part b covers pages 201-205
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Part B Covers pages 201-205. Repricing Gap Example. Assets Liabilities Gap Cum. Gap 1-day $ 20 $ 30 $-10 $-10 >1day-3mos. 30 40 -10 -20 >3mos.-6mos. 70 85 -15 -35 - PowerPoint PPT PresentationTRANSCRIPT
Interest Rate Risk IInterest Rate Risk I
Chapter 8
© 2008 The McGraw-Hill Companies, Inc., All Rights Reserved.McGraw-Hill/Irwin
Part BCovers pages 201-205
8-2
Repricing Gap Example
Assets Liabilities Gap Cum. Gap
1-day $ 20 $ 30 $-10 $-10
>1day-3mos. 30 40 -10 -20
>3mos.-6mos. 70 85 -15 -35
>6mos.-12mos. 90 70 +20 -15
>1yr.-5yrs. 40 30 +10 -5
>5 years 10 5 +5 0
8-3
Applying the Repricing Model
Example II:
If we consider the cumulative 1-year gap,
NII = (CGAPone year) R = (-$15 million)(.01)
= -$150,000.
8-4
Equal Rate Changes on RSAs, RSLs
Example: Suppose rates rise 1% for RSAs and RSLs. Expected annual change in NII,
NII = CGAP × R
= -$15 million × .01
= -$150,000 With positive CGAP, rates and NII move in
the same direction. Change proportional to CGAP
8-5
Unequal Changes in Rates
If changes in rates on RSAs and RSLs are not equal, the spread changes. In this case,
NII = (RSA × RRSA ) - (RSL × RRSL )
8-6
Repricing Gap Example
Assets Liabilities Gap Cum. Gap
1-day $ 20 $ 30 $-10 $-10
>1day-3mos. 30 40 -10 -20
>3mos.-6mos. 70 85 -15 -35
>6mos.-12mos. 90 70 +20 -15
210 225
>1yr.-5yrs. 40 30 +10 -5
>5 years 10 5 +5 0
8-7
Unequal Rate Change Example
Spread effect example: RSA rate rises by 1.0% and RSL rate rises by 1.0%
NII = interest revenue - interest expense
= ($210 million × 1.0%) - ($225 million × 1.0%)
= $2,100,000 -$2,250,000 = -$150,000
8-8
Unequal Rate Change Example
Spread effect example: RSA rate rises by 1.2% and RSL rate rises by 1.0%
NII = interest revenue - interest expense
= ($210 million × 1.2%) - ($225 million × 1.0%)
= $2,520,000 -$2,250,000 = $270,000
8-9
Unequal Rate Change Example
Spread effect example: RSA rate rises by 1.0% and RSL rate rises by 1.2%
NII = interest revenue - interest expense
= ($210 million × 1.0%) - ($225 million × 1.2%)
= $2,100,000 -$2,700,000 = -$600,000
8-10
Simple Bank Repricing
Maturity Balance 0 to 1 >1
Securities 0.75 9,000 9,000
Consumer Loans 0.5 10,000 10,000
Consumer Loans 1.5 15,000 15,000
Consumer Loans 3 16,000 16,000
Prime-Based Loans 3 50,000 50,000
Total Assets 100,000 69,000
Demand Deposits - Fixed 5 15,000 15,000
Demand Deposits - Variable 0.01 35,000 35,000
CDs 0.5 30,000 30,000
CDs 0.75 5,000 5,000
CDs 2 5,000 5,000
Equity NA 10,000
Total Liabilities & NW 100,000 70,000
1 year Cum Gap -1,000
Change In Mkt Rates 1%
Change in NII -10
Chang in NII/ Assets -.01%
Repricing Model – 1 Year Cum Gap Analysis
8-11
Simple Bank Repricing
Maturity Balance 0 to 1 >1
Securities 0.75 9,000 9,000
Consumer Loans 0.5 10,000 10,000
Consumer Loans 1.5 15,000 15,000
Consumer Loans 3 16,000 16,000
Mortgage Loans 3 50,000 50,000
Total Assets 100,000 19,000
Demand Deposits - Fixed 5 15,000 15,000
Demand Deposits - Variable 0.01 35,000 35,000
CDs 0.5 30,000 30,000
CDs 0.75 5,000 5,000
CDs 2 5,000 5,000
Equity NA 10,000
Total Liabilities & NW 100,000 70,000
1 year Cum Gap -51,000
Change In Mkt Rates 1%
Change in NII -510
Chang in NII/ Assets -.51%
Repricing Model – 1 Year Cum Gap Analysis
8-12
Difficult Balance Sheet Items
Equity/Common Stock O/S Ignore for repricing model, duration/maturity = 0
Demand Deposits Treat as 30% repricing over 5 years/duration = 5 years
70% repricing immediately/duration = 0 Passbook Accounts
Treat as 20% repricing over 5 years/duration = 5 years 80% repricing immediately/duration = 0
Amortizing Loans We will bucket at final maturity, but really should be
