I recently finished reading a report published by Invictus Consulting Group, LLC, a bank management consulting firm located in NYC. The report touched upon 11 subject areas of interest to all bank CEOs and CFOs. I have created a three part posting to cover the critical takeaways I derived from the report.
• Part One: Regulatory, Compliance and Cybersecurity
• Part Two: Balance Sheet Risk Management
• Part Three: Board of Directors’ Topics
I encourage you to download their full report, 2016: A Regulatory Outlook. Invictus is doing some great work in the bank industry.
Part Two: Balance Sheet Risk Management
Credit Risk and Asset Quality:
• Capital requirements may increase for Commercial Real Estate (CRE) loan portfolios.
• There has been an increase in origination loan risk through underwriting exceptions and risk layering practices.
• Invictus research found 754 banks with CRE concentrations above 250 percent. Regulatory guidance suggest banks have unhealthy concentrations when CRE loans represent 300 percent of capital.
• Banks have been going out further on the yield curve and increasing the mismatch between asset and liability maturities.
• There are dangerous trends in auto lending with 30 percent of all new vehicle financing featuring maturities over six years.
Earnings and Liquidity:
• Lower interest rates are causing banks to increase asset maturities.
• The FDIC has twice updated its guidelines on brokered deposits in 2015.
• Undercapitalized banks are prohibited from accepting brokered deposits.
• Federal Reserve proposes adding investment-grade munis to bank assets needed to satisfy liquidity requirements.
• Largest four banks hold 91% of derivatives, while nearly 100% are owned by top 25 banks.
• FDIC has launched a study that looks at the challenges and opportunities for small, closely-held banks and another that looks at the structural profitability of community banks.
Interest Rate Risk:
• Keep your imbedded IRR assumptions current with basis to support it.
• Peer averages must consider the bank’s unique circumstances.
• Differentiate between rising and falling interest rate scenarios.
• Fed reveals three common IRR mistakes:
o Risk limits do not match the risk measurement tools used to quantify risk exposures.
o Failure to customize or assess vendor default or industry standard assumptions in IRR models.
o Not using independent or third-party review of IRR management programs.
• OCC determined that most banks use the economic value of equity (EVE) to measure IRR and the results ranged from a 44% loss in EVE to a 29% increase. BankBosun Note: While EVE is similar to Earning at Risk (EaR), EVE considers a much longer time horizon to allow for the mark-to-market or maturity of all assets and liabilities.
Forward-Looking Risk Analytics:
• Invictus quote: “Smart community banks are also using forward-looking analytical tools in stress testing, M&A, capital planning, interest rate risk management and AALLL calculations. Forward-looking analytical tools give banks a competitive edge but help them win high marks from examiners.”
• Fed has disclosed a pilot program to target high-risk banks.
• BankBosun Note: Invictus and others have forward-looking Risk Analytics systems and processes linked to current economic conditions as required by the forthcoming FASB ruling on CECL. Stay tuned for future BankBosun podcasts on CECL
•See Part One and Three for continued analysis of the Invictus Report.