A/L Benchmarks

ALCO Meetings (Part 3 of 3 Parts)

The final four ALCO meeting of the year can be used to review the Peer Report to observe your bank's performance compared to other banks of similar asset size.  This comparative analysis is useful when looking for industry trends and to make sure that your risk management policies are realistic.  Remember that the Peer Report comes at the end of each quarter after every bank in the country's data has been modeled using the A/L Benchmarks model.  The Peer Report does not come at the same time as your other A/L Benchmarks report(s).

The data in your Peer Report is taken from the Industry Report, available online at http://blogs.olsonresearch.com/.  The Industry Report is a sample of commercial banks representing 50 states, the District of Columbia and other territories.  Some definitions that are helpful when reviewing the Peer Report:

1)  Mean is a statistical mean of the sampled group, the sum of a group or sample of values divided by the number of observations in the group or sample.

2)  Standard Deviation is the statistical measure of variance from the mean representing the dispersion of data (distance) from the mean.

The Standard Deviation reported in the Peer Report is one standard deviation from the mean which encompasses the middle 60% of all banks.  The highest 20% and the lowest 20% have been excluded.  For example, if the Mean for the ROA measurement is .78 and the standard deviation is .86, then 60% of all banks fall between -0.08 and 1.64 (0.78 +/- 0.86).

3)  The High, Median and Low numbers are exactly that, the highest, the median and the lowest bank in the peer sampling.

Again from the perspective of of your bank compared to banks of similar asset size, thoroughly analyze the earnings performance, balance sheet mix, capital adequacy, asset quality, liquidity and interest rate risk in your institution.  Discussion should include (but is definitely not limited to):

Earnings

• Are changes in ROA, ROE and NIM consistent with industry trends? (Compare to the previous quarter and/or year.)
• Are changes in ROA, ROE and NIM related to changes in yield, cost of funds or both?
• What does the bank's overhead look like in relation to peers?
• Is the bank trend in overhead consistent with trends in the industry?
• Is the bank in compliance with internal risk management policies?  Are these policies appropriate?

Balance Sheet Mix

• How does your bank compare in terms of composition to your peers?
• When looking at the differences in asset mix between your bank and peer banks, what affect would you expect to see in terms of earnings?  Does this seem to be consistent with your theory?
• How do differences in funding mix affect your cost structure?  What steps are available for you to take to minimize your cost of funds?
• Is the bank in compliance with internal risk management policies?  Are these policies appropriate?

Capital Adequacy

• First and foremost, is your capital within regulatory guidelines?
• What is the trend for your capital levels?
• Is your capital within the bank's risk management policies?

Asset Quality

• What is the current level of Non-Performing Assets in relation to the level of  ALL?  How has this relationship changed over time?
• What is the anticipated level of both Non-Performing Assets and potential Charge-Offs?
• What additional Provisions will be necessary to cover Non-performing Assets and Charge-Offs?  Discuss the impact on earnings.
• What are the bank's premium levels in relation to peers?
• Is the bank in compliance with internal risk management policies?  Are these policies appropriate?

Liquidity

• How does your bank compare in terms of asset liquidity? 
• How does your bank compare in terms of funding liquidity?
• Identify your contingent sources of funding.  Compare the cost of these contingency plans to the cost of generating core deposits.
• Are there any imbedded options in your FHLB credits and under which interest rate environment will these options likely be exercised?  How will this affect your earnings?
• If all contingent sources of funding are currently being utilized, what are your alternatives if these avenues are no longer available?
• Are all non-pledged securities marketable?
• Is the bank in compliance with internal risk management policies?  Are these policies appropriate?

Interest Rate Risk

• What is the direction and magnitude of your Net Interest Earnings at Risk?  How does this compare to your peers?
• What is the direction and magnitude of your Economic Value of Equity at Risk (EVE)?  How does this compare to your peers?
• Have you consciously taken on some longer term risk to EVE in order to minimize shorter term risk to earnings or vice versa?
• What is the likelihood, given the current rate environment, that this worst case scenario will play out?
• Can you identify where the risk is coming from to both earnings and economic value of equity (EVE)?  Are you being appropriately compensated for this risk?
• What steps can you take to minimize the current risk to earnings and economic value of equity (EVE)?
• Is the bank in compliance with internal risk management policies?  Are these policies appropriate?

