Subscribe via E-mail

Your email:

Echo Partners Community Bank Blog

Current Articles | RSS Feed RSS Feed

Bank Ratings and Bank Failures February 28 2014

  
  
  
  

piggy bankOn Friday February 28, the FDIC was named receiver for Vantage Point Bank (PA) and Millennium Bank (VA).

A link to our bank rating reports is shown below.

Vantage Point Bank

Millennium Bank

As is typical, an examination of the financial position of these banks indicates well below normal capital levels and generally above normal noncurrent loans. With Millennium Bank, this bank's capital has been reported as negative for some time now.

You can learn more about our bank ratings system, including video tutorials, on our website.

Photo provided by Nina Matthews Photography

Download your bank's asset liability report.

 

Community Bank Interest Rate Risk Limits

  
  
  
  

Does it matter if interest rate risk limits are symmetrical? This is actually a very common question that I get from community bankers, although usually in a slightly different context.

Here's what I often hear... If you bust a limit on the "good" or positive side is it still a problem?

For example, let's say your Earnings at Risk (EaR) or Economic Value of Equity (EVE) profile is stable to liability sensitive...like this one.

Good EVE

If you plot your EaR or EVE changes against rate shocks you will see a downward sloping line with positive changes in the "down rates" scenarios, while you have relatively flat changes in the "rates up" scenarios.

But in the rates down scenarios you are exceeding the stated policy limits.

You understand that negative changes in EaR or EVE are less desirable, but your "common sense" tells you that busting a limit on the upside (too much EaR or EVE improvement!) isn't really a problem Is this a reasonable conclusion?

Now for the answer.

This is really a trick question with 3 answers.

The first ("ivory tower" theoretical) answer is that risk is the variation from your base EaR or EVE. So, in the theoretical sense, this is still a potential problem. But as problems go, it's a high quality problem.

The second (practical) answer is that it doesn't matter since we are talking about

  • A change that results in building EaR or EVE (good for the bank) and
  • Rate scenarios that are extremely unlikely to occur with rates already near zero.

Absent some other issue, I doubt that your regulators will criticize you too harshly for positioning the bank to excessively add to EaR or EVE.

But to give yourself some cover, it might be a good idea for the board to revise your policy limits to only focus on the "negative" changes, or reductions in EaR and EVE.

That is, make your policy limits asymmetrical, limiting reductions in net interest income or EVE, but not constraining improvements.  So even if your A/L report shows symmetrical policy limits, you don't really have a policy bust at all.

That way you can avoid the real criticism for not reporting and acting on a policy limit bust at the board level.

Unfortunately, in today's regulatory environment, I must also qualify my response in its entirety by acknowledging that you could also get an examiner with an axe to grind who will somewhat unreasonably hold you to the "ivory tower" definition of risk. Hopefully that won't be the case.

Earlier I mentioned 3 answers, but I've only given you 2 so far.  So, what's the 3rd scenario?

The third answer relates to positive changes in the rates down scenarios being overwhelmed by significant EaR or EVE reductions that bust policy limits in the much more likely rates up scenarios.  Here's an example.

EVE Liability Sensitive
In this scenario, the bank really is focused on the wrong issue.  They are fiddling while Rome burns.

This bank's problems with policy limits are not related to the down rates at all.  That's simply a distraction from managing and dealing with significant up rate interest rate risk results.  

With several recent regulatory warnings on EVE risk and higher rates, I'd suggest that if your bank has a profile like this, you better get busy on some risk mitigation.

If you have banking questions that you would like to see me address, please click here and I will send you a private and personal response.

Let me know how I can help. Thanks.

Howard


Download your bank's asset liability report.

 

Bank Training Program: Interest Rate Risk and ALCO Issues (19 of 19)

  
  
  
  

Hello everyone.  Here with a another extract from the Complete ALCO Blueprint, my comprehensive bank training course.  

 

This is Howard Lothrop from Echo Partners here today to talk with you about interest rate risk ALCO considerations.  

This is a catchall topic.  It actually has a a lot practical bearing on how you get along with regulators and how you implement some of the ALCO topics we talk about.  

Here's what it boils down to.  The 2010 joint interest rate risk advisory recognizes that management and regulators, when applying the requirements of the joint interest rate risk advisory, should consider the size of the bank.  

