bank liquidity and wholesale funding part ii. 2 this course will address bank liquidity and...

Bank Liquidity andBank Liquidity andWholesale Funding Part IIWholesale Funding Part II

Bank Liquidity andBank Liquidity andWholesale Funding Part IIWholesale Funding Part II

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Bank Liquidity and Wholesale Funding Part II

This course will address bank liquidity and wholesale funding history and trends.

Click the links below to launch each section of the course.

Bank Liquidity andBank Liquidity andWholesale Funding IIWholesale Funding IIBank Liquidity andBank Liquidity and

Wholesale Funding IIWholesale Funding II

Liquidity Risk Liquidity Risk Warning IndicatorsWarning Indicators

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Background: Examination Trends

June 30, 2004 – FDIC-supervised banks with 3- or 4-rated liquidity studied closely

2004 exam data indicated less than 1% of FDIC-supervised banks had marginal or poor liquidity

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Common Factors

Factors shared by institutions with 3- or 4-rated liquidity:– Asset size characteristic of 'community' bank– Rapid asset growth funded by higher cost

funding– Stagnant core deposit levels

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Determining Trends

Review examination reports and UBPR ratios for banks with poor liquidity

Determine early warning indicators Lone indicators do not imply bank headed

toward liquidity problem Multiple indicators – monitor banks closely

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Liquidity Risk Warning Indicators

Early Warning Indicators Trust Preferred Securities Asset Securitization Deposits

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Early Warning Indicators

Weak funds management policy, liquidity monitoring, and control of processes

Competition from the marketplace straining efforts to attract core deposits

Developing a pattern of offering higher rate deposits to attract funds

Reduction in secondary sources of liquidity

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Early Warning Indicators (Continued)

Previously unsecured lines of credit require collateral

Securities portfolio almost totally pledged as collateral

FHLB borrowing requirements change from blanket lien to specific lien

Unproven stability of large depositors

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Early Warning Indicators (Continued)

Increasing trend in adverse classifications and past-due loans

Weaknesses in loan underwriting and credit administration

Replacement of loan officers

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Early Warning Indicators (Continued)

Ratios for loans-to-assets, loans-to-deposits, and loans-to-core deposits trending upward, or in excess of 100%

Net non-core funding dependency ratio high relative to peer ratios

Escalating level of unfunded loan commitments, letters of credit, other contingent liabilities

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Strategies Contributing to Downgrade

Low level of core funding Board of Directors abdicating liquidity risk

oversight to bank management Aggressive loan growth Outdated funds management policy

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What We've Learned

Based on patterns and trends, we've learned:

Evaluating bank funding strategies and liquidity – challenging for examiners

Many innovative funding strategies add to this challenge

Characteristics and behavior of traditional core deposit products have evolved and changed

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Examiners Must Evaluate

Characteristics/risks of banks' core funding sources

Characteristics/risks of banks' non-core funding sources

Overall management of banks' liquidity position

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Liquidity Risk Warning Indicators

Early Warning Indicators Trust Preferred Securities Asset Securitization Deposits

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Trust Preferred Securities

Viewed as capital injection

rather than a funding source…

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Liquidity Risk Warning Indicators

Early Warning Indicators Trust Preferred Securities Asset Securitization Deposits

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Asset Securitization as a Funding Source

Can be effective funding source Associated risks Contain early amortization clauses Clause may be triggered – banks must

repay earlier than expected

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Consider the Issuing Institution

Issuing institution – large concentration of residual assets

Overall cash flow might depend on residual cash flows form underlying assets' performance

If performance declines, cash flow is less than anticipated

Could impact bank's liquidity position

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Asset Securitization and Reputation

Bank's reputation critical to ability to securitize

If reputation damaged, may be unable to secure assets

Could seriously impact bank's liquidity position

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Liquidity Risk Warning Indicators

Early Warning Indicators Trust Preferred Securities Asset Securitization Deposits

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Deposits

Play critical role in bank's operation Increasing market competition – many

banks have difficulty retaining and growing deposit base

Many banks have difficulty differentiating core/non-core deposits

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Core Deposits

Difficult to simply rely on definition when calculating bank's core deposit base.

