.30% 9.36% 9.20% 8.87%
NEV Percent Change -15.39% -3.45% 0.00% -1.00% -5.21% -7.84% -10.66%
Net Economic Value AnalysisInterest Rate Scenario
Net Economic Value AnalysisInterest Rate Scenario
58
Prepayment Materiality
-200 -100 Base 100 200 300 400Initial 15 year fixed 48 43 23 11 7 6 6
30 year fixed 52 47 21 9 6 6 53/1 ARM 44 39 39 39 37 34 31
-200 -100 Base 100 200 300 400Model A 15 year fixed 36 32 17 8 5 5 4
30 year fixed 27 25 18 13 7 6 53/1 ARM 39 35 16 7 4 4 4
-200 -100 Base 100 200 300 400Model B 15 year fixed 24 22 11 5 3 3 3
30 year fixed 18 17 12 8 4 4 33/1 ARM 26 23 11 5 3 3 3
59
Prepayment Materiality
Financial Institution - Mortgage Initial Model A Model BNEV Ratio - Up 300 9.03% 8.21% 7.32%NEV % Change Up 300 -23.04% -32.76% -40.33%Asset Duration - Up 300 2.77% 2.94% 3.11%Liability Duration - Up 300 1.16% 1.16% 1.16%
Financial Institution - Auto Initial Model A Model BNEV Ratio - Up 300 9.25% 9.01% 8.67%NEV % Change Up 300 -7.84% -10.53% -17.22%Asset Duration - Up 300 1.55% 1.59% 1.63%Liability Duration - Up 300 1.01% 1.01% 1.01%
60
Spread / Basis Risk
• Secondary market spreads widen due to economic or market conditions
• Mortgage spreads
• Auto spreads
• November 2008 spreads
• Discount spreads are used to determine the value of a holding. Higher spreads (i.e. a higher rate expected by the market) result in lower prices
• Capital drops, and capital volatility increases
61
62
Spreads
62
63
Spreads
63
Rate Spreads
Primary vs. secondary rates comparison as of Dec 2008
• Primary - average offering rates– New auto 5.75% – Credit cards 10.00%– Home equity 4.30%
• Secondary market rates– New auto AA spread over LIBOR/Swap 10.40% -
12.10%– Credit cards 12.25%– Home equity AA spread over LIBOR/Swap 30.40% - 42.10%
64
Two More Sample Financial Institutions
Financial institution - Mortgage• Total Assets = $900 million
– 48% Mortgages– 19% Investments– 4% Auto loans
• Total Liabilities = $784 million– 40% Share certificates– 16% Money market– 19% Savings
• Total Capital = $117 million
Financial institution - Auto• Total Assets = $900
million– 52% Auto loans– 18% Mortgages– 26% Investments
• Total Liabilities = $784 million– 40% Share certificates– 16% Money market – 19% Savings
• Total Capital = $117 million
65
Spread / Basis Risk
Financial Institution - Mortgage Initial Spreads + 200NEV Ratio - Up 300 11.60% 7.59%NEV % Change Up 300 -23.30% -35.07%Asset Duration - Up 300 2.57% 2.75%Liability Duration - Up 300 1.64% 1.64%
Financial Institution - Auto Initial Spreads + 200NEV Ratio - Up 300 14.22% 13.99%NEV % Change Up 300 -2.89% -7.66%Asset Duration - Up 300 1.61% 1.66%Liability Duration - Up 300 1.64% 1.64%
66
Twisted Yield Curve
• Interest rate shift with a change in the spread between two interest rates at different maturity points
• Non-parallel shifts and twists
• Change in shape and slope of yield curve
• Choose a curve that adequately stress your balance sheet
• These changes stress different parts of the balance sheet
• “Shocking” this new curve then measures the risk to the balance sheet (in other words, if the curve moved like this, what would the new ALM report look like at that time?)