spread out in buckets as principal is repaid. Not a problem for duration/market value methods
8-13
Difficult Balance Sheet Items
Prime-based loans Adjustable rate mortgages
Put in based on adjustment date Repricing/maturity/duration models cannot cope with
life-time cap
Assets with options Repricing model cannot cope Duration model does not account for option Only market value approaches have the capability to
deal with options Mortgages are most important class Callable corporate bonds also
8-14
Prime Rate Vs Fed Funds 1955-2009
0
5
10
15
20
25
Fed Funds Rate
Prime Rate
8-15
Prime Rate Vs Fed Funds 1997-2009
0
1
2
3
4
5
6
7
8
9
10
Fed Funds
Prime Rate
8-16
Prime Rate Vs Fed Funds 2007-2009
0
1
2
3
4
5
6
7
8
9
Fed Funds
Prime Rate
8-17
Simple Bank Repricing
Maturity Balance 0 to 1 >1
Securities 0.75 9,000 9,000
Consumer Loans 0.5 10,000 10,000
Consumer Loans 1.5 15,000 15,000
Consumer Loans 3 16,000 16,000
Prime-Based Loans 3 50,000 50,000
Total Assets 100,000 69,000
Demand Deposits - Fixed 5 15,000 15,000
Demand Deposits - Variable 0.01 35,000 35,000
CDs 0.5 30,000 30,000
CDs 0.75 5,000 5,000
CDs 2 5,000 5,000
Equity NA 10,000
Total Liabilities & NW 100,000 70,000
1 year Cum Gap -1,000
Change In Mkt Rates 2%
Change in NII -20
Chang in NII/ Assets -.02%
Repricing Model – 1 Year Cum Gap Analysis
8-18
Simple Bank Repricing
Maturity Balance 0 to 1 >1
Securities 0.75 9,000 9,000
Consumer Loans 0.5 10,000 10,000
Consumer Loans 1.5 15,000 15,000
Consumer Loans 3 16,000 16,000
Prime-Based Loans 3 50,000 50,000
Total Assets 100,000 69,000
Demand Deposits - Fixed 5 15,000 15,000
Demand Deposits - Variable 0.01 35,000 35,000
CDs 0.5 30,000 30,000
CDs 0.75 5,000 5,000
CDs 2 5,000 5,000
Equity NA 10,000
Total Liabilities & NW 100,000 70,000
1 year Cum Gap -1,000
Change In Mkt Rates 6%
Change in NII -60
Chang in NII/ Assets -.07%
Repricing Model – 1 Year Cum Gap Analysis
8-19
Repricing Model – 1 Year Cum Gap Analysis
Simple S&L Repricing
Maturity Balance 0 to 1 >1
Securities 0.75 12,000 12,000
Consumer Loans 0.5 2,000 2,000
Consumer Loans 1.5 2,000 2,000
Consumer Loans 3 2,000 2,000
Fixed Rate Mortgages 30 82,000 82,000
Total Assets 100,000 14,000
Demand Deposits - Fixed 5 0 0
NOW Accounts 0.01 20,000 20,000
CDs 0.5 61,000 61,000
CDs 0.75 10,000 10,000
CDs 2 5,000 5,000
Equity NA 4,000
Total Liabilities & NW 100,000 91,000
1 year Cum Gap -77,000
Change In Mkt Rates 1%
Change in NII -770
Chang in NII/ Assets -.77%
8-20
Repricing Model – 1 Year Cum Gap Analysis
Simple S&L Repricing
Maturity Balance 0 to 1 >1
Securities 0.75 12,000 12,000
Consumer Loans 0.5 2,000 2,000
Consumer Loans 1.5 2,000 2,000
Consumer Loans 3 2,000 2,000
Fixed Rate Mortgages 30 82,000 82,000
Total Assets 100,000 14,000
Demand Deposits - Fixed 5 0 0
NOW Accounts 0.01 20,000 20,000
CDs 0.5 61,000 61,000
CDs 0.75 10,000 10,000
CDs 2 5,000 5,000
Equity NA 4,000
Total Liabilities & NW 100,000 91,000
1 year Cum Gap -77,000
Change In Mkt Rates 2%
Change in NII -1,540
Chang in NII/ Assets -01.54%
8-21
Repricing Model – 1 Year Cum Gap Analysis
Simple S&L Repricing
Maturity Balance 0 to 1 >1
Securities 0.75 12,000 12,000
Consumer Loans 0.5 2,000 2,000
Consumer Loans 1.5 2,000 2,000
Consumer Loans 3 2,000 2,000
Fixed Rate Mortgages 30 82,000 82,000
Total Assets 100,000 14,000
Demand Deposits - Fixed 5 0 0
NOW Accounts 0.01 20,000 20,000
CDs 0.5 61,000 61,000
CDs 0.75 10,000 10,000
CDs 2 5,000 5,000
Equity NA 4,000
Total Liabilities & NW 100,000 91,000
1 year Cum Gap -77,000
Change In Mkt Rates 6%
Change in NII -4,620
Chang in NII/ Assets -4.62%
8-22
Comparison of 1980 Bank vs S&L
No Change in Rates No Change in Rates
Simple Bank Yield Balance Interest Simple S&L Yield Balance Interest
Assets 6.5% 100,000 6,500 Assets 7.0% 100,000 7,000
