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IRR 101-GUIDANCE FOR OUTSIDE DIRECTORS
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IRR 101-GUIDANCE FOR OUTSIDE DIRECTORS
Dave WicklundDirector of Educational and Advisory Services
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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
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IRR 101-GUIDANCE FOR OUTSIDE DIRECTORS
•IRR Measurement & Modeling•IRR Management Program•Questions & Comments
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IRR Measurement & Modeling•IRR Defined
•Types of IRR
•IRR Models•Gap•Earnings Simulation•Capital Valuation
•Modeling Scenarios•Yield Curve Risk Modeling
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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)
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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
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IRR Models – Gap
Rate Sensitive Assets - Rate Sensitive LiabilitiesTotal Assets
Rate Sensitive AssetsRate Sensitive Liabilities
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IRR Models - GAP
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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)
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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
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Rate
Rate
IRR Models – Earnings Simulation
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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
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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)
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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
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IRR Models – Capital Valuation
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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)
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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
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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
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Yield Curve Risk Modeling
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FF 3M 6M 1YR 2YR 3YR 5YR 10YR 30YR
Base
Up 200
Up 400
Yield Curve Risk Modeling - GPS
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Yield Curve Risk Modeling-Compass
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IRR 101-GUIDANCE FOR OUTSIDE DIRECTORS
•IRR Measurement & Modeling•IRR Management Program•Questions & Comments
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IRR Management Program
• Management Oversight and Monitoring
• IRR Measurement and Modeling
• Internal Controls
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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
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IRR Internal Controls
• Assumption Documentation and Support
• Independent Review
• Backtesting
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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
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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
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THANK YOU FOR ATTENDING
IRR 101-GUIDANCE FOR OUTSIDE DIRECTORS
Dave [email protected]
1-800-323-328130