Additionally, you can take a look at your institution from the Regulatory perspective.  Both the FDIC and the OCC have established some benchmarks for both bank performance and risk tolerance.  The Canary Report is used by both institutions to determine which banks and what areas within the bank warrant a closer examination.  You can find the Canary Report on the back page (page 4) of the Peer Report.  Again, Canary ratios have been calculated for all banks in the country as well as the District of Columbia and other territories.  The benchmarks in the Canary ratios, as defined by the OCC, are not individuated by asset size.

This concludes our series on ALCO meetings.  It is our goal to assist you in making your monthly ALCO meetings as productive, and ultimately profitable, as possible.

ALCO Meetings (Part 2 of 3 Parts)

Again on a rotating basis, four meeting a year can be used to review model assumptions used in the A/L Benchmarks model.  I would further suggest that these meeting be held in January, April, July and October to coincide with data submission which typically occurs in February, May, August and November.

You can find your modeling assumptions beginning on page 53 of the Executive Report under Service Kit Inputs.  Although the service kit information is optional, it is good modeling practice to submit as much detailed information as possible. 

The first piece of data in addition to the call report is an investment download.  We can obtain this information from your bond dealer or you can upload this file yourself.  This allows us to model your investments on a Cusip by Cusip basis.  It also allows us to capture all of the optionality in the portfolio (call dates, repricing dates, spreads et cetera).  Here is a link to the investment data specifications:

http://blogs.olsonresearch.com/main/2007/01/investment_data.html

The next piece of information that is required is a loan data file. Similar to the investment data file, this allows us to model your loans on a loan by loan basis.  Here is a link to the loan data file format options:

http://blogs.olsonresearch.com/benchmarks/2007/12/loan-detail-fil.html

It is important to note the following differences in file formats:

It should be pretty obvious that we would like you to send us the data using the #2 or #3 format.  These file layouts don't contain any sensitive customer data (like Social Security Numbers, etc.)  These formats also provide us with some very informative additional fields.  Certainly if you have variable rate loan that are at or approaching floors, we should be capturing this data.   If we you are not uploading your loan file using the #2 or #3 format, why not?  This is good ALCO discussion.

The next modeling assumption to review is the detailed information on your time deposits.  The call report does not break out fixed and variable rate time deposits so this information is needed to accurately calculate the cash flows of these instruments.

Moving along, has the bank enacted a sweep account since the modeling assumptions were last reviewed?  If so, we will need the Core Deposit Balances & Expense items.  Additional information on core deposits (DDA, NOW, Savings and MMDA) includes the core deposit repricing beta factors and the decay assumptions.  These assumptions are used for the earnings simulation (core deposit repricing beta) and EVE simulation (decay assumptions).  Your "core" deposit accounts are unique in that 1)  they have no contractual maturity and, 2) rates are typically administered; they change when management decides to move the rate.  How do these issues affect your model?

Let's look at the core deposit repricing beta factors first. In English this means, for every 100 basis point movement in Fed Funds, what is the corresponding movement in your Now, Savings and Money Market rates?  Is it 10%, 50% or 100%? A good analysis would look at a recent time period, for example 1/30/08 to 4/30/08 or 4/30 08 to 10/29/08, where Fed Funds moved 100 basis points (downward).  Next look at your deposit rates for those same time periods and calculate the percentage movement.

The decay assumptions looks at the behavior of these deposits in terms of maturity.  The accounts don't actually mature, but what is the average life of these deposits?  You have four modeling options for decay assumptions.  The first option was proposed by FDICIA (305) back in the early 90's but never adopted.  These decay assumptions are rather "short", meaning, the assumption is that these core deposits are in the bank for a shorter time frame, typically with a duration of approximately -1.7 years.  The OTS uses a decay formula (technically not a decay assumption) that takes into account the current rate paid on these deposits.  The OTS decay formula tends to be a bit longer in terms of duration, -2.0 years or more.  The bank can hire an independent outside party to conduct a core deposit study at a cost of approximately $8000-10,000.  (The cost tends to eliminate this choice pretty quickly!)  Finally, you can conduct your own internal study by collecting data from all closed account by category that includes the open date, closed data and average balance.  You would need to collect at least 1-2 years of data to begin your study with 5 years of historical data being optimal.  From this closed account data, we can provide custom decay assumptions, typically reviewed annually for accuracy.

The banking industry is relying more and more on the FHLB to provide sources of funding.  It is important to provide detailed data, including call or put options, on each of your FHLB advances in order to accurately model their projected expenses and cash flows:

Other Supplemental Data up for review includes Unusual Non-Interest Income and Expenses, useful in determining the overhead piece of the Present Value Calculation.  Non-interest income and Expenses that can be classified as unusual or non-reoccurring can be backed out of the operating expense component of the discount rate calculation.  Supplying the Common Shares Outstanding allows us to calculate an earnings per share ratio and the State Tax Rate insures accuracy in calculating the appropriate taxes in the forecast.