Now it's one thing for a $45 billion bank to have a certain degree of modeling sophistication.  It's a whole other ballpark for a $100 million bank.  You should consider both.  

As management team and as regulators you should consider the nature and complexity of the activities at your bank.  

Now, if you're making simple loans, relatively short to moderate term finals, simple investment securities...  We're not going into inverse floaters or things that respond inversely to the normal interest rate risk relationships we know...  If you have a simple noncomplex bank you should be permitted by your regulator to have a simpler and less complex interest rate risk model and ALCO process.  

On the other hand, if you've got a lot of complexity in your activities, if you've got sophisticated financial derivatives hedging, if you've got other risk aspects of your bank that either by nature or complexity are much more sophisticated, then the regulator is going to ask that your ALCO process be similarly increased in sophistication.  

And all of these come under the overall limit and that is the management and regulators should consider the adequacy of your capital and earnings in relation to your overall interest rate risk profile.  

So if you have a much higher degree of capital you're much more well-capitalized that in a typical bank or have high,earnings you can justify a riskier IRR profile.  

On the other hand, if you're really just rarely meeting the minimum on your capital agreements and your earnings have been spotty we probably need to back off on the interest rate risk side a little bit.  

A lot of this when you get right down to it its banking common sense or banking 101.  

If you have any questions about this or any other topic in banking or any other topic which spoken about in this series please go to    http://echopartners.com/ask      Leave your question and I will give you a personal response.  

This is the final lesson. Lesson, number 19 in this 19 part series.  If you missed anything or want to start from the beginning sign up   http://echopartners.com/lessons        

This been an extract from my comprehensive bank training course the Complete ALCO Blueprint.  This is Howard Lothrop.  Thank you again and goodbye

Download your bank's asset liability report.

 

Bank Training Program: Risk Mitigation (18 of 19)

  
  
  
  

Hello everyone.  Thank you again for joining us here for another extract from the Complete ALCO Blueprint.  

My name is Howard Lothrop and I'm with Echo Partners.  I'm here today to talk with you about risk mitigation.  

Talked about it in earlier lessons the board is responsible for setting risk tolerance limits and management is responsible for reporting our interest rate risk results relative to those limits.  

So, what if we have a situation where the results approach or surpass the limits?  One thing you can do depending on the situation at your bank is you can revise your policy limits.  Now, if you've been keeping artificially tight limits there's no shame in hiking your limits.  It can help but understand many banks don't like to move limits up so let's move on to the next question. 

You could use balance sheet alteration.  What we're talking about here we're talking about organically changing your interest rate risk sensitivities and the way you do this is by carefully choosing your product and pricing decisions.  

Here you can focus on on more floating rate investments or loans.  You know you shorten the maturity range of your investment portfolio.  You lock in some long-term FHLB advance money.  If you do all of those sorts of nuts and bolts things with your balance sheet then you can use them to change your interest rate risk posture.  If those don't work or don't work fast enough and that's really the key because many of these balance sheet alterations take time to work it into your interest rate risk results then there's hedging.  

Hedging is where you use a financial derivative, a swap or a floor to either revise the interest rate risk sensitivity of the bank or to put a limit on it now.  

We don't have to do this -- in the guise of a financial derivative directly.  Although we can certainly do it through an FHLB advance that have some of these components embedded in it.  If you do that you have of course the FHLB as counterparty and you have no messy hedge accounting.  So there you have it.  

If you have questions please let me know    http://echopartners.com/ask   I will answer any banking questions personally.  

This is lesson 18 of our 19 part series.  If you've missed any or you want to start from the beginning get  signed up    http://echo partners.com/lessons    

Again this is an extract from my comprehensive bank training course the Complete ALCO Blueprint.  This is Howard Lothrop.  Thank you and goodbye

Download your bank's asset liability report.

 

Bank Training Program: Reporting and Limits (17 of 19)

  
  
  
  

Hello everyone.  Thank you for joining us today for another extract from the Complete ALCO Blueprint.  

My name is Howard Lothrop and I'm with Echo Partners.  I'm here today to talk with you about reporting and limits.  

In the very beginning we talked about corporate governance.  We talked about the board and the board responsibility for setting risk tolerance limits.  The board sets limits.  

