Managing Interest Rate and Liquidity Risks in the Current Banking Environment

MANAGING INTEREST RATE RISK (IRR) AND LIQUIDITY RISK IN THE CURRENT ENVIRONMENT MATT HOBERT

MANAGING IRR & LIQUIDITY RISK Outline State of Banking Liquidity Risk Interest Rate Risk Current Environment

MANAGING IRR & LIQUIDITY RISK Objectives Gain a General Perspective on the Current Banking Environment Understand Liquidity Risk and the Impact on the Bank s Financial Condition & Profitability Understand the Importance of Monitoring and Managing Your Interest Rate Risk Position Articulate Tactical and Strategic Plans in the Current Environment

STATEOF BANKING Credit Quality Prolonged period of historically low credit costs Some cracks emerging in certain markets/ sectors Investor focus on office space and CRE Big questions around Interest Rate environment and loan resets Debt service coverage, cap rates etc. Capital Levels Banking system carrying significantly more capital than we did prior to the great recession Bank (regulatory capital levels) in general remain strong across the industry Tangible capital ratios which are impacted by unrealized losses in bond portfolios are strained across the industry Capital Markets largely closed for community banks Loan and Deposit Growth Regionally dependent- in general SC banks showing growth

STATEOF BANKING Interest Rate Environment Industry reeling from unprecedented rate of increase to the Fed funds rate Rapid increase in rates has decimated bond portfolio values, creating large increases in unrealized losses Bond portfolios are not a source of liquidity without realizing previously unrealized losses Liquidity has become strained for the industry, and bank failures have resulted Increase in rates have awoken depositors, banks have to pay up significantly to retain and grow deposits NIM and Earnings compression

LIQUIDITY RISK Liquidity Institutions ability to meet its needs for cash to fund loan and deposit outflows. Deposits are like air, I ll take all I can get -MS Bank CEO Great liquidity management often goes unnoticed. Moran

LIQUIDITY RISK Adequate Level of Liquidity Sufficient to meet the Bank s cash and collateral obligations at a reasonable cost Capable of meeting expected and unexpected cash flow requirements Ability to raise cash quickly (within 30 days), without principal loss at a reasonable cost

LIQUIDITY RISK Key Measures of Liquidity Liquidity Ratio 15%+ Loan to Deposit Ratio? What about illiquidity in the bond portfolio Cash to total Assets - 3%-5% Wholesale Funding to Total Funding (including core deposits) 15% or less

LIQUIDITY RISK Managing Liquidity Early Warning System ( Triggers ) Bank Specific Ratio Weaknesses Bank Performance Weakness External (Economic, political, etc.) Contingency Funding Plan (CFP) Liquidity Stress Testing Coordinated with CFP

LIQUIDITY RISK Common Mistakes Too much reliance on volatile funding Do not take economic changes seriously Too much reliance on backward looking measures Lack of Discipline- Willing to change indicators/measures in policy without good reason

INTEREST RATE RISK Interest Rate Risk The risk that a change in market rates will affect a financial institution s income and the market value of its assets and liabilities. Asset sensitive is where assets are repricing faster than liabilities. Liability sensitive is where liabilities are repricing faster than assets.

INTEREST RATE RISK Components of Interest Rate Risk Repricing Risk Interest rates moving up or down Basis Risk Assets correlated to different market rates than liabilities (Prime vs Libor) Yield Curve Risk Slope of the curve changing (steep, flat, inverted) Option Risk Risk that rate changes prompt changes in amount/maturity of instruments

INTEREST RATE RISK Key Measures of Interest Rate Risk Earnings at Risk The % change in net interest income (NIM) from a change in market rates. Economic Value of Equity The % change in the value of assets and liabilities due to a change in market rates Sensitivity of Key Modeling Assumptions Is the Bank more sensitive to a particular assumption relative other key assumptions?

INTEREST RATE RISK Managing Interest Rate Risk Strategic Positions Asset or Liability Sensitive Loans Fixed vs Variable Mix Cash & Investment Securities Mix & Fixed vs Variable Rates (Duration) Deposits Non-Maturity Deposits vs CDs Borrowings and Wholesale Deposits Tactical Changes - Products Asset Rates and Terms Funding Rates and Terms

INTEREST RATE RISK Key Considerations of IRR Management No single measure of interest rate risk is totally accurate Interest Rate Risk exists in more places than the Bank s NIM (Noninterest income, credit risk, liquidity risk) Process is the Key - Not the Tools Team Approach Know your Market/Customers(Pricing/Products) View multiple scenarios/forecasts

CURRENT ENVIRONMENT Strategic & Tactical Plans Regulator s Stance Loan Demand (Fixed vs Variable) Deposit Costs (Mix)

CURRENT ENVIRONMENT Strategic & Tactical Plans What do WE think interest rates will do? What does the FOMC think rates will do? What does the market think rates will do? Rates Rising- how would you manage interest rate risk? Rates falling- how would you manage interest rate risk Rates Stay the same?

WHERE ARE RATES GOING??? Source: Performance Trust, S&P Capital IQ PRO

FOMC DOT PLOT MARCH 2024

MARCH 2024 YIELDS Source: Chatham Financial

MAY 2024 YIELDS Source: Chatham Financial

REAL WORLD IRR EXAMPLES Is this bank asset or liability sensitive? What are some strategies to mitigate Interest Rate Risk for this bank? Source: Raymond James

REAL WORLD IRR HEDGING EXAMPLE Is this bank asset or liability sensitive? How much Earnings at Risk does this transaction protect Where is the interest rate risk in this transaction? Source: Raymond James

QUESTIONS?