Asset Liability Management Modeling in a COVID-19 World

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 Ranges 

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: 

  • Check the discount rate assumptions in the model: Frequently, yield curves are used for the deposit discount factor, such as Libor, FHLB or Treasury. In some cases, a cost of servicing factor adjustment may be included (but may no longer be relevant). Spot rates are less frequently used for discounting but may create a different value as opposed to using a curve. 
  • Check if you need to update or revisit the decay life adjustment: Non-maturity deposit growth has been significant across the board due to economic conditions and with the strategic emphasis on transaction accounts. While deposits appear to be “sticky” now, consider whether the decay lives or factors need to be updated for the bank’s current deposit gathering strategies or for possible surge balances. 

Overall Net Interest Income (NII) Base Case Forecast vs. Actual

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:

  • Back-test a short-term period: Most models forecast and report monthly results. Comparing a recent month actual vs. forecast using a rate/volume variance approach, and performing that test more frequently (perhaps quarterly) can further isolate unusual trends or results that suggest possible model adjustments. 
  • Check for forecasted loan fees (yield adjustments): We are noticing significant fluctuations in the actual vs. forecasted loan fee income levels, certainly much is related to PPP loans. However, your bank may also experience fluctuations in other loan fees, such as mortgage banking activities or loan fees related to new loan products that were not captured or contemplated in the model forecast.  
  • Check for reasonable interest rate floors: In the current low market interest rates environment, it is advisable to revisit the expectations and assumptions related to the new/reinvestment volume rates, particularly in the falling scenarios for loans, securities, and time deposits. While rate floors are applied at the individual loan model level, floors related to new /reinvestment volume tend to be overlooked and may be modeled at a default rate of 0%. Rate floors should also be considered for interest-bearing non-maturity deposits. 
  • Check for aggregation of tiered pricing deposit accounts. Some models are set up to use aggregated pricing for simplicity, but taking the time to break down deposit balances into tiered categories may refine model results.

Loan Prepayment Assumptions

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:

  • Loan prepayments tracking: Some clients have experienced significantly lower loan yields and margins than anticipated due to higher loan refinancing. If you are not tracking prepayments, we suggest you consider.  
  • Compare actual prepayments to model assumptions: If they are significantly different, evaluate the impact of higher prepayment levels. It may decrease both the base case and impact sensitivity of both NII and EVE in falling rate scenarios. 


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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