67
68
Twisted Yield Curve-Steepener
68
Dec-11 TYC Change Dec-11 TYC Change Dec-11 TYC Change Fed Funds 0.25 0.25 0.00 Swap FHLB Dallas Prime 3.25 3.25 0.00 1 month 0.30 1.25 0.95 1 month 0.25 1.20 0.95 3 month 0.58 1.40 0.82 3 month 0.26 1.20 0.94 Treasury Curve 6 month 0.81 1.60 0.79 6 month 0.32 1.80 1.48 1 month 0.02 1.00 0.98 12 month 1.13 2.20 1.07 12 month 1.03 2.30 1.27 3 month 0.02 1.00 0.98 24 month 0.73 2.35 1.62 18 month 1.07 2.50 1.43 6 month 0.06 1.50 1.44 36 month 0.82 3.25 2.43 24 month 1.12 2.80 1.68 12 month 0.11 1.50 1.39 48 month 1.01 3.50 2.49 36 month 1.39 4.00 2.61 24 month 0.24 2.00 1.76 60 month 1.22 4.25 3.03 48 month 1.63 4.30 2.67 36 month 0.36 3.00 2.64 120 month 2.03 5.30 3.27 60 month 1.94 5.00 3.06 60 month 0.83 4.00 3.17 360 month 2.62 5.90 3.28 120 month 2.79 5.80 3.01 120 month 1.88 5.20 3.32 360 month 2.90 6.20 3.30
69
Twisted Yield Curve
70
Twisted Yield Curve- Flattener
70
Dec-11 TYC Change Dec-11 TYC Change Dec-11 TYC Change
Fed Funds 0.25 0.25 0.00 Swap FHLB Dallas
Prime 3.25 3.25 0.00 1 month 0.30 2.24 1.94 1 month 0.25 2.20 1.95
3 month 0.58 2.32 1.74 3 month 0.26 2.25 1.99 Treasury Curve 6 month 0.81 2.55 1.74 6 month 0.32 2.30 1.98 1 month 0.02 2.02 2.00 12 month 1.13 2.81 1.68 12 month 1.03 2.85 1.82 3 month 0.02 2.02 2.00 24 month 0.73 2.58 1.85 18 month 1.07 3.00 1.93 6 month 0.06 2.20 2.14 36 month 0.82 2.75 1.93 24 month 1.12 3.00 1.88 12 month 0.11 2.40 2.29 48 month 1.01 3.00 1.99 36 month 1.39 3.40 2.01 24 month 0.24 2.60 2.36 60 month 1.22 3.00 1.78 48 month 1.63 3.70 2.07 36 month 0.36 2.80 2.44 120 month 2.03 3.40 1.37 60 month 1.94 3.70 1.76
60 month 0.83 2.80 1.97 360 month 2.62 4.00 1.38 120 month 2.79 4.20 1.41 120 month 1.88 3.25 1.37
360 month 2.90 3.35 0.45
71
Twisted Yield Curve
Twisted Yield Curve Steepener
Financial Institution - Mortgage Initial Twisted YCNEV Ratio - Up 300 11.60% 4.51%NEV % Change Up 300 -23.30% -47.65%Asset Duration - Up 300 2.57% 2.79%Liability Duration - Up 300 1.64% 1.54%
Financial Institution - Auto Initial Twisted YCNEV Ratio - Up 300 14.22% 13.22%NEV % Change Up 300 -2.89% -8.33%Asset Duration - Up 300 1.61% 1.65%Liability Duration - Up 300 1.64% 1.54%
72
Conclusion
• IRR Policy update
• What-ifs stress different aspects of the balance sheet. Understanding the impacts assumption changes have is important in helping monitor and manage interest-rate risk
• Assumptions
• Supplemental IRR test– NMD assumption sensitivity– Prepayment sensitivity– Basis risk– Twisted YC
• Testing IRR impact of strategy
73
2911 Turtle Creek Blvd.Suite 500Dallas, Texas 75219Phone: 800.752.4628Fax: 214.987.1052
www.almfirst.com
top related