Repo information is combined on the call report with overnight Fed Funds.  Pricing and maturity structure can vary dramatically so for accuracy, it is important to isolate Repos from Fed Funds.  Additionally, it is important to supply the prepayment speeds for Residential and Multi-Family real estate loans.  Has this changed dramatically in the current rate environment?  When was the last time the prepayment speed was reviewed?

The final and most comprehensive assumption that you should be reviewing is the forecast of the balance sheet, new pricing rates and non-interest income and expense items.  Often the bank's budget is scrutinized and then cast in stone for the year.  We know, however, that the budget is actually much more dynamic than that.  At least quarterly, ALCO should review current balance sheet targets, pricing decisions and non-interest and expense items and adjust as necessary. 

Again, these assumptions should be reviewed by ALCO quarterly,  prior to data submission.  Please do not hesitate to call your Analyst if you have any questions on modeling assumptions or have a unique situation that is not addressed in any of the outlined input formats.

Online support sessions

We now have the ability to support our clients with GoToAssist, which allows us to interact with your computer.  We can connect with your computer and literally walk you through the uploading process or review specific aspects of your reports.  To utilize this service, simply click on the Start Support Session link, then call us at 1-888-657-6680 for further instructions. 

Data File Specifications

Here are links to our suggested data file formats:

• Call report data files
• Investment data files
• Loan data files

Once you have created a data file, you may upload it to us using our Secure file upload (sign-in required) area.

Balance Sheet Projection

We have had many requests from clients and regulators for the ability to use a custom budget.  Although we have always had this option, the additional cost has been prohibitive for some clients.  On this page, you have the ability to enter Targeted End-Of-Period Balances for you entire Balance Sheet at no additional cost.  For reference, it may be beneficial to enter the Historical Actual EOP balances from your call report before beginning.  Please note that if you enter any balances, you must complete the BALANCES FOR ALL QUARTERS.  If a category is left blank, the default assumption is flat balance sheet, or no growth.

Additionally, you have the ability to enter the Floating Rate Pricing Spread.  Fixed Rate loans are priced at 50 basis points above the floating rate pricing.  If this relationship is not appropriate for your bank, you can enter your fixed rate pricing in the Notes field of the service kit (see below).

New Pricing rates for deposits should reflect the rate currently being paid on NOW, Savings, Money Market, Small and Large time deposits.

Income and Expense Items should be entered as a QUARTERLY figure for each labeled quarter.  Again, please be sure that if you are entering this information, you fill in ALL QUARTERS.

Equity transactions should also be entered on a QUARTERLY basis, filling in with zeros where appropriate.  Please note that the dividend figure should be entered as a TOTAL DOLLAR figure NOT per share.

If you enter an estimated Net Income Forecast, we can look for entries that might be out of sync to make sure that the forecast is as accurate as possible.

Please enter the number of FTE employees so that we can calculate a Salaries and Benefits per employee figure.

Finally, please enter a rate forecast.  There are three options here:

1)  Enter a projected rate forecast for Fed Funds

2)  Enter a projected rate forecast for two distinct yield curve points; the 2 Year CMT and the 30 Year CMT, Or

3)  Enter a projected rate forecast for Fed Funds AND the 2 Year CMT and the 30 Year CMT

Again you must complete ALL QUARTERS.

Forecast notes to the analyst preparing you reports is for any additional information that you would like to convey that does not fit in this file or information that has been requested by your analyst.  We realized that as detailed as these inputs are, there isn't a spreadsheet large enough to encompass all possible scenarios that might occur in your bank.  Here is where you can communicate the unique nature of you bank so that we can model appropriately.

Other Items

As the category implies, other items are a group of important miscellaneous items.  First, you need to supply information on any unusual and/or infrequent non-interest income and expenses.  These unusual items affect two areas.  First, overhead is a piece of the Fair Value calculation and if identified, we can back unusual items out of the overhead piece.  Secondly, we do not want to forecast income or expenses that will not reoccur.

We can also calculate earnings per share, common dividend per share and  book value per share if we have an ACTUAL number of shares outstanding.  (Please note that this is the only number on the Service Kit that is NOT stated in 000's.)

The State Tax Rate varies widely across the country; we use a default State Tax Rate of 0%.

The call report combines the average balance and expense information for Repos with Fed Funds Purchased.  Although the rates on both instruments have been very similar in the past, those days are gone and we have seen rate differences of over 100 basis points.  Please provide the QUARTERLY Repo expense, End-Of-Period balance and average balance so that we can model Repos separately from Fed Funds.

