ALCO & Fair Value Reporting:

Community Bank Best Practices, 2013

(includes sample reports)

Fred Poorman Jr., CFA, Managing Principal

Lawrence Poppert III, CPA, Managing Principal

Michael Van Zandt, CPA, Principal

mvanzandt@bankriskadvisors.com

1

introduction

Welcome

sessions is interactive

• please ask questions

• quick introductions

• please note your title & functional

responsibilities

• what issues you would like addressed

• we will note how the co-sourced process can

help with your function

• loan example:

• map your loan rating process to market-

based approach

• quarterly updates on market spreads by

rating grades, FICO/LTVS, etc.

• stress-testing based on ratings migration,

spread/LTV/FICO changes, etc.

2

Introduction

Welcome

session overview

• process issues

• model inputs

• model processing

• outputs & outcomes

• available reports

• annual ALCO reporting calendar for

regulatory compliance

• view risk & return on an integrated basis

• other issues

• liquidity risk

• credit risk

• enterprise risk

3

introducing our firm

• Market/IRR risk

• Credit risk

• Liquidity risk

• Model risk

each business

segment has:

• Principal w/ CFA or

CPA designation

• 3 of 4 have

Quantitative Director

w/ PhD and practical

experience

• Next year:

Enterprise risk

People

• Principals average 25+ years experience

• Consultants average >25+ yrs. experience in

academia, audit, bank, regulatory, software, and

on Wall Street

• Backgrounds include ”C” level bankers, CPAs,

CFA, and PhDs

Processes

• process summaries are checklist-driven prepared

by Big 4 auditor.

• detailed process documentation; i.e. 200+ pages

for ALCO reporting.

• certain processes & deliverables have been

reviewed/validated by 3rd parties.

4

firm is moving into

proprietary analytical

products:

• Core Deposits

analyses

• Loan prepayment

analyses

• Liquidity risk

reporting, scenario

analysis, and stress

testing

• Integrated financial

risk stress-testing

meets client and

international market

needs

systems licensed

• Bloomberg for investment analytics and data

• Moody’s (formerly Markit) for structured cash flow

(CMOs & ABS) analytics.

• SAS & JMP for statistically-driven behavioral loan

and deposit analyses

• Secure, encrypted SharePoint for collaboration

and doc transfer

• ZMdesk for ALCO, Economic Capital, Fair Value,

and Credit Risk reporting and analyses, OAS-

based valuations and stochastic analyses. “Tops

down” loan stress-testing.

• ZMnet powers www.onlineALMnetwork.com a

cloud-based solution since 2006.

• Sageworks Financial for ALLL preparation,

review and validation. “Bottoms up” loan stress-

testing and concentration analysis.

5

firm is adding Credit division:

• CCR engagements

• EC engagements

• Loan grading, pricing, and FTP

• Rollout ZM credit capabilities to more banks

• Have Quant PhD from DB & NYU

• Principals to be announced upon completion of FDIC assignments

• Integrated financial risk stress-testing proprietary product in 2013

more stuff

• business mix:

• 80% mid-size banks

• Begin marketing to community and large-

size banks in Q4 2012

• 95% domestic

• FL is largest domestic market

• active in European, Mid-Eastern & Asian markets

via presentations & publications

• Proposal pipeline includes banks in

Canada, France, Holland, India,

Indonesia, Israel, and Scotland

• new website by month-end

• onlineALM processing capabilities quadrupling; in

process now

• only firm doing parallel benchmarking validation

in mid-size bank market with a “comprehensive”

ALM model

6

different U,S.

regulators have

different views of risks

different international

regulators have

different views of risks

Basel III is attempt to

ensure comparability

on both a national and

international basis

This applies to risk and

Capital.

9 Risk types (OCC/Treasury)

• Credit risk

• Interest Rate risk (market)

• Liquidity risk

• Price risk (market)

• Foreign Currency Translation risk (market)

• Transaction risk

• Compliance risk

• Strategic risk

• Reputation risk

7

OCC focus

D.C. relationships

Examiner training

Open & ongoing

dialogue

All-day training session earlier this month

• OCC

• Director, Market Risk

• Capital Markets Specialists from 7

regional offices

• Bank

• CEO, CFO, Treasurer, analysts

• Mortgage Bank

• CEO, VP Capital Markets, analyst

• Bank Risk Advisors

• managing principal, market risk principal,

sr. consultant

8

why take an integrated

view?

silo risk management

ignores interactions

between risk types

may result in risk

multiplication not risk

mitigation

accurate financial

product pricing and

valuation requires an

integrated approach

• engagements begin with education and

knowledge transfer

• ongoing process

• onsite training

• in-person, teleconference and web

conference ALCO presentations and

attendance

• New ALCO charter & policy

• ongoing focus on integrated approach

• banking & mortgage banking

• risk interactions and correlations

9

why take an integrated

view?

