Bank Exam Prep

As LSU’s football players take time out of their BCS Championship preparations to cram for finals (we need them to make their grades so we can beat Alabama again), please take some time to prepare for the liquidity discussions that are likely to occur during your next exam.

The March 2010 Interagency Policy Statement on Funding And Liquidity Risk Management reiterated the importance of cash flow projections, diversified funding sources, stress testing, a cushion of liquid assets, and a formal contingency funding plan as primary tools for measuring and managing liquidity risk.  Here are a few ways that you can use your APC reports to show examiners that you are following their guidance.  (Before using any of these answers, be sure the facts are appropriate for your institution.)

Examiner Question:  Have you stratified the bank’s liquidity / identified the bank’s cushion of liquid assets?
APC Solution:  We designed a Forward Liquidity Model in Excel that identifies the types of on-balance sheet liquidity and segregates them into relatively homogeneous pools (“Cash and Cash Equivalents”, “Liquidity Cushion” and “Other”).  This spreadsheet, which is designed to be maintained by bank personnel on a monthly or quarterly basis, identifies the bank’s liquidity pools and projects the bank’s future liquidity position.  The second page of the Forward Liquidity Model uses the current liquidity volume and projections of future cash flows to estimate the bank’s liquidity over the next year.

Examiner Question:  How do you analyze the bank’s future liquidity position?  Have you developed cash flow projections (sources and uses of funds model)?
APC Solution:  The spreadsheet allows bank personnel to make monthly projections of cash flows for all major balance sheet categories (loans, illiquid assets, deposits, borrowings, capital) to project the net liquidity over the next twelve months.  Cash flows into or out of the securities portfolio are not included in the model, as all securities are assumed to be liquid and would not impact the bank’s liquidity position.
Bank’s Response:  This is the model (hand over most recent report) that [bank employee] uses to identify our on-balance sheet sources of liquidity and project liquidity over the coming year.

Examiner Question:  Tell me about your methods for ensuring diversified funding sources…
APC Solutions:  The Deposit Distribution by Type graph on page four of the standard monthly report set shows that you monitor deposit mix on a monthly basis.  The CD and FHLB repricing schedules (included in the last 15 pages of the standard report set) show the tenor (remaining maturity) of funding.  The Nonmaturity Deposit Rate Projections report (page 10) show your consideration of the behavior of nonmaturity deposits.  Our standard Liquidity and Funds Management Policy discusses sources of funding and sets limits on various types of nontraditional funding.
Bank’s Response:  We have several reports (point to appropriate pages in the APC monthly report set) that provide insights into funding diversity and behavior.  In addition to local deposits, we consider FHLB advances, Qwickrate / National CD Rateline funding and brokered deposits as important tools in ensuring a diversity of source and tenor of funding.  Our Funds Management Policy provides guidance on the appropriate use of each nontraditional funding source.  We also consider the bank’s interest rate risk position when determining which funding sources to pursue.

Examiner Question:  Do you have a formalized contingency funding plan (stressed liquidity model)?
APC Solution:  Our standard Liquidity and Funds Management Policy has an entire section dedicated to contingency funding.

Examiner Questions:  Do you stress test your liquidity?  Do you have a contingent funding model?
APC Solution:  We have developed a simple stress model that shows the sources available to fund rapid deposit runoff.  Using Call Report information, we run this report quarterly.
Bank’s Response:  Our Liquidity Policy addresses contingency funding.  (Be sure to read this section of the policy before you discuss it).  This model (hand over most recent report) shows how we could fund up to $X million of rapid deposit runoff using a variety of funding sources, including excess cash and overnight funds, liquid securities (that can be sold, pledged or REPO’ed), Fed Fund / Discount Window / FHLB borrowing capacity and loan sales.  We also have the capacity to raise funds through Qwickrate / National CD Rateline.

As you cram for your next exam, please call or email if there is anything we can do to help.  You have lots of important things to do and lots of customers to care for.  So do we!  You are our customer, and one of our most important tasks is making your exam experience as good as possible.

Economic Value of Equity Model

Many of you have heard my soapbox speech about the foolishness of Economic Value of Equity calculations and models. I have recent reports of examiners who acknowledge the minimal value of the models but fall back on the “Washington says we have to check and see if you have one” line. In most examinations, it appears that EVE is a “check the box” issue. If you have an EVE report, the examiners don’t take the time to see what it says or how it was calculated. They are happy to be able to mark it off their list and move on to other tasks.

We have been working on an EVE report worthy of the APC logo, and I think we have come up with
a viable product. I plan to introduce it using September 2011 data and make it a quarterly or annual report (your preference). We will have most of the necessary data in our files but will need a new securities report that provides shocked market values. We will be calling soon to request the data and give you information on acquiring it from your portfolio accounting firm.

Bank Policies

There are a few field examiners in our area (the gulf south) who have become enamored with reviewing bank policies. In addition to checking the “big three” policies (Loan, Liquidity and Interest Rate Risk), they are reviewing (somewhat randomly) the following: Capital Plan / Policy, Dividend Policy, Transactions with Affiliates Policy, Management Continuity / Succession Policy and Expense Reimbursement Policy. If you don’t have one or more of these on your policy bookshelf, you should adopt one before the next “friendly visit”. We will gladly share samples of some of these policies, so don’t feel like you have to reinvent the wheel or buy a policy from a vendor.