Management is responsible for determining the ways to measure and monitor interest rate risk and reporting the results of your interest rate risk model relative to the board approved risk tolerance limits.  You must report these limits as well as the actual results to the board.  

Let's talk for a minute about limits versus targets.  There's a difference.  You may have a board approved limit that is wider than the actual strategic target of the bank.  That is if if we have a limit for 200 basis point rate shock a limit of 20% change in our earnings at risk, the board may actually have a target of a 10% variance or less.  

Understand the difference.  Targets are what we shoot at.  If we make them great.  If we've missed them well you know you will try better next time.  Limits are as the name sounds.  The limit that the board has imposed upon the bank.  

Bust the limit?  You better report it to the board.  Then we can talk about risk mitigation.  

You have questions, please let me know    http://echopartners.com/ask    You will get a personal response.  

This is lesson 17 in our 19 part series.  Sign-up at  http://echopartners.com/lessons    You will get the entire series extracted from the Complete ALCO Blueprint.  

This is Howard Lothrop.  Thank you and goodbye

Download your bank's asset liability report.

 

Bank Training Program: Independent Annual Review (16 of 19)

  
  
  
  

Hello everyone.  Thank you for joining us today.  This material is an extract from my comprehensive bank training course, the Complete ALCO Blueprint.

My name is Howard Lothrop and I'm the founder of Echo Partners.  We're a full-service asset liability and bank consulting firm.  

Today we'll talk about the independent annual review.    It's an important responsibility, and it's spelled out clearly in the 2010 joint advisory on interest rate risk.  The board is responsible for an annual review of the interest rate risk management strategies policies, procedures and limits of the bank.  

When you get right down to it what we're talking about here is the entire ALCO process.  

Now how does the bank perform the review? Well in certain cases you may have a sufficiently independent section of the bank.  It may do some of this or we might see an internal audit.  We may see somebody engage with a third-party.  

Here's the key.  However you do it make sure you're not just ticking and tying the numbers.  You have to evaluate the ALCO process.  You're going to need specialized asset liability help to do that.  

If you have questions go to the website   http://echopartners.com/ask   Give me a call, leave me a question and I'll give you a personal response.  

This is a 19 part series.  This was lesson 16.  To see the entire series sign-up at  http://echopartners.com/lessons    You will get the entire set of extracts from my Complete ALCO Blueprint.  

This is Howard Lothrop.  Thank you and goodbye

Download your bank's asset liability report.

 

Bank Training Program: Backtest (15 of 19)

  
  
  
  

Hello everybody.  I'm here for another extract from the Complete ALCO Blueprint.  

This is Howard Lothrop the founder of Echo Partners. I'm here today to talk with you about one of my favorite subjects, the backtest.  

Backtesting is one of my favorites because it has so many uses.  We do backtesting because our regulators require us to, but we should do it even if there it weren't for regulators because it's so helpful to us in managing the bank and in managing our model.  

But we want to look at the backtest to evaluate the effectiveness of our model in replicating the interest rate sensitivity of the bank.  How do you do this?  

Well you compare the forecast from the interest rate risk model with the actual results.  Then we take this forecast, we adjust it for known variances.  

Known variances will be things that we didn't know at the beginning of the period that would have changed our forecast.  Things like how much did the bank actually grow?  What was the actual change in the balance sheet mix and what was the actual change in interest rates?

You adjust for those known variances and come up with the adjusted forecast.  Compare it with your actual results and you are left with unknown variances as your residual.  Now unknown variances of less than 10% or that are immaterial in dollar terms typically signify a well performing model.

If you have questions about this go to  http://echopartners.com/ask    I will respond to your banking questions personally.  

This is our 19 part series on our Complete ALCO Blueprint.  This is lesson 15.  Sign up   http://echopartners.com/lessons    if you've missed any to see the entire series.  

This is an extract from the Complete ALCO Blueprint.  I'm Howard Lothrop.  Thank you and goodbye

Download your bank's asset liability report.

 

Bank Training Program: Model Validation (14 of 19)

  
  
  
  

Hello everyone.  Thank you for joining us today.  This is an extract from the Complete ALCO Blueprint, my comprehensive bank training course.  

My name is Howard Lothrop and I'm the founder of Echo Partners asset liability and bank consulting firm.  

