liquidity path 2007 poorman
DESCRIPTION
bank liquidityTRANSCRIPT
page 1the ALMnetwork
Liquidity Management: Best Practices in Measurement & Reporting
PATH 2007
Fred Poorman, Jr., CFAManaging PrincipalThe ALMnetwork
page 2the ALMnetwork
who is the ALM Network?introduction
An independent consulting firm providing financial institutions with customized ALM services.
Long-time IPS-Sendero client (20+ years) Our consulting network has worked with banks of all
sizes ranging from de novos to large regional banks. every bank receives personalized service, with a customized
solution based on their unique requirements
page 3the ALMnetwork
Key Focus on the Liquidity Risk Exam
MIS meaningful and informative? Does MIS capture funding concentrations, rollover risk wholesale funding report, collateral availability, liquidity trends, and compliance with policy?
Does bank have meaningful Risk Limits? Risk measurement forward looking cash flow funding
gap or a needs/sources projection over next 12 months?
Use of Structured Funding products prudent? Does management understand the risk in the structure? Need to use ILP!
Thanks to Ray Diggs and the Credit and Market Risk evaluation team at the OCC, headed by Deputy Comptroller Kathy Dick.
page 4the ALMnetwork
Prospective liquidity (Ray talked about) What can we use for liquidity When we can access it Where is it Why we would do this How do we do this Who will do it
Projected liquidity (now talking about)
funding liquidity
page 5the ALMnetwork
Liquidity ratio comments
Fed examiner: “Liquidity ratios are meaningless and frequently misleading”
OCC examiner: “Many banks liquidity schedules are really liquidation schedules”
Ex-OCC examiner: “Liquidity management is not liquidation management”
page 6the ALMnetwork
Balance sheet approach
The balance sheet is traditionally presented & ordered from most liquid to lease liquid Cash Fed Funds & short-term investments Investments Loans Other assets Fixed (PP&E) assets
page 7the ALMnetwork
Balance sheet approach
Balance sheet presentation may be misleading in the 21st
century Cash
Do you run your bank with excess (vault) cash?
Are you selling & closing branches in the next month or two? Have you provided prior notice?
Cash is not usually a source of cash?
page 8the ALMnetwork
Balance sheet approach
Fixed (PP&E) assets: is your bank keeping its branches? If yes, then “Fixed Assets” is a liquidity source via sales/lease
back If no, it may be an available intermediate liquidity source (then
Cash is released as well) Fixed assets are a more ready source of liquidity than
cash? BOLI can be surrendered for cash Both sale/leaseback & BOLI likely have tax
consequences
page 9the ALMnetwork
Balance sheet approach
Balance sheet approach is misleading Liquidity and AL managers know this Board & Executive Management may not Ongoing Board education may be lacking on this topic
page 10the ALMnetwork
Basel Principle 4:
“A bank must have adequate information systems for measuring, monitoring, controlling and reporting liquidity risk. Reports should be provided on a timely basis to the bank’s board of directors, senior management and other appropriate personnel.”
What type of liquidity reporting will be required in the future? The Basel Committee has specified sound practices for measuring liquidity.
page 11the ALMnetwork
Sample Liquidity Report from OCC: Base scenario
page 12the ALMnetwork
Principle 5:
“Each bank should establish a process for the ongoing measurement and monitoring of net funding requirements.”
How do you do this? Use cash flow projections to identify the future time periods - for example: one day, one week one month, one quarter, and one year during which there will be a shortfall (or surplus) of cash flow liquidity.
Liquidity measurement should be multi-dimensional (Principle 6)
page 13the ALMnetwork
Single scenario, OCC example
page 14the ALMnetwork
Principle 6:
“ A bank should analyze liquidity utilizing a variety of “what if” scenarios.”
Bank treasurers discuss interest rate risk using different rate scenarios, like by 2% rate shock scenarios, yield curve flattener (or twist), and forward rate scenarios (deterministic).
