asset/liability management – year 2 - madison, wi · asset/liability management: positioning,...

Lecture Materials

ASSET/LIABILITY MANAGEMENT – YEAR 2

Darren D. Herrmann Executive Vice President & Treasurer

UMB Financial Corporation & UMB Bank Kansas City, Missouri

[email protected] 816-860-7195

July 31, 2017

Asset/Liability Management: Positioning, Profitability & Process

Graduate School of Banking, Madison, Wisconsin 1

Asset/Liability Management:Positioning, Profitability & Process

Darren D. HerrmannExecutive Vice President & Treasurer

UMB Financial Corporation

Graduate School of Banking

Madison, WisconsinJuly 31, 2017



Year 2 OverviewDarren Herrmann—Day 1• Asset/Liability Management (ALM): Positioning, Profitability

& Process

Andy Trovillion—Day 2 • Interest Rate Risk Measurement and ManagementJohn McQueen—Day 3• Developing an Effective Liquidity Strategy Dave Koch—Day 4• Putting it all together: Implementation of a Risk-Return

Framework



DisclosuresThe information and opinions expressed in this message are solely those of the author and do not necessarily state or reflect the opinion of UMB Bank, n.a. or UMB Financial Corporation. This communication is provided for informational purposes only. UMB Bank, n.a. and UMB Financial Corporation are not liable for any errors, omissions, or misstatements.



Overview• ALM Overview• ALM and the Current Environment• ALM & Profitability

• Drivers of Net Interest Income (NII)• A Case Study• Marginal Cost of Funding• Capital/Leverage Deployment/Reversal• Intersession Project Part 1

• The ALM Process• Structure, responsibilities• Seven Steps to an Improved ALCO• Intersession Project Part 2



ALM Overview



ALM

Definition• The term “asset/liability management”

refers to the processes of acquiring and deploying funds to maximize net interest income, and thereby profitability and the value of the bank, while balancing against related financial risks and constraints.



ALM

Net Interest Margin

Interest Rate Risk

Liquidity Risk

ROE

LeverageROA



ALM’s Primary Areas of Responsibility• Net Interest Income• Balance Sheet & Off Balance Sheet Structure

• ALM Mix • Loan and Deposit Pricing• Investment Portfolio Management• Wholesale Funding • Capital/Leverage

• Risk Measurement and Management/Constraints• Interest Rate Risk• Liquidity Risk• Capital



ALM Levers

• Balance Sheet Composition/Mix• Pricing• Capital/Leverage• Interest Rate Risk• Liquidity Risk



ALM and the Current Environment



Questions for the Current ALM Environment• Should I keep making fixed-rate loans?

• Should I add funding with tenor now?

• Will my deposit mix shift back toward my pre-crisis position?

• Am I modeling deposit sensitivity appropriately?

• Should I lever or delever my balance sheet?

• What could happen to my liquidity as rates increase and the Fed shrinks its balance sheet?

• How has technology changed the competitive landscape in terms of raising deposits, rate sensitivity, switching costs (remote deposit capture, mobile banking, Kasasa)?

• Do I know who my large funds providers are and how they might behave?

• Do I know the trend in uninsured deposits at my institution?



• What is the marginal cost of new deposits raised?

• The Fed has increased 75 basis points since December 2015, has the expected impact materialized in your bank’s NIM?

• Do I have exposure to a flattening yield curve and if so which kind?

• Am I using derivatives to enable loan growth and/or protection during flat curve period?

• What is my bond portfolio’s exposure to rising rates and what are the market value and liquidity implications?

• What is the potential impact of Fed Quantitative Easing reversal and tax reform on my bond portfolio’s market value and what are the liquidity implications?

• What will be the impact of no more Reg. D?

• Do I have a Liquidity Coverage Ratio (LCR) bank in any of my markets and how could that impact deposit rates?

Questions for the Current ALM Environment



Is This Time Different?



Quantitative Easing: That Was Easy



Yield Curve Is Flat by Historical Norms (Spread between the 10 and 2 year treasury rates on average)

1.18 1.29

1.77

1.58

1.04 0.93

Last 30 years Last 20 years Last 10 years Last 5 years Last year Current



Interest Rates: Past, Present, Future?

