asset liability mgmt. – banking book risk - garp€¦ · asset liability mgmt. – banking book...

Asset Liability Mgmt. – Banking Book Risk

Tom Haczynski SVP – SunTrust Bank Market Risk Management July 2015

2

The views expressed in the following material are the

author’s and do not necessarily represent the views of

the Global Association of Risk Professionals (GARP),

its Membership or its Management.

Today’s Agenda

3

I. Asset/Liability Management 4-11

II. Interest Rate Risk 12-30

III. Conclusion 31

IV. Acknowledgements 32

I. Asset/Liability Management

4

Interest Rate Risk (“IRR”)

Liquidity Risk

Key Objective: Achieve the desired trade-off between risk and return

Funds Transfer Pricing

Non Interest Income/Expense Allocation Methodologies

Capital Attribution

Asset/Liability Management (“A/LM”), the management of long-term balance sheet risks arising from core banking activities, focuses on two major areas of risk:

Performance Measurement ("PM") Methodologies:

Interest Income Loan Interest Income FTP Credit for FundsLess: Interest Expense FTP Charge for Funds Deposit Interest Expense

Equals Net Int Income ("NII") FTP'd NII FTP'd NII

Less: Loan Loss Provision Expected Loss ("EL") + Chge OffsEquals Adjusted NII

Plus: Non Int. IncomeLess: Non Int. Expense

Equals Net Inc Before Taxes

Less: Income TaxesEquals Net Inc After Taxes

Divided by Equity Capital Capital Allocation Methodology

Equals Return on Equity ("ROE")

GAAP-Based Income Statement: PM-Based Income Statement

Regulatory (Advanced, Standard), EC Based

Product NIM, RAROC & NIACC = Bal Sheet Optimization

Income TaxesNet Inc After Taxes

Adjusted NII

Funds Transfer Pricing ("FTP")

Non Int Income/Expense Allocation Methodologies

U/W process creates grids for Pricing Models

Methodologies: ProRata / Direct Costing / Full Absorption / Svce Level Agmts ("SLA's")

Net Inc Before Taxes

Less: Capital Charge (EC * Hurdle Rate)Net Inc After Capital Charge ("NIACC")


5

Achieve the desired trade-off between risk and return














Adjusted NII








6















Adjusted NII








7



8

Loan Pricing Example

Loan A Loan B

Interest Income 5.00% 7.00%Interest Expense -2.00% -3.00% Net Int Income ("NII") 3.00% 4.00%Loan Loss Provision -0.20% -0.40% Adjusted NII 2.80% 3.60%

Non Interest Income 0.40% 0.40%Non Interest Expense -0.80% -1.00% Net Income Before Taxes 2.40% 3.00%

Income Taxes 33% -0.80% -1.00% Net Income After Taxes 1.60% 2.00%

Equity Capital 8.00% 16.00%

Return on Equity ("ROE") 20.00% 12.50%


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Loan A Loan B







10


Loan A Loan B






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Financial Intermediation involves a bank’s use of its balance sheet to move funding from depositors (i.e., savers) to borrowers

Savers and borrowers do not know each other; they know only the bank

Liquidity Risk, Interest Rate Risk and Credit Risk are caused by the differing attributes of depositors and borrowers

Bank Risk Management

Depositors Bank Borrowers

Short term, floating rate $ Long term, fixed rate $

Liquidity Risk Credit Risk Interest Rate Risk


II. IRR – Definition

II. Interest Rate RiskInterest Rate Risk in the ALM Context means Adverse Impacts From Changes in Interest Rates On:

Economic Value of Equity(EVE)

Net Interest Income(NII)

1 2

Represents major revenue source for commercial banks

Key area of focus for investor community

Current Income Focus

Based on the discounted Net Present Value (NPV) of the cash flows from all on and off balance sheet items

Not externally reported; indication of economic value

Extremely important concept many have not heard about

Long-Term Shareholder Focus

12

Market Value of Equity (“MVE”)

Balance Sheet

Change in the Loan or Deposit mix Acquisitions, divestitures Hedging activity

Yield Curve

Change in the absolute level of rates Change in the steepness

Spread & Basis Risk

Impact of “risk on” vs. “risk off” Index used to price the funding differs from index used to price the asset

Option Risk

Adjustable rate loans with caps or floors Loans which give borrowers the right to prepay IMDs which allow depositors to withdraw funds at any time

II. IRR – Sources & Drivers

13

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II. IRR – Balance Sheet Composition Measuring the Interest Rate Gap

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Management can alter the rate sensitivity of the Balance Sheet based on desired objective. Objective: Approach: Reduce asset sensitivity Buy longer-term securities Lengthen the maturities of loans Move from floating-rate to fixed-rate loans Enter into a Receive-Fixed-rate swap position Increase asset sensitivity Buy short-term securities Shorten loan maturities Make more loans on a floating-rate basis Terminate an open Receive-Fixed-rate swap position Reduce liability sensitivity Attract longer-term deposits Issue long-term debt Increase liability sensitivity Attract short-term deposits

