IRR 101-GUIDANCE FOR OUTSIDE · PDF fileIRR 101-GUIDANCE FOR OUTSIDE DIRECTORS ... Interest...

IRR 101-GUIDANCE FOR OUTSIDE DIRECTORS

To Connect to the Conference Call: 1-888-394-8197, Access Code 775629

Problems Connecting? Call Plansmith:1.800.323.3281, ask for Danielle

1

IRR 101-GUIDANCE FOR OUTSIDE DIRECTORS

Dave WicklundDirector of Educational and Advisory Services

dwicklund@plansmith.com

2

Plansmith•BankersGPS

•Call Report Data•Updated Quarterly•Web-based System

•Financial Compass•Instrument-level Inputs•Monthly Updates•Client-hosted Software

•Budget Compass•Educational and Advisory Services

3

IRR 101-GUIDANCE FOR OUTSIDE DIRECTORS

•IRR Measurement & Modeling•IRR Management Program•Questions & Comments

4

IRR Measurement & Modeling•IRR Defined

•Types of IRR

•IRR Models•Gap•Earnings Simulation•Capital Valuation

•Modeling Scenarios•Yield Curve Risk Modeling

5

IRR DefinedInterest Rate Risk is the risk that ________ interest rates adversely impact both short-term ________ AND the bank’s longer-term _________ ________.

Low Probability/High Impact Events (Fat Tails)

6

IRR Defined – Types of IRR

INTEREST RATE RISK

Repricing Risk

Assets and liabilities repricing at different

times

Yield Curve Risk

Assets and liability repricing tied to

different points on the yield curve

Option Risk

Changes in the timing of asset and liability cash

flows

Basis Risk

Asset and liabilities price off of different indexes

7

IRR Models – Gap

Rate Sensitive Assets - Rate Sensitive LiabilitiesTotal Assets

Rate Sensitive AssetsRate Sensitive Liabilities

8

IRR Models - GAP

9

IRR Models – Earnings Simulation

Also Known as:•Earnings at Risk (EAR)•Income Simulation•Net Interest Margin Shock•Sensitivity of Earnings (SOE)•Interest Rate Sensitivity Analysis (IRSA)

10

IRR Models – Earnings Simulation

•Nine Separate Income Statements-400 -300 -200 -100 Base +100 +200 +300 +400

•RSA X = Interest IncomeRSL X = (Interest Expense)

Net Interest Income

RSA=Rate Sensitive AssetRSL=Rate Sensitive Liability

11

Rate

Rate

IRR Models – Earnings Simulation

12

IRR Models – Earnings Simulation

Strengths:•Results are easy to understand (change in NII) •Measures how the bank will perform over time•Captures more types of IRR than gap

Weaknesses:•More time and resources to produce than gap•Highly assumption dependent

13

IRR Models – Capital Valuation

Known as:•Market Value Equity (MVE) •Economic Value of Equity (EVE)•Fair Value of Equity (FVE)•Present Value of Equity (PVE)•Market Value of Portfolio Equity (MVPE)•Net Portfolio Value (NPV)

14

IRR Models – Capital Valuation•Nine Separate Balance Sheets

-400 -300 -200 -100 Base +100 +200 +300 +400•Balance sheet values determined using discounting cash

flowsPresent Value of Assets

Less: (Present Value of Liabilities)Present Value of Equity

•Compare each scenario’s shocked VE with Base VE toget % Δ EVE

15

IRR Models – Capital Valuation

16

IRR Models – Capital Valuation

Strengths:• Good for trend analysis regarding how long-term risk

position changes over time• Can be related directly to an “unrealized” loss number• Can capture multiple types of IRR

Weaknesses:• Standard EVE provides inaccurate valuation of embedded

options and may understate risk• May be misunderstood because it is not “actionable” • Subjectivity in key model assumptions (prepmts/NMDs)

17

Modeling Scenarios

•Static/No-Growth (NOT Dynamic/Budget) •Immediate/Shock (NOT Ramp/Gradual Rate Changes)•Material Stress Levels (parallel up to +/-400 bps)•12 AND 24-Month Simulation Periods•Non-Parallel Changes in Market Rates

18

IRR Modeling Principles•IRR Defined

•Types of IRR

•IRR Models•Gap•Earnings Simulation•Capital Valuation

•Modeling Scenarios

•Yield Curve Risk Modeling19

Yield Curve Risk Modeling(Risk from changes in the slope of the yield curve)

•Short, medium, and long-term rates often changeby different amounts •Infinite potential shifts •Many IRR models only assume parallel shifts

20

Yield Curve Risk Modeling

21

0

1

2

3

4

5

6

7

8

9

FF 3M 6M 1YR 2YR 3YR 5YR 10YR 30YR

Base

Up 200

Up 400

Yield Curve Risk Modeling - GPS

22

Yield Curve Risk Modeling-Compass

23

IRR 101-GUIDANCE FOR OUTSIDE DIRECTORS

•IRR Measurement & Modeling•IRR Management Program•Questions & Comments

24

IRR Management Program

• Management Oversight and Monitoring

• IRR Measurement and Modeling

• Internal Controls

25

IRR Management Oversight

• Board and ALCO Reporting/Monitoring

• IRR Policy

• Provide Authorization

• Establish Measurement System and Limits

• Detail Options to Manage IRR

• Require Independent Review

26

IRR Internal Controls

• Assumption Documentation and Support

• Independent Review

• Backtesting

27

Plansmith’s Educational & Advisory Services• Model Assumption and Scenario Assessment/Development• Policy & CFP Assessment/Development• ALCO Assistance/Participation• Independent Review• Backtesting• Board and/or Senior Management Training• Capital Planning and Stress Testing• Examination Support• IRR and Liquidity Management Webinar Series

28

Summary/Questions

• Measurement & Modeling• Risk to Short-term Earnings & Long-term Capital

• Measurements - Gap, EAR, & EVE

• Scenarios

• Management Oversight• Educated Board and Engaged Management

• Policies and Controls

29

THANK YOU FOR ATTENDING

IRR 101-GUIDANCE FOR OUTSIDE DIRECTORS

Dave Wicklunddwicklund@plansmith.com

1-800-323-328130