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1.00

2.00

3.00

4.00

5.00

6.00

3 MO 6 MO 1 YR 2 YR 3 YR 5 YR 7 YR 10 YR 30 YR

2007 2011 2013 2017 1 Year Forward Rates



Declining Asset Sensitivity Due to Both Sides of Balance Sheet & Growth in Net Interest Income Over Time (Projections Assume Static Balance Sheet)

317 340

363 484560

7.89%

6.73% 6.88%7.24%

6.53%

5.00% 4.57%5.20%

5.96%7.16%

2.90% 2.16%

1.68%1.28%

‐0.63%

‐1.00%

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0

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Mar 13 Mar 14 Mar 15 Mar 16 Mar 17

Percen

tage Change from

Uncha

nged

Rates

Millions of $

Year 1 Up 100 Basis Point Ramp Sensitivity Over Time

Net Interest Income Unchanged Rates in dollars, left axixYear 1 Interest Income Sensitivity ‐ Up100 Ramp, right axisYear 1 Interest Expense Sensitivity ‐ Up100 Ramp, right axisYear 1 Net Interest Income Sensitivity ‐ Up100 Ramp, right axis



Cost of Funds vs. Market Rates Will Be Key to Interest Rate Risk Sensitivity—Historically 55% of Market Rates

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Percent

Cost of Funds with DDA Comparison

UMB Financial Corporation Commerce Bancshares, Inc. Peer Avg (w/o UMBF) 1 Month Libor

CreditCrisis

‐ 0.10 0.20 0.30 0.40 0.50 0.60 0.70 0.80 0.90 1.00

Jun‐15

Jul‐15

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Percent

1 Month Libor Cost of Interest Bearing Liabilities

Cost of Funds with DDA



Funding Mix More Indeterminate, Less Term

30% 31% 33% 36%40% 39% 41% 42% 39% 38%

19% 18% 17%18%

19% 19%22%

26%28% 30%

20% 19% 21%23%

23% 27%22%

19% 21% 18%9% 11%

10%8%

6%6% 6% 5% 6% 6%22% 21% 19% 15% 12% 10% 9% 8% 8% 7%

2008 2009 2010 2011 2012 2013 2014 2015 2016 2017

DDA NOW MMDA Savings CDs



ALM & Profitability



NII & Margin Components000s Omitted

Average Interest Avg.Earning Assets Balance Inc/Exp Rate

Investments 311,041 7,496 2.41%Loans 433,842 17,310 3.99%Other 18,690 850 4.55%EA/Int. Inc./YEA $763,573 $25,657 3.36% Costing LiabilitiesNOW Accounts 190,646 534 0.28%MMDA Accounts 104,073 260 0.25%Savings Accounts 39,202 39 0.10%CDs 45,146 262 0.58%Borrowings 112,809 1,004 0.89%IBL/Int. Exp./COF $491,876 $2,099 0.43%

Net Interest Spread 2.93%

Net Int. Inc./NIM $23,558 3.09%

Free Funds $271,697



NII & Margin Components000s Omitted

Earning Assets $763,573 $25,657 3.36% Yield on Earning AssetsInterest Bearing Liabilities $491,876 $2,099 0.43% Cost of FundsFree Funds $271,697 $22,398 2.93% Contribution of SpreadFree Funds Ratio 35.58% 0.15% Contribution of Free Funds %

$1,159 Contribution of Free Funds $Net Interest Income $23,558 3.09% Net Interest Margin

InterestIncome

InterestExpense

Free Funds/Earning Assets271,697/763,573

Contribution of Spread*Earning Assets2.93%*763,573

Free Funds*Cost of Funds271,697*.43%

Free Funds Ratio*Cost of Funds35.58%*.43%



Drivers of Net Interest Income



Drivers of NII

• Rate (Pricing, credit risk interest rate risk, liquidity risk)

• Volume of assets and liabilities• Mix of assets and liabilities



Net Interest Income Variance Equations

Avg. Avg. Avg. Avg.Balance Rate Balance Rate309,937 2.07% Investments 311,041 2.41%719,755 Earning Assets 763,573

Investments Rate M2 * L2 * R2 - M2 * L2 * R1

Variance 311,041 / 763,573 763,573 2.41% - 311,041 / 763,573 763,573 2.07% = 1,058