Today we continue to dive deep into model validation.  We spoke about this in earlier lesson.  

I want to go deeper and talk about data integrity.  You need to be able to match up and control the entry of data into your interest rate risk model and the modeling process.  This is true both for GL or subsidiary ledger information as well as for the input of your assumptions.  

The next thing you need to be concerned about with model validation is the conceptual soundness of the model.  

This is a talking it through kind of thing.  When rates rise does the model provided for asset prepayments to slow? Conversely when rates rise do you perhaps see an increase in liability repricing or prepayment?  Deposits withdrawn early, or advances called?.  

The question is does the model have essential theoretical underpinnings that allow it to accurately and faithfully produce interest rate risk estimates? 

Now part of that is related to mathematical accuracy.  Note that mathematical accuracy is something that you really can't as a model user determine.  

And so what happens here is that the regulators have understood this and said that you may rely upon an independent third-party model validation opinion.  

Typically this can be provided by your model vendor.  The way this works is the vendor goes out and engages an independent third-party.  They test the model for the conceptual soundness, data integrity and the mathematical accuracy.  They provide you with a summary of the opinion.  You provide it to your auditor and to your regulator.  That's all that's involved. 

Make sure you get that third-party model validation opinion from your vendor updated regularly.  I suggest annually.  

If you have any questions please let me know.  Go to the website    http://echopartners.com/ask   I will give you a personal response.  

Again, this is our 19 part series we're up to lesson 14 at this point.  If you've missed any lessons and you want to make sure you get the entire series go to the website and sign up    http://echopartners.com/lessons

Thank you again.  This is an extract from my comprehensive bank training course the Complete ALCO Blueprint.  This is Howard Lothrop.  Thank you and goodbye

Download your bank's asset liability report.

 

Bank Ratings and Bank Failures January 31 2014

  
  
  
  

piggy bankOn Friday January 31, the FDIC was named receiver for Syringa Bank (ID).

A link to our bank rating report is shown below.

Syringa Bank

As is typical, an examination of the financial position of this bank indicates well below normal capital levels although noncurrent loans seem to have stabilized.

You can learn more about our bank ratings system, including video tutorials, on our website.

Photo provided by Nina Matthews Photography

Download your bank's asset liability report.

 

Bank Training Program: Internal Control and Validation #2 (13 of 19)

  
  
  
  

Well hello, everyone.  Thank you for being here.  Today we get another extract from the comprehensive bank training course the Complete ALCO Blueprint.  

My name is Howard Lothrop.  I'm with Echo Partners and I'm here today to speak with you about internal control and validation.  

You'll remember in an earlier lesson we talked about this in a very micro sense with respect to assumption reasonableness, assumption change log and assumption documentation.

Today we're going to step back a little bit and take a bigger picture view.  Our validation requirements really stem from OCC 2000-16 and when you think about it in terms of the regulatory history this is a seminal released from the OCC, which still rings true today even though it's been been augmented and regulators have looked at a little more stringently.  

All you need to know about validation pretty much is still in OCC 2000-16.  What it talks about in that is a model validation is validating the inputs of your model.  That is the transfer of the financial data and assumptions into the model itself.  

It talks about validating the processing of the model.  Now validating the processing of the model is typically done through a third-party independent model validation opinion.  

And then that the model has to be validated with respect to its outputs, as well as reporting and its results as used by management and the board.  

So model validation covers the entire area.  

Backtesting is a key part of the entire process.  Backtesting compares the results of your interest rate risk model to the actual results received by the bank and produced by the bank.  Backtesting gives you a way of helping to assess the degree to which your model accurately represents and models the interest rate risk sensitivity of the bank.  

And then the Board of Directors is charged with the responsibility for ensuring that there is an annual review typically called the independent annual review of the entire ALCO process.  All the board approved policies strategies and limits.  

If you have any concerns or questions about this please go to the website     http://echopartners.com/ask    I will be glad to give you a personal response.  

This is lesson 13 out of our 19 part series.  To make sure you will get the entire series sign up at      http://echopartners.com/lessons    

This has been an extract from the Complete ALCO Blueprint.  Howard Lothrop speaking.  Thank you and goodbye

Download your bank's asset liability report.

 

All Posts