We have made several subtle changes in recent months to our Liquidity and IRR policies to reflect examiner comments and revisions to our reports. If you haven’t updated these two policies in a while, please let us know and we will send you our current templates.

FDIC Insurance Assessment Invoices

The FDIC sent out second quarter assessment worksheets and invoices this week. This is the first invoice based on the lower rate schedule effective April 1. For those of you in Risk Category I (most CAMELS 1 and 2 institutions), your base annual assessment rate dropped from 12 basis points to 5 basis points (a 59% reduction). The assessment base shifted from Total Deposits (as of the Call Report date) to Average Total Assets less Average Tangible Equity.

The net result for most banks in Risk Category I is a 40-45% expense reduction. If you have not adjusted your daily or monthly accruals in a while, you may be overaccrued. If so, give me a call and let’s talk about a couple of options for making the adjustments.

Rest in Peace, Regulation Q

I hope you all took time out of your day on Thursday to celebrate the one year anniversary of Dodd-Frank.  On this day, the CFPB spread its wings and Regulation Q was repealed.  The Durbin Amendment was also scheduled to kick in, but the actual implementation of interchange fee reform has been pushed to October 1.

Over the last few months, the most frequently asked question in my client meetings has been something akin to “What are your other banks doing about commercial interest account pricing?”.

My answer:  Most community banks are asking this question but are waiting to see what the big banks do before any major product rollout.

Thursday morning, as I drove to the office, I heard a new Capital One add on the radio.  They were promoting their new business checking product.  Capital One business customers in all their markets except Louisiana can earn a promotional rate of 1.10% for the first year, but all those loyal Hibernia customers in Louisiana who stuck around after the acquisition only earn 0.50%.  I guess that when you already have the state’s largest deposit market share (20% of total LA deposits as of June 2010), you don’t have to pay up for deposits.

As with most highly promoted products, there are lots of strings attached to this account.  In case you don’t want to read the fine print on Capital One’s website, here are the details:

• 25 transactions per month required to earn promotional rate (default rate is 0.05%)
• Promotional rate only applies to balances between $10,000 and $100,000.  
• All other funds earn a tiered promotional rate of 0.05% to 0.50% (0.05% to 0.25% in LA)
• $8.00 monthly maintenance fee if you don’t maintain an average daily balance of $10,000
• Transactions over 300 per month are charged $0.17 each
• Existing customers must deposit $10,000 of new money within 30 days or promotional rates disappear

I haven’t seen any other big banks roll out an aggressive product, yet.  If you have, please send details and I will begin compiling a list for future dissemination.  In the meantime, be sure you have some sort of product to offer if asked, and make sure your front line team members know about it.

Static Gap - What a Waste of Paper!

We continue to get reports from clients about examiners who are overly concerned about Static GAP measures in banks that are asset sensitive.  The typical Report of Examination comment sounds something like this:

The bank is highly asset sensitive over the next 12 months, with rate sensitive assets exceeding rate sensitive liabilities by $30MM, resulting in a positive gap of 1.85, well above policy parameters of 0.50 to 1.50.  In addition, policy limits are overly broad and should be revisited by the board.

If you hear such a comment during an exam, or if you want to head off an examiner before he writes such a comment in his report, try this line of logic:

Our bank’s Static GAP (refer to the RSA / RSL @ One Year Horizon lines on page seven of your monthly APC report set) is between 1.52 and 1.85, depending on the optionality assumptions applied to our securities portfolio.  I understand that these numbers seem high relative to examiner expectations and our policy limits, BUT…

Static GAP is an imprecise measurement that looks at a single date in time, 365 days in the future, and does not consider the timing of asset and liability repricing between now and then.  We prefer to use a more accurate measurement (APC’s Interest Margin Sensitivity Report) that looks at monthly changes over the same one year period and measures the results in a variety of ways (refer to the Summary of IMSA Results box at the bottom of page eight).  We are also at a unique point in the history of interest rate risk, where the potential for material rate decreases is very tiny.  We are comfortable with a large positive GAP, as it should result in stronger earnings when rates rise.

If the examiner continues to fixate on Static GAP, consider this angle:

My ALCO and my board understand that we could reduce our GAP position in several ways, but we are not comfortable with any of them.  Which of the following would you recommend, in light of the current economic situation?

1. Making fixed rate loans with longer maturities at the bottom of the interest rate cycle?  (decreasing liquidity and possibly taking excess credit risk to acquire the loans)
2. Increasing my security portfolio’s price risk by purchasing fixed rate securities at the bottom of the interest rate cycle?  
3. Encouraging customers to shorten their CD maturities such that I will have to reprice them sooner if rates rise?

When responding to examiner concerns, please don’t say “we’ll change our limits” or “we’ll lower our GAP” unless you fully understand the implications.  Instead, say something like “I’ll bring your concerns to ALCO and the board”.  Once the examiner writes “President Johnson committed to tighten the bank’s GAP limits”, it’s hard to do anything but comply, even if that’s not what you said.

I’ll close this commentary with two final stabs at the adequacy of Static GAP calculations:

• Barron’s Banking Dictionary notes: “By itself, interest rate gap is an imprecise measurement…”
• Investopedia explains: “Simple static gaps are inherently imprecise measurements…”

Don’t take my word for it – the Internet says it’s true!