Investments Volume M2 * L2 * R1 - M2 * L1 * R1

Variance 311,041 / 763,573 763,573 2.07% - 311,041 / 763,573 719,755 2.07% = 369

Investments Mix M2 * L1 * R1 - M1 * L1 * R1

Variance 311,041 / 763,573 719,755 2.07% - 309,937 / 719,755 719,755 2.07% = -347

Total Investments Variance 1,080

Net Interest Income Variance Analysis Calculation ExampleDollars 000s Omitted

Period 1 Period 2

Rate Variance = M(2)*L(2)*R(2) - M(2)*L(2)*R(1) Volume Variance = M(2)*L(2)*R(1) - M(2)*L(1)*R(1) Mix Variance = M(2)*L(1)*R(1)* - M(1)*L(1)*R(1)



Net Interest Income Variance Analysis

Period 1 Period 2 Rate + Volume + Mix = TotalAmount Rate Amount Rate Variance Variance Variance Variance

Earning Assets309,937 2.07% 311,041 2.41% Investments 1,058 369 -347 1,080391,643 3.68% 433,842 3.99% Loans 1,345 916 637 2,89818,176 4.60% 18,690 4.55% Other -9 49 -26 14

$719,755 3.01% $763,573 3.36%

$21,664 $25,657 Interest Income $2,393 $1,335 $264 $3,993 Costing Liabilities

167,524 0.15% 190,646 0.28% NOW Accounts 248 16 18 283123,014 0.11% 104,073 0.25% MMDA Accounts 146 7 -27 12534,318 0.09% 39,202 0.10% Savings Accounts 4 2 2 842,064 0.51% 45,146 0.58% CDs 32 13 3 4790,593 0.45% 112,809 0.89% Borrowings 496 29 71 596

$457,513 0.23% $491,876 0.43%

$1,040 $2,099 Interest Expense $925 $67 $67 $1,059

$20,625 2.87% $23,558 3.09% Variance $1,468 $1,268 $198 $2,933

Sample BankNet Interest Income Variance Analysis

(000s Omitted)



Case Study



Year-to-Date -- Jun 2009 Year-to-Date -- Jun 2008AVG AVG VARIANCE ANALYSISRATE RATE

AVERAGE INTEREST EARNED/ AVERAGE INTEREST EARNED/ RATE BASIS VOLUME MIX TOTALASSETS: BALANCE INC/EXP PAID BALANCE INC/EXP PAID VARIANCE VARIANCE VARIANCE VARIANCE VARIANCE Net Loans 436,723 10,013 4.58% 405,634 11,702 5.74% (2,704) (70) 2,240 (1,154) (1,688) Total Investment Securities 446,703 7,048 3.51% 313,818 6,601 4.64% (2,278) (5) 1,634 1,095 447 Other Earning Assets 43,277 97 .57% 44,635 609 2.86% (489) (3) 103 (123) (512) Total Earning Assets 932,151 17,159 3.87% 768,882 18,912 5.12% (5,471) (78) 3,977 (182) (1,754) Int IncLIABILITIES: - - - - - - - - - Total Demand Deposits 235,101 - 189,917 - - - - - - Total Transaction Accounts 368,692 929 .51% 284,896 1,825 1.29% (1,317) (12) 396 38 (896) Total Time Deposits 148,622 1,714 2.33% 147,947 3,055 4.15% (1,336) (17) 537 (525) (1,341) Total Interest Bearing Deposits 517,314 2,643 1.03% 432,843 4,879 2.27% (2,652) (29) 933 (487) (2,236) Total Borrowings 150,951 197 .26% 137,335 1,627 2.38% (1,595) (10) 316 (141) (1,430) Total Interest Bearing Liabilities 668,265 2,841 .86% 570,178 6,507 2.29% (4,247) (39) 1,248 (628) (3,666) Int ExpInterest Income & Rate Earned 17,159 3.87% 18,912 5.12% - - - - - Interest Expense & Rate Paid 2,841 .86% 6,507 2.29% - - - - - Net Interest Income & Rate Spread 14,318 3.01% 12,406 2.83% (1,224) (39) 2,729 446 1,912 NIINet Interest Margin 3.25% 3.41%

Net Interest Income Variance Analysis



Drivers of NII Observations• Fairly large negative rate variance during period of

declining rates becoming a drag on net interest income growth

• What does that indicate?• The bank has seen its spread widen but its net interest

margin decline• What explains this?• What does this indicate about this bank’s interest rate risk

exposure?• The bank’s volume variance offset the negative rate

variance due to significant asset growth, what happens if this growth slows and rates stay low?

