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?
- 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)
- Increasing my security portfolio’s price risk by purchasing fixed rate securities at the bottom of the interest rate cycle?
- 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…”