Bank lenders discuss credit risk using different economic scenarios, like growth vs. recession.
Do you use “what if” for liquidity measurement? Scenario and time horizon analysis
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Projected liquidity Cash flow gap
Multi-scenario Base scenario Shock scenarios Twist scenarios
Multi-period 1 month 3 month 12 month
Measuring liquidity
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Better practice suggestion: Integrated analysis
It is both common sense and a liquidity better practice to use consistent data, scenarios, and methods to analyze: Liquidity risk Earnings risk Value, or Economic Capital risk
page 17the ALMnetwork
Scenario analysis
Rate ScenariosU.S. Treasury rates
BaseDescription Forward -2% Shock +2% ShockLevel/Slope shift 0/0 -200/0 +200/0Short/Long rates (approx.) 0/0 -200/-200 +200/+200
3 mo 4.98 2.98 6.98 6 mo 5.01 3.01 7.01 1 yr 4.93 2.93 6.93 2 yrs 4.58 2.58 6.58 3 yrs 4.54 2.54 6.54 5 yrs 4.54 2.54 6.54 10 yrs 4.65 2.65 6.65 30 yrs 4.84 2.84 6.84
10 yr - 2 yr slope 0.06 0.06 0.06
Parallel Shifts
page 18the ALMnetwork
Scenario analysis
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3 mo 6 mo 1 yr 2 yrs 3 yrs 5 yrs 10 yrs 30 yrs
Forward -2% Shock +2% Shock
page 19the ALMnetwork
Better Practice or a New Regulatory Requirement?
In the OCC’s Northeast district, the CEOs of national banks recently received a letter on this topic. A sample letter reads “What should bankers do? Banks need to assess the impact of yield curves
twists now... if a model can not run yield curve twists, bank
managers should reassess the adequacy of their model and consider moving to one that can better predict the bank’s exposure to various, or more realistic, rate scenarios.“
Do you do this for Liquidity Management?
page 20the ALMnetwork
Scenario analysis
Rate ScenariosU.S. Treasury rates March 2007
BaseDescription Forward Big Bull Little Bull Little Bear Big BearLevel/Slope shift 0/0 -200/+200 -50/+100 +50/+100 +200/+200Short/Long rates (approx.) 0/0 -300/-100 -100/0 0/+100 +100/+300
3 mo 4.98 2.06 3.99 4.97 5.95 6 mo 5.01 2.08 4.04 5.03 6.03 1 yr 4.93 2.16 4.05 5.05 6.16 2 yrs 4.58 2.14 3.87 4.87 6.15 3 yrs 4.54 2.41 3.98 4.98 6.42 5 yrs 4.54 2.99 4.27 5.27 6.99 10 yrs 4.65 4.21 4.93 5.93 8.21 30 yrs 4.84 4.18 5.01 6.01 8.18
10 yr - 2 yr slope 0.06 2.06 1.06 1.06 2.06
Yield Curve Twists
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Scenario analysis
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2.00
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9.00
3 mo 6 mo 1 yr 2 yrs 3 yrs 5 yrs 10 yrs 30 yrs
Forward Big Bull Little BullBig Bear Little Bear
In SVAL, use the rate builder tool to create your scenarios. Usually this is a 2 or 3 step process –document it.
Vantage currently has “shock” only capabilities.