FHLB Borrowings

Complete this page of the Service Kit only if you have FHLB advances.  Record the name or Advance ID# for your reference, amount, current rate, maturity date and if the advance is amortizing (Y or N).  For variable rate advances, also include the index rate, spread, repricing frequency (D, M, Q, A) and the next reprice date.  Make sure that this date has not already passed and truly represents the next possible reprice.

Many FHLB advances have call options so we need the date of the call (or put) and if the call (or put) is at the FHLB's option (F - the default assumption) or the Bank's option (B).

Finally, the FHLB sends the bank a report entitled "Customer Mark-To-Market Shocks" and the data from this report is also a useful in modeling your FHLB portfolio appropriately.

Deposits - Core Factors

Core Deposits accounts (DDA,NOW, Savings and MMDA) comprise a large part of a banks funding, especially in a community bank.  Questions begin to emerge on how to model the deposit behavior in terms of sensitivity to market rate changes and maturity structure for valuation.

Core Deposit accounts typically have administered rates, meaning the rates change when the powers that be at the bank say they change.  We do know however that there is often some response to market rate changes.  To model this sensitivity we use a Core Deposit Repricing Beta factor. This is the percentage of rate change each account will move with a 100 basis point movement in Fed Funds. 

For example, if Money Market accounts are extremely rate sensitive and perhaps even tied to the Fed Funds rate, the Core Deposit Repricing Beta factor is 100%; Money Market accounts move step in step with Fed Funds. 

Let's look at another example.  If you have not moved the rate on your savings accounts in the last 10 years, the Core Deposit Repricing Beta factor would be 0%, or no sensitivity to movements in Fed Funds.  These are extreme examples and most accounts behave somewhere in between these extremes. 

Also remember that the Core Deposit Repricing Beta factors are not always symmetrical in the rates up and rates down scenarios.  Bankers will move rates down as quickly as possible (more sensitivity to market rate changes and a higher core deposit beta factor) while delaying an increase in the rates on core deposits as long as possible (less sensitivity to market rate changes and a lower core deposit beta factor).  Here is a related post that talks about Core Deposit Beta factors.  And another one here.

In order to calculate the Present Value on an account we need maturity structure of the cash flow.  This presents a particular problem with accounts that have no contractual maturity.  In the case of Core Deposits, we use a Decay Assumption to show how the accounts behave in terms of maturity.  There are four choices for decay assumptions:

1)  FDICIA 305 (default assumption) 

This was proposed by FDICIA over a decade ago and never adopted for several reasons, primarily because the behavior of these accounts in terms of "maturity" varies widely from bank to bank depending on size, location, age, marketing strategy et cetera.   FDICIA 305 tends to produce shorter (modified) durations, typically 1.6 to 1.7 years.  To the right you will find the decay assumptions proposed by FDICIA 305:

2)  OTS NPV

The OTS uses their own formula to determine Net Present Value (NPV) for all Thrifts and the (modified) duration using the OTS formula tends to be longer than the FDICIA 305 proposal, typically over 2 years.

3)  3rd Party data

There are a few vendors who will do an account analysis of your core deposits and calculate a decay rate for each account (DDA, NOW, Savings and MMDA).  This methodology is very precise but also very expensive.  You can supply this data via our secure upload site.

4)  Custom Decay

This is the preferred method of examiners if you do not use a 3rd Party analysis.  Clients internally calculate a decay structure by analyzing the average life of their core deposits, typically done by using a five year history of closed accounts.  This can be difficult due to the purging of closed accounts but you can begin by collecting this data now.  Once the analysis is complete, you can provide this information here.

More reference on Decay Assumptions can be found here.

Deposits - CD's

In addition to the data found on your call report, we ask clients to provide detailed data on the maturities and cash flows of the time deposit portfolio in order to accurately model the behavior of these accounts.  Please provide a breakout of CD's into fixed rate maturities and variable rate repricing dates.  For large time deposits (> $100,000), we also ask for the percentage of fixed rate instruments for regular, brokered and public time deposits.

Investments

In order to model your investments accurately we prefer, and more importantly examiners prefer, an investment download from your Bond Account Vendor or one that is created internally.  This allows us to capture all of the optionality in the portfolio that is absent on the call report and model bonds on a CUSIP level.

 

If an investment download is not an option, we ask that you input more detailed information about your portfolio such as the percentage of each category that is fixed rate, the prepayment speed and a cash flow analysis.