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Volatile Deposits

CDs under $100,000 obtained from Internet CD source– Defined as core deposits– May be volatile in response to interest rate

changes

Local, large CDs – Defined as non-core deposits– May be very stable

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Core vs. Non-Core Funding

Apply it to bank's overall funding Do not just apply it to deposit base Evaluate characteristics/behavior of all

funding sources to determine core vs. non-core

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Deposit Brokers

Rise in use of deposit brokers Traditional served as intermediaries

between banks/investors With advent of Internet/CD listing services,

investors identify high-yield deposit sources Banks willing to compete – can attract

deposits

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Brokered Deposits

May be labeled 'brokered' even if they were not obtained through a deposit intermediary

If the effective yield on a deposit is more than 75 bp over prevailing yields, the deposit may fall within 'brokered' guidelines

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Factors to Consider

Depositor Loyalty

Management Tracking

Due Diligence

Impact to Earnings/Capital

Contingency Plan

Diversification vs. Cost

UBPR Ratio Analysis

Liquidity Ratios

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Depositor Loyalty?

Dependent on relationships

Affected by yield

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Management Tracking

Monitoring:– Number– Magnitude

Plan for changes in volume

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Due Diligence

Due diligence prior to entering relationship:

Consider reputation

Check references

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Impact on Earnings and Capital

Does management:

Assess impact to earnings and capital?

Consider impact of rate sensitive deposits?

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Contingency Plan - Purpose

Manage fluctuations in liquidity

Monitor liquidity risk

Maintain appropriate assets

Measure and project funding requirements

Manage access to funding sources

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Contingency Plan - Elements

Define responsibilities/decision-making authority

Assess potential for erosion Assess potential liquidity risk posed by

other activities

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Contingency Plan - Elements

Analyze/project significant on- and off-balance sheet funding cash flows and their related effects

Match potential sources and uses of funds

Identify and assess adequacy of contingent funding sources

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Contingency Plan - Elements

Assess potential for triggering legal restrictions on bank’s access to brokered deposits

Accelerate timeframes for reporting in a problem liquidity situation

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Diversification vs. Cost

Maintain access to more funding lines

Allow flexibility

Minimize risk associated with a single funding source

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UBPR Ratio Analysis

Useful analytical tool

Can be used to identify trends

Used in conjunction with bank’s internal liquidity ratios

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UBPR Ratio Analysis and Peer Groups

Important to recognize peer group comparisons may not be useful

Banks free to manage funds as they deem appropriate

Examiners – do not assume liquidity problem just because bank is different from peers

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UBPR Ratio Analysis and Big Picture

May not provide accurate picture of bank's liquidity

Examiners – evaluate characteristics and behavior of asset and liability accounts before analyzing UBPR liquidity ratios

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Beyond UBPR Ratio Analysis

Consider account categories to determine if UBPR ratios capture them appropriately

Do not simply rely on UBPR definition

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UBPR Ratio Analysis - Example

UBPR definition – out-of-area CDs less than $100,000 from Internet listing service – core deposit

Reality – these deposits are generally unstable – not a true core deposit funding source

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Common Liquidity Ratios

Net short-term non-core funding dependence Net non-core funding dependence Net loans and leases to deposits Net loans and leases to total assets Short-term assets to short-term liabilities Pledged securities to total securities Brokered deposits to total deposits Core deposits to total liabilities

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Ratios for Analysis

In the past, focus was on two ratios

Currently, selection of ratios provided for analysis – all should be considered

Also consider bank's internal ratios

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Liquidity Risk Warning Indicators

Early Warning Indicators

Trust Preferred Securities

Asset Securitization

Deposits

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In the next section…

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