Liabilities 2.5% 90,000 -2,250 Liabilities 4.9% 96,000 -4,704
Equity 0 10,000 Equity 0 4,000
NII 4,250 NII 2,296
Operating Expenses -2,000 Operating Expenses -1,400
Pre-tax income 2,250 Pre-tax income 896
Taxes at 35% -788 Taxes at 35% -314
Net income 1,463 Net income 582
ROA 1.46% ROA 0.58%
ROE 14.6% ROE 14.6%
8-23
Comparison of 1980 Bank vs S&L
Rates Up 6% Rates Up 6%
Simple Bank Yield Balance Interest Simple S&L Yield Balance Interest
Assets 10.6% 100,000 10,640 Assets 7.8% 100,000 7,840
Liabilities 7.3% 90,000 -6,570 Liabilities 10.6% 96,000 -10,176
Equity 0 10,000 Equity 0 4,000
NII 4,070 NII -2,336
Operating Expenses -2,000 Operating Expenses -1,400
Pre-tax income 2,070 Pre-tax income -3,736
Taxes at 35% -725 Taxes at 35% 1,308
Net income 1,346 Net income -2,428
ROA 1.35% ROA -2.43%
ROE 13.5% ROE -60.7%
8-24
Restructuring Assets & Liabilities
The FI can restructure its assets and liabilities, on or off the balance sheet, to benefit from projected interest rate changes. Positive gap: increase in rates increases NII Negative gap: decrease in rates increases NII
The “simple bank” we looked at does not appear to be subject to much interest rate risk.
Let’s try restructuring for the “Simple S&L”
8-25
Weaknesses of Repricing Model
Weaknesses: Ignores market value effects and off-balance
sheet (OBS) cash flows Overaggregative
Distribution of assets & liabilities within individual buckets is not considered. Mismatches within buckets can be substantial.
Ignores effects of runoffs Bank continuously originates and retires consumer
and mortgage loans and demand deposits/passbook account balances can vary. Runoffs may be rate-sensitive.
8-26
A Word About Spreads
Text example: Prime-based loans versus CD rates
What about libor-based loans versus CD rates?
What about CMT-based loans versus CD rates
What about each loan type above versus wholesale funding costs?
This is why the industry spreads all items to Treasury or LIBOR
8-27
*The Maturity Model
Explicitly incorporates market value effects. For fixed-income assets and liabilities:
Rise (fall) in interest rates leads to fall (rise) in market price.
The longer the maturity, the greater the effect of interest rate changes on market price.
Fall in value of longer-term securities increases at diminishing rate for given increase in interest rates.
8-28
Maturity of Portfolio*
Maturity of portfolio of assets (liabilities) equals weighted average of maturities of individual components of the portfolio.
Principles stated on previous slide apply to portfolio as well as to individual assets or liabilities.
Typically, maturity gap, MA - ML > 0 for most banks and thrifts.
8-29
*Effects of Interest Rate Changes
Size of the gap determines the size of interest rate change that would drive net worth to zero.
Immunization and effect of setting
MA - ML = 0.
8-30
*Maturities and Interest Rate Exposure
If MA - ML = 0, is the FI immunized? Extreme example: Suppose liabilities consist of
1-year zero coupon bond with face value $100. Assets consist of 1-year loan, which pays back $99.99 shortly after origination, and 1¢ at the end of the year. Both have maturities of 1 year.
Not immunized, although maturity gap equals zero.
Reason: Differences in duration**
**(See Chapter 9)
8-31
*Maturity Model
Leverage also affects ability to eliminate interest rate risk using maturity model Example:
Assets: $100 million in one-year 10-percent bonds, funded with $90 million in one-year 10-percent deposits (and equity)
Maturity gap is zero but exposure to interest rate risk is not zero.
8-32
Modified Maturity Model
Correct for leverage
to immunize, change:
MA - ML = 0 to
MA – ML& E = 0 with ME = 0
(not in text)