• What levers remain for this bank to pull?



Net Interest Income Variance Analysis$ In Thousands

Year-to-Date -- 2013 Year-to-Date -- 2012AVG AVG VARIANCE ANALYSIS

RATE RATEAVERAGE INTEREST EARNED/ AVERAGE INTEREST EARNED/ RATE VOLUME MIX TOTAL

ASSETS: BALANCE INC/EXP PAID BALANCE INC/EXP PAID VARIANCE VARIANCE VARIANCE VARIANCENet Loans 585,582 9,267 3.78% 502,719 9,023 4.26% (988) 1,078 154 244 Investment Securities 679,385 4,544 1.90% 611,730 4,839 2.22% (833) 591 (54) (295)Other Earning Assets #1 21,721 248 3.55% 16,896 211 3.77% (26) 30 32 36 Other Earning Assets #2 81,706 98 .29% 85,313 115 .32% 7 10 (34) (17) Total Earning Assets 1,376,012 14,156 2.64% 1,224,685 14,187 2.95% (1,839) 1,709 99 (31)LIABILITIES: - - - - - Total Demand Deposits 465,905 403,855 - - - - Total Rate Bearing Transaction Accts. 588,867 247 .10% 497,235 293 .14% (98) 38 14 (46)Total Time Deposits 112,048 357 .77% 133,181 505 .91% (68) 47 (127) (148)Total Int Bearing Deposits 700,915 603 .21% 630,417 798 .30% (167) 85 (113) (195)Total Borrowings 170,871 100 .14% 153,066 105 .17% (5) 12 (12) (5)Total Interest Bearing Liabilities 871,787 704 .20% 783,483 903 .28% (171) 96 (125) (200)

Interest Income & Rate Earned 14,156 2.64% 14,187 2.95%Interest Expense & Rate Paid 704 .20% 903 .28%Net Interest Income & Rate Spread 13,452 2.44% 13,284 2.67% (1,668) 1,613 223 168 Net Interest Margin 2.52% 2.77%



Drivers of NII Observations• Bank continues to offset negative rate variance with

positive volume variance and positive mix variance• What constraints could this bank face in trying to continue

this strategy?• The bank is sacrificing net interest margin for net interest

income, what financial goals must be a priority (ROA vs. ROE vs. EPS)?

• As you survey the regulatory and competitive landscape what if anything concerns you about the bank’s funding base?

• What levers remain for this bank to pull?



Tier One Leverage Ratio %

9.739.29

8.057.32

6.55 6.897.53

2007 2008 2009 2010 2011 2012 2013



Drivers of NII Conclusions• Determine what has been driving net interest income• If rate variance has been positive, will likely be negative as rates

rise• Assess what levers exist to alter this• Assess likelihood of offsetting this negative rate variance through

growth or mix changes• If already highly loaned, assess likelihood of improving mix

variance on the liability side of the balance sheet• Assess the impact of any changes on the institution’s risk profile• Model forward results and load into simple comparison• Consider the potential impact of sustained high or low rate

environments



Capital/Leverage



• Bank has utilized excess deposits to leverage capital by having balance sheet size in excess of budget

• Strategy has generated 1%+ ROA and 11%+ ROE to date• Funding position has changed so that now inflated balance sheet

funded with new more rate sensitive deposits• Given likelihood of increasing interest rates, deposit beta unclear--

should leverage continue to be deployed?

Background



Spread on “Wholesale” Funded Bond Purchases

‐1.50%

‐1.00%

‐0.50%

0.00%

0.50%

1.00%

1.50%

2.00%

2.50%

Q2 16 Q3 16 Q4 16 Q1 17 Q2 17 Q3 17 Q4 17 Q1 18 Q2 18 Q3 18 Q4 18 Q1 19

Beta 50% Beta 75% Beta 100% Forecast Rate Change



ROE on “Wholesale” Funded Bond Purchases

‐6.00%

‐4.00%

‐2.00%

0.00%

2.00%

4.00%

6.00%

8.00%

10.00%

Q2 16 Q3 16 Q4 16 Q1 17 Q2 17 Q3 17 Q4 17 Q1 18 Q2 18 Q3 18 Q4 18

Beta 50% Beta 75% Beta 100% Forecast Rate Change

Dilutive Line



• What is the impact of this leverage on overall interest rate risk profile?• What is the impact of this leverage on overall liquidity risk profile?• How would the bank minimize the risk of narrowing spreads becoming

negative?• What is missing from this analysis that could adversely impact the

indicated results?