Borrow more via purchased liabilities

II. IRR – Balance Sheet Composition Levers to Manage the Position

A Tale of Two Banks

II. IRR - Example

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Re-pricing maintains spread and price stability

Normal Inverted

Flat

Potential Shapes

II. IRR - Yield Curve

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Actual Shapes


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1.0

2.0

3.0

4.0

5.0

6.0

0 5 10 15 20 25 30

Inte

rest

Rat

e (%

)

Tenor (Years)

Steep Curve -- 28 Jul 2003

4.5

4.8

5.0

5.3

5.5

0 5 10 15 20 25 30

Inte

rest

Rat

e (%

)

Tenor (Years)

Inverted Curve -- 27 Nov 2006

6.0

6.5

7.0

7.5

8.0

0 5 10 15 20 25 30

Inte

rest

Rat

e (%

)

Tenor (Years)

Flat Curve -- 12 Jun 2000

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Generally, the term structure of interest rates is upwardly sloping.

Yield curve reflects expectations -- Fed actions, growth/inflation rates, market supply and demand forces etc.

Yield curve movements can dramatically impact NII and MVE.

Recent Trends

-

1

2

3

4

5

US Swap Curve (%)

6/30/2010 6/30/2014 6/30/2015

-

0.5

1.0

1.5

2.0

2.5

3.0

Swap Curve Steepness (%)

2Y vs. 5Y 2Y vs. 10Y

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II. IRR - Yield Curve Labor Market Trends

Inflation is well-below both the 2% long-term goal and 2.5% top end of FOMC’s target range. Energy prices keep headline inflation low; market-based expectations rise for the first time since Oct-2014. Sustained low inflation measures call into question when the timing of the first Fed Rate hike will occur.

Source: BEA, Moody’s Analytics

Inflation Trends


21

32 22 19 21 15 13 11 9 8 7

Jan-15

Mar-15

May-15

Jun-15

Aug-15

Oct-15

Nov-15

Jan-16

Mar-16

Expected First Fed Rate hike


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The The Federal Reserve should wait until the first half of 2016 before raising interest rates because inflation remains too low and there are "significant uncertainties as to the future resilience of economic growth," per the IMF on 7/2/2015 in its annual review of the U.S. economy.

Fed Actions Since 1990


23 Source: FRED, Federal Reserve Economic Data

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A/LM managers rely on a sensitivity framework to measure and monitor IRR.

Framework consists of “what-if” analysis of significant factors that affect IRR across a wide range of potential interest rate environments and business scenarios.

Uses include:

Limit compliance Inform/educate committee members Develop strategies

It is critical to highlight:

Key assumptions and Sensitivity of results

II. IRR Sensitivity

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The analysis includes the following 4 steps:

1. Scenario key inputs & assumptions: Base case rate scenario Current position, new volumes, contractual behavior Optionality (e.g., loan prepayments, deposits withdrawn early, rate caps/floors)

2. Identify major drivers: Assets and Liabilities that will re-price over different time horizons Off-balance sheet items that have cash flow implications

3. Calculate NII & MVE @ Risk under the base case rate scenario

4. Select a new interest rate forecast, re-run the model and compare to Base Case Impact of technology

II. IRR Sensitivity Process

90’s Forward

Advanced Measures

Gap Analysis

Crude Earnings

Simulations

More Robust NII Simulations; Static MVE

Multi-Dimensional NII & MVE Scenario

Analyses

1970’s

Indicators

1980’s

Estimates

Late 80’s - 90’s

Estimates and Measures

Process (continued)

Acc

urac

y &

Sop

hist

icat

ion

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II. IRR Sensitivity SURPRISES!

-6%

-4%

-2%

0%

2%

4%

6%

8%

Year 1 NII Sensitivity

Prior

Current

II. IRR – NII Sensitivity Scenario Results

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II. IRR – NII Sensitivity Scenario Results – “9 Box”

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SCENARIO: Rates Lower Most Likely Rates Higher

Volumes Lower

Base CaseBase Case-Most Likely

Volumes Higher

II. IRR – NII Sensitivity Scenario Results – “35 Box”

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SCENARIO: Down Shock

Flattener Most Likely Steepener Up Shock

Deposit Beta Lower

Deposit Growth Lower

Loan Growth Lower

Base Case Base Case-Most Likely

Loan Growth Higher

Deposit Growth Higher

Deposit Beta Higher

II. IRR – NII Sensitivity Scenario Results

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An effective A/LM process creates value by optimizing the risk/return tradeoff relative to a multitude of competing constraints!

Product Mix

Interest Rate Risk

Liquidity

Regulatory

Client Needs

Infrastructure Capabilities

III. Conclusion

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32

Aleem Gillani SunTrust Bank Al Kolesar SunTrust Bank Tony Santomero Citigroup

IV. Acknowledgements

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