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Projected liquidity
Projected Cash Flow Summary($000)
Rate Scenarios BaseDescription Forward -2% Shock +2% Shock
3 month cumulativeAssets 73,118 107,421 68,652Liabilities 82,396 92,287 82,134Net Cash Flow (9,278) 15,134 (13,482)Net CF/Assets Ratio (%) -1.85% 3.02% -2.69%
Sensitivity: % change from BaseAssets 47% -6%Liabilities 12% 0%Net Cash Flow -263% 45%
1 year cumulativeAssets 256,559 382,545 230,003Liabilities 241,247 268,330 240,787Net Cash Flow 15,312 114,215 (10,784)Net CF/Assets Ratio (%) 3.05% 22.76% -2.15%
Sensitivity: % change from BaseAssets 49% -10%Liabilities 11% 0%Net Cash Flow 646% -170%
Assets 501,726Repo 25,000
Parallel Shifts
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Projected liquidity
Projected Cash Flow Summary($000) March 2007
Rate Scenarios Base Yield Curve TwistsDescription Forward Big Bull Little Bull Little Bear Big Bear
3 month cumulativeAssets 73,118 99,098 95,605 69,855 66,808Liabilities 82,396 92,185 92,140 82,204 82,095Net Cash Flow (9,278) 6,913 3,465 (12,349) (15,287)Net CF/Assets Ratio (%) -1.85% 1.38% 0.69% -2.46% -3.05%
Sensitivity: % change from BaseAssets 36% 31% -4% -9%Liabilities 12% 12% 0% 0%Net Cash Flow -175% -137% 33% 65%
1 year cumulativeAssets 256,559 285,983 246,118 230,974 208,929Liabilities 241,247 266,424 266,247 240,787 240,227Net Cash Flow 15,312 19,559 (20,129) (9,813) (31,298)Net CF/Assets Ratio (%) 3.05% 3.90% -4.01% -1.96% -6.24%
Sensitivity: % change from BaseAssets 11% -4% -10% -19%Liabilities 10% 10% 0% 0%Net Cash Flow 28% -231% -164% -304%
Assets 501,726Repo 25,000
page 24the ALMnetwork
Better Practice or a New Regulatory Requirement?
Banks need to assess the impact of yield curves twists now... Deterministic rate scenarios shown above
Let the model produce multiple scenarios… LPS or similar stochastic or lattice process Not necessary for community banks Useful info/cool graphs, though
page 25the ALMnetwork
Stochastic scenarios:NCF comparisons, Year 1
Liquidity @ Risk metrics <-3 -3 to -2 -2 to -1 -1 to mean mean to +1 +1 to +2 +2 to +3 +3 to +499% Confidence Interval (224,858) 583,504
Liquidity @ Risk (323,345) 485,017
95% Confidence Interval (63,186) 421,831Liquidity @ Risk (161,672) 323,345
SummaryNCF (386,531) (224,858) (63,186) 98,487 260,159 421,831 583,504 745,176 3 month LIBOR 0.25 0.53 1.41 2.28 3.16 4.03 4.91 5.78 Probability 1% 12% 11% 14% 36% 11% 16% 0%Cumulative Probability 100% 88% 77% 63% 27% 16% 0% 0%
This is a different bank from the prior examples.
This uses LPS to produce rate scenarios.
page 26the ALMnetwork
Stochastic scenarios:NCF comparisons, 40% vol (vol shock, base is 20%)
Net Cashflow Projected, Year 1
R2 = 85%
-2,000,000.
-1,000,000.
0.
1,000,000.
2,000,000.
0% 2% 4% 6%
Ending 3 month LIBOR rate, Rate/NCF relationship:
$ in 000
page 27the ALMnetwork
Stochastic scenarios:NCF comparisons, Year 1
0%
25%
50%
75%
100%
(386,531) (224,858) (63,186) 98,487 260,159 421,831 583,504 745,176
ProbabilityCumulative Probability
Net Cashflow Projected, Year 1
page 28the ALMnetwork
Measuring Liquidity
Metrics: Base case, 1 year median net cash flow =
About $100 million excess 95% confidence interval, 1 year net cash flow =
-$63 million to $420 million excess 99% confidence interval, 1 year net cash flow =
-$225 million to $583 million excess Very different results than interest rate “shock”
scenarios
page 29the ALMnetwork
Measuring Liquidity: final thoughts
Metrics: Measurement determines management approach Multiple metrics are of value Different approaches result in different
perspectives Disclosure
Trend is toward ever-increasing transparency, this is Basle Principle 13
GSEs have agreed to greater disclosure Equity analysts/investors need additional
disclosure due to Reg FD
