6/1/2021 - By Terry Treadwell, CPA
Throughout this COVID-19 pandemic, we have seen some unusual and unexpected Asset Liability Management (ALM) model results. Most notably, model results are showing lower Economic Value of Equity (EVE) values relative to base case book values than normal, created by the historically low levels of market interest rates. We have also observed cases where projected or actual asset growth rates are putting stress on regulatory capital ratios, creating a need to re-evaluate (and possibly lower) internal minimum capital target levels.
The following are three model areas you might want to review with your model vendor and the Asset Liability Committee (ALCO) to help you identify possible assumptions adjustments to your model.
Overall EVE to book value typically ranges between 100% and 150%. The largest drivers are the non-maturity deposit decay assumptions and the discount rates used for the present value of the deposit base. The EVE is directly impacted by the relative value of market premiums for non-maturity deposits, which typically range from 1% to 10%. We are seeing significant fluctuations in market value deposit premiums which may suggest that key deposit related assumptions warrant re-evaluation and/or adjustment. Things to consider:
A normal actual NII is typically less than a 5% variance when compared with the forecasted first year NII (using a static balance sheet). We are currently seeing more significant variations, some of which are related to PPP loans and associated fees. They may also be indicators for management to re-evaluate or adjust the key model assumptions. Things to consider:
We have gotten used to being in a stable rate environment over the past few years. The Interest Rate Risk (IRR) related to loan prepayments has been much less than the risk related to the key deposit assumptions, we are seeing some surprising impacts on model results. Things to consider:
If you have any questions about Asset Liability Management (ALM), don't hesitate to contact our Financial Institutions team.
About the Author | Terry Treadwell, CPA
Terry is a consultant in the Financial Institution Advisory Group at Saltmarsh, Cleaveland & Gund with more than 25 years of experience serving financial institutions. Her primary areas of concentration are asset/liability management including interest rate risk modeling, strategic balance sheet planning and liquidity management.
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