silo risk management

ignores interactions

between risk types

may result in risk

multiplication not risk

mitigation

accurate financial

product pricing and

valuation requires an

integrated approach

• the traditional franchise hedge of mortgage

banking is that origination/sales & servicing

are natural value hedges

• rates increase

• origination/sales value declines

• servicing value increases

• rates decrease

• origination/sales value increases

• servicing value decreases

• an updated franchise hedge of mortgage

banking is that core deposits are natural

value hedges

• rates increase

• origination/sales value declines

• core deposit values increases

• rates decrease

• origination/sales value increases

• core deposit value decreases

10

co-sourcing and team

approach

• Bank

• Bank Risk Advisors

• ZMFS

Bank team

• ALCO

• Finance

• Mortgage Banking

• Board

Bank Risk Advisors team for your community

bank

• Greg Driscoll, Principal

• Lawrence Poppert, Managing Principal

• Michael Van Zandt, Principal

ZMFS

• Full-featured ALM with OAS capabilities

• www.onlineALMnetwork.com

• Priced @ $25,000/yr. (included)

11

process issues

• model inputs

• data inputs

• granular data inputs for bank

• data inputs for mortgage bank

– monthly: some granular some

summary

– annual: all granular to validate

summary approach

12

process issues

• model inputs

• assumption inputs

• capital markets by Bank Risk

Advisors, reviewed by Bank

– many automated via Bloomberg

– others use third parties like Level

One for mortgage inputs

• all other assumptions by bank &

mortgage bank reviewed by Bank

Risk Advisors

13

process issues

• model processing

• About ZMFS

• Started as Pinehurst Analytics Liability

Management Systems (PALMS), a

spin out from Smith Breeden

– Focused on FHLBs and others

– Purchased by Fiserv in 1998

– Spun out in 2003

• ZMFS

– Z(hoa) M(iner) Financial Systems

original clients include:

» FHLBs

» Broker/Dealers

» Banks

» Fund Managers

» Bank Risk Advisors

• Have expanded market presence in

banks, Cus, broker/dealers. Fund

managers, and consultant

14

process issues

• model processing

• About ZMFS & Bank Risk Advisors

• Principals and staff have worked

together for 15+ years

• ALMnetwork/BRA assisted ZMFS with

production release of ZMnet

• Quantitative Director of BRA, through

his own company, wrote ZMdesk

user’s manual and validated v3.5

prepayment model

• Ongoing development and technology

partnership

• About Bank Risk Advisors’ independence

• Ongoing relationship with Fiserv since

1987

• Previous beta client of

SunGard/Bancware and others

• Ongoing relationship with Thomas Ho

Co.

15

process issues

• model processing

unique two-tier

architecture with:

1. ZMdesk with ALM &

Trading views

2. ZMnet, seen as

onlineALMnetwork

(2006)

• ZMnet, seen as

onlineALM (2007)

• ZMnet, others (2008-

2012), including

Corp CUs

• www.onlineALMnetwork.com

• ZMnet v3.3

• Mike, who is the best in the business

will demo the current implementation

• www.ALMnetwork.onlineALM.com

• ZMnet v3.5

– New prepayment model

– Enhanced planning capabilities

– Additional stress-testing and

sensitivity analysis functionality

• Mike will demo the new version

• ZMdesk v3.5

• “Comprehensive model” with Trading

& ALM views

• Credit functionality (PD, LGD,

transition matrices and vectors)

• Mike will demo if you wish

16

reporting

Welcome

report notes

• proprietary ALM reports available on

SharePoint

• 100+ reports available @

www.onlineALMnetwork.com

• reviewed with Finance/Treasury and

Mortgage Banking teams

• reviewed twice with ALCO, with more to

come

• reports used as inputs for liquidity

reporting, scenario analysis, stress-

testing, and survival horizon analysis

17

reporting

18

reporting

19

Lots of summary

reporting

20

Lots of detailed

reporting

21

reporting pipeline

ALCO report

• 10 page summary

• 60 pages of detailed reports

online reports

• >100 reports

quarterly Fair Value reports

• 50 pages of process and third party sources

• 20 tabs of spreadsheets for review

Annual ALCO calendar examples

• Quarterly fair value report

• Deposit sensitivity analysis for rates and

attrition

• Prepayment sensitivity analysis

• OAS/credit stress testing

• Stochastics (100 or 1000)

• Basis risk

• Annual/quarterly/monthly back-test

• Annual budget/strategic planning

analytics

• Ad hoc analysis

• Monthly/quarterly forecast vs. static

balance sheet

• Daily rate update with re-forecast and

analysis (almost real-time ALM)

22

People +

Process +

Systems =

Best practices at a

value price

People

• Summit NJ team from 10 years ago

• Team from community and mid-size bank

backgrounds

Process

• Documented processes provided to bank,

auditors, and regulators

• Training provided to bank personnel to

generate reports, do “what ifs”, and create

annual and strategic plans

• Scalable design, including liquidity, credit,

enterprise, and capital stress-tests

Systems

• Leading edge systems

• Cloud-based ALM modeling since 2006

• Full featured ALM model included

23