Key Considerations



Marginal Cost Funding



Marginal Cost Funding AnalysisNo Growth Strategy

Interest Interest InterestBalance Rate Expense Balance Rate Expense Balance Rate Expense

MMDA 15,000,000 0.25% 37,500 15,000,000 0.75% 112,500 13,500,000 0.25% 33,750 Wholesale Funding 1,500,000 1.83% 27,450 Combined Position 15,000,000 0.25% 37,500 15,000,000 0.75% 112,500 15,000,000 0.41% 61,200

Marginal Cost Savings 51,300 Marginal Cost Break Even 5.25%

Growth StrategyInterest Interest Interest

Balance Rate Expense Balance Rate Expense Balance Rate ExpenseExisting CDs 15,000,000 0.75% 112,500 13,500,000 0.75% 101,250 15,000,000 0.75% 112,500 New Money 37 Month CD Special 2,250,000 1.25% 28,125 Old Money 37 Month CD Special 750,000 1.25% 9,375 Wholesale Funding 1,500,000 1.50% 22,500 Combined Position 15,000,000 0.75% 112,500 16,500,000 0.84% 138,750 16,500,000 0.82% 135,000

Marginal Cost of Funds $ 26,250 22,500 Marginal Cost of Funds Rate 1.17% 1.50%

Comments:75% new money assumption gets the special CD option down to a marginal cost of 1.17%.

Current Position Rates Up 50bp Match Rate Rates Up 50bp Don't Match Rate

Current Position Special Nets $3 Million 50/50 Split No Special, Fund Wholesale



• What is my expected range of new money to be raised?• What is my expected range of existing deposit cannibalization?• Am I raising in all locations or the cheapest?• What is my expected rate of outflow if don’t match rate?• How much outflow can I tolerate?• What would my wholesale funding options cost? • What are my breakeven results?

Key Considerations



Intersession Project Part 1

Analysis of Financial Performance



Equity MultiplierTotal Assets 100,000,000$ Total Equity 8,000,000$ Equity Ratio 8%Equity Multiplier 12.5

Peer Total Assets 100%Peer Equity 8%Equity Multiplier 12.5



Seven Steps to a Better ALCO



Seven Steps to a Better ALCO• Step 1: Make your policies metric driven• Step 2: Get your membership right• Step 3: Focus your agenda on risk/return metrics

and action items• Step 4: Build meeting information around agenda• Step 5: Review Your Risk/Return Profile

--Is the bank measuring the opportunity cost of its current interest rate risk position?

• Step 6: Pricing methodologies should be robust and reflect metrics

• Step 7: Have action items--Meeting should not just be a history lesson



Setting Limits

0.00%

0.20%

0.40%

0.60%

0.80%

1.00%

1.20%

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500

1,000

1,500

2,000

2,500

3,000

3,500

4,000

Base Case 20% NII Limits 0.80% ROA

Comparison of Base Case to Limit Methodologies

NII ROA

Base Case 20% NII LimitsMinimum .80%

ROA MetricTotal Assets 100,000,000 100,000,000 100,000,000 NII 3,500,000 2,800,000 3,192,308 NI 1,000,000 545,000 800,000 Tax Rate 35% 35% 35%ROA 1.00% 0.55% 0.80%

ROA metric requires NII limit of < 9%, not 10%-20%



Expected Outcomes

• More engaged ALCO• Better questions• Increased volume and quality of ideas• Greater strategic focus • Improved financial results



Intersession Project Part 2

ALCO Responsibilities and Tools



Conclusions• ALM’s primary responsibilities center on

• Net interest income and net interest margin • Rate, volume, mix

• Interest rate risk• Liquidity risk• Capital Management

• Levers—Balance Sheet Mix Composition, Capital/Leverage, Pricing, Interest Rate Risk, Liquidity Risk

• Understand the interest rate cycles and what the yield curve is saying

• Follow the 7 steps for an improved ALM process



Questions?

Darren HerrmannExecutive Vice President & TreasurerUMB Financial [email protected]

asset/liability management – year 2 - madison, wi · asset/liability management: positioning,...

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