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HOW DO YOUR ALCO POLICY LIMITS, RESULTS, AND KEY DEPOSIT ASSUMPTIONS MEASURE UP?

By Greg Puritz, CPA, MBA, CGMA

Business Productivity Solutions, Inc.

Aventura, FL


October 26, 2021


“OCC Interest Rate Risk Statistics Report – Spring 2021”


The OCC recently released a new publication called the “Interest Rate Risk Statistics Report”. This is the second consecutive publication, providing data collected from its regulated banks as of March 31, 2021. The data was collected on 946 banks in its mid-size and community bank supervision area from March 31, 2019, to October 31, 2020. It is aggregated and broken down by Bank size and type, not by geographic location. The link to the publication is available here. The OCC says that this will be a semi-annual publication.


Policy Limits and Key Assumptions


Over the last 20 years, one of the most common questions I have received is “What should my limits be? Do you think the regulators will be okay with these?” If you ask a regulator, they provide a standard response that they cannot recommend limits for you. They may hint that yours are too high or low, but that’s it. Fortunately, as a consultant working with various local banks, I have seen what different banks are using, and the response they receive from their regulators, and can guide my clients to an acceptable range.


However, this is the first time we can see actual data collected from a large population of banks so we can benchmark our limits, shock results, and deposit pricing betas and lives.

So, let’s dig in and see what the results show.


Earnings at Risk

The table below shows the various results for Earnings at Risk using the standard regulatory prescribed instantaneous, parallel shocks as shown. The scenarios represent various level of interest rate changes, and the various columns represent the impact on the first twelve months of net interest income.



The scale used is typical for today’s rate environment. As rates are at near all-time lows, there are only limited rate down scenarios applicable. However, the upside shows changes up to a +400 Bps. The results represent an average of many banks for the various scenarios broken into percentiles. The Median represents that half of all banks are over and half under the reported changes. The range you should be looking at is between the Median to the 75th percentile meaning that 75% of all banks were within these changes. As you can see, the range was from -2% tin the -200 Bps scenario to 16% in the +400 Bps rate scenario. Your bank should generally be between the median and 75th percentile point for each scenario.


Economic Value of Equity


Below are the results of various scenarios on the economic value of equity (EVE). EVE is the total present value of cash flows for all assets less liabilities of the banks at the instruments current rate plus the scenario rate. It captures all lifetime cash flows as opposed to just one year of earnings and is one of the main analyses used by banks to measure interest rate risk.



Policy Limits


Below is a summary of the averages of OCC banks for policy limits used to manage earnings at risk and economic value of equity. The different ranges can be seen as aggressive (25th percentile being widest ranges used) to 75th percentile being most conservative). Earnings at Risk (12-month NII) ranges from --5% in the +/-100 bps scenario to -20% in the +400-bps scenario.

For Economic Value of Equity, the different ranges can be seen as aggressive (25th percentile being widest ranges used) to 75th percentile being most conservative). EVE for the 75th percentile ranges -10% in the -100-bps scenario to -30% in the +400-bps scenario.


THE TREASURE WITHIN!

The real nuggets in the reports are the information on repricing betas and deposit lives. These are two of the key assumptions used in modeling IRR and have a significant impact on the results. Industry data has been non-timely or non-existent for banks until now.




The OCC shows the data from its banks by percentile and for each of the main non maturity deposit categories. The average of the 75th percentile (most conservative to use) shows a repricing beta of 50% for money market, 30% for NOW and interest checking, and 30-31% for Savings. As you can see, the 25th percentile shows much smaller sensitivity to rate changes. Unless you have very strong data and results to support this, you should probably be between median and 75th percentile. Some banks erroneously use -100% for the beta in the falling rate scenarios which means they drop rates by the same amount as the rate drop, does not hold up in the real world or the study.


In South Florida, which is a large and very competitive deposit market, banks here typically use the 75th percentile or even higher repricing betas. I have seen some banks here with betas over a 100% which means that deposit rates exceeded the rate increase by the FED. It also shows how rate sensitive our market is.



Another key nugget of information are the average lives used for various non maturity deposits. The average life is the midpoint of the decay life of the deposits. That means for modeling purposes, your decay life (total time to runoff your deposits) is twice the average life. So, for money market, half of all banks in the OCC are using decay lives of 6.5 years modeling money market and 9.5 years for non-interest-bearing deposits.


These lives do seem a little long and the survey suggests that the data is not as complete. The OCC says “At the beginning of 2020, the OCC switched from collecting annual decay rates for NMDs to average lives. As a result, the number of observations of average lives is much smaller than the number of NII and EVE exposures and risk limits”. So, it is likely we may see some significant changes in these lives over the next few quarters. Using the median average life and double it, and you should be closer to the middle range of all OCC banks.


CONCLUSION


Despite this available information, don’t forget the regulators say you should conduct your own deposit study on your data to come up with both Betas and Decay rates to be used. This is just a reasonableness check on those assumptions.



About Business Productivity Solutions, Inc.

Business Productivity Solutions Inc. is a bank consulting firm founded in 2002 and located in South Florida. It specializes in providing financial and regulatory risk advisory services to the Banking industry and has 20 years’ experience in the field. Its clients include some of the top performing banks in South Florida over the last 10 years including 1st United Bank, City National Bank, Coral Gables Bank, Espirito Santo Bank, First Southern Bank, First Green Bank, Florida Community Bank, Grove Bank & Trust, US Century Bank and Professional Bank.

Its portfolio of services ranges from providing a full range of ALM services such as Independent Reviews and Validations, Deposit Studies, Prepayment Studies, and Backtesting of ALM models. BPS also provides independent validations of ALLL (Allowance for Loan and Lease Losses), interim CFO services, building and validating financial models, and strategic planning and budget support. Its founder, Gregory Puritz, holds an MBA in Finance as well as a CPA in Florida. He is a former regulator and Big Four alumni. He has over 25 years’ experience in the Financial Planning and Analysis area and implementing reporting solutions. Please visit www.bpsusa.net for more information or leave a message at 786-457-0871.

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