Have the ALCO minutes for your interest rate risk reviews started to feel a little stale? It’s important to keep in mind that even though interest rate risk analysis can seem monotonous, especially during flat interest rate environments, it’s an important monitoring task for management and the board—kind of like monitoring your own blood pressure. It’s best if things do not change too much, or too quickly, unless it’s a planned strategic shift, much like the process of working with your doctor to change the results of your blood pressure.
If you feel like your ALCO minutes have become a little repetitive, it might be time to expand and add new review topics. In addition to the primary “net interest income at risk” and “net worth at risk” results that are the mainstay of IRR analysis, consider discussing and documenting the following as part of your ALCO meetings.
The best-case scenario would be to review the entire list in this article every quarter, but this could be a little daunting for a committee to cover in one meeting. The purpose of this list is to encourage discussion, guide the ALCO members, and increase awareness of how each item affects interest rate risk. Consider this schedule as a suggestion if you are just starting to add these items to the ALCO agenda.
Quarter 1 – Loan Portfolio Review
- Current loan turnover/prepayment – Do you have in-house reporting that tracks current turnover speeds of your loans? If so, confirm the information from the report is being utilized by whoever runs your ALM reports. Watch for changes and discuss possible reasons why changes may have occurred. Slowing prepayment speeds can increase your interest rate risk in an up-rate environment. They may also be a sign of future delinquency.
- Average weighted maturities – Discuss the average weighted remaining maturities of your loan products. Again, watch for changes and trends. As an example, if you have an old loan product and you are no longer adding new loans, then the AWM will decrease over time and the ALM modeler should have this information to adjust the model accordingly.
- Market rates compared to current yield – Review how your loan yields compare to the market rates utilized in your ALM model. If your credit union does a lot of risk based lending, then the market rates should be adjusted accordingly. Because we have been in a low rate environment for such a long time, most portfolios have repriced close to market rates. There should not be much of a difference between your loan yields and the market rates and any material discrepancies should be identified and documented.
- Adequate loan classifications and identification of new loan terms – Discuss the different loan types identified in your ALM model and review how the loan products are grouped to capture various terms or repayment characteristics. Also, be aware of new loan products and new terms and discuss if they are being identified appropriately in the ALM Model. For example, if you have added a new HELOC product with terms that are substantially different than older HELOCs, it would be appropriate to review how these loans are behaving. Also, consider other possible differences, such as prepayment speeds, between direct and indirect auto loans. Take note of how loans types differ from each other.
Quarter 2 – Investment Portfolio Review
- New investment types – This one is straightforward but an important point nonetheless. If you have moved into new investment types, review whether the ALM modeler has been given all the information about the new investment such as call dates, step terms, and CUSIP numbers when available. Provide as much detail on investments as possible to the person running the analysis. It is also very important for the ALCO committee to understand how the investment products potentially react in various rate environments.
- Market values – Compare changes in investment market values. Market values from period to period can be found in your ALM reports and in most cases from your broker. Market values of Investment types can change quite a bit when interest rates change due to their maturity schedules and call or step options.
Quarter 3 – Share Accounts Review
- Betas – Review the betas and discuss whether they seem reasonable for the level of rate sensitivity expected from each share type. Betas can be calculated using industry or credit union specific data. We have both options available for our clients. Review and ask if the historical betas are in line with the current management objectives. There may have been a shift within the credit union or its membership that make the historical betas less reliable. Changes in management philosophy or objectives regarding the adjustment of deposit rates, or variation from industry data, if being used, needs to be discussed and then communicated to your ALM modeler.
- Average lives – The committee should ask if there is anything unique about, or any changes to, the credit union’s membership that might affect the average lives of deposits. The average lives of deposits may turn out to be different than estimated. Therefore, the value of modeling alternative scenarios with a range of assumptions should be prepared by the modeler, reviewed, and understood.
Quarter 4 – Other Model Assumptions and Policy Limits
- Forecasted non-interest income and expenses – Do the ALCO members understand how non-interest income and expense items are forecasted? For example, the ALMPro defaults to a 12-month look back for all non-interest income and expense items. The question then becomes, should the default calculation be overridden if there are anomalies, such as higher than expected PLL or pre-merger activity?
- Policy limits – Most credit union IRR policies call for an annual review. Also, as net interest margins continue to be pressured, policy limits that worked a few years ago, may no longer be appropriate. Discuss if policy limits for interest rate risk should be adjusted and document why or why not.
If you ask these questions as part of your ongoing ALCO meetings, document both the discussion and the results of any additional analysis. You will find your ALCO meetings are more helpful, better meet regulatory expectations, and are hopefully a little more interesting.