Liquidity

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Liquidity Funds ManagementRegulatory
Perspectives CSBS Conference May 19, 2006

• Albert Crego
• Senior Financial Analyst
• Federal Deposit Insurance Corporation
• Washington, DC

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Agenda

• Operating Environment
• Funding Trends
• Some Caveats About Historical Metrics
• Regulatory Emphasis
• Sources and Uses of Funds
• Contingency Funding Plans

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Operating Environment
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Operating Environment
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Operating Environment
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Yield Curve Liquidity

• Flat Yield Curve Impacting NIMs
• Wells Fargo, US Bancorp, BOA Cite Flat Curve
  Impacting Operations
• Smaller Banks Impacted too

• Environment Created to Either Alter Risk
  Selection, or Enhance Efficiency ?
• Market Incentive to Alter Balance Between
  Liquidity Earnings ?

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Operating Environmentmargins

• The Average NIM for the Industry is 3.49
• 47 bps lower than the recent high in 2002 of 3.96

Source FDIC calculations from Call Report data
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Funding Trends
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Historical Liquidity Metrics

• Common Sense is not So Common.
• -Voltaire

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Historical Liquidity Metrics

• Loans to Deposits
• Net Non Core Funding Dependence Ratio
• Net Loans To Assets

• Robust enough in todays environment?

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Metrics Relevance a Function of Balance Sheet
Structure

• Amortizing Consumer Loan Portfolio
• FICOs 740-770
• WALTV 70
• Strong Asset Quality
• Predictable CF
• Funding Source Stable Retail or Wholesale with
  Similar Weighted Average Life

• Commercial loan Portfolio
• SBA Loans
• Working Capital
• FFE
• Uncertain cash flows and credit quality
• Funding Source Stable Retail Deposits

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Net Non Core Funding Dependence

• Non-core Liabilities Short Term Investment
• Long Term Assets

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Actual Calculation

• Time100M Borrowings Federal Funds
  Purchased Securities Repurchased Brokered
  Deposits (Interest-bearing balance Securities maturing 1year Federal Funds Sold Securities Purchased
  Repos) / Net Loans HTM Securities AFS
  Securities1year ORE

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Net Non Core Funding Dependence

• Most common ratio emphasized in reports of
  examination
• Definition of Core and Non Core not entirely
  aligned with current environment

• 10 year MTN
• 5 year Fixed Rate Advance
• Tiered Money Market Accounts 50M
• 99M Time Deposit

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Net Non Core Dependence Ratio Does it
Adequately Address Prudent Borrowing Strategies ?
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Net Non Core Funding Dependence

• Assets Depicted as Long Term ?
• What about Securitization
• Pool sales of even non-conforming loans
• Participations
• Loans Pledged as Borrowings

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Net Non-core Funding Dependency Ratio Breakdown
by Liquidity Rating
Source FDIC
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Loan to Deposit Ratio Breakdown by Liquidity
Rating
Source FDIC
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A Caveat - Static Balance Sheet Measures

• May mask Liquidity Risk under Normal and Adverse
  Business Conditions
• Should not be Sole Measures Used to Monitor and
  Manage Risk

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Source FDIC
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Regulatory Emphasis on Liquidity

• Assessment of Financial Institutions Liquidity
  Position Includes Following
• Current and Prospective Sources of Liquidity
  Versus Funding Needs
• Effectiveness of Management to Identify, Measure,
  Monitor, and Control Risk, Including Contingency
  Funding Plans

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Uniform Financial Institutions Rating System
(UFIRS)

• Liquidity rating based upon, but not limited to,
  an assessment of the following evaluation
  factors     The adequacy of liquidity sources
  compared to present and future needs and the
  ability of the institution to meet liquidity
  needs without adversely affecting its operations
  or condition.

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Uniform Financial Institutions Rating System
(UFIRS)

• The capability of management to properly
  identify, measure, monitor, and control the
  institution's liquidity position, including the
  effectiveness of funds management strategies,
  liquidity policies, management information
  systems, and contingency funding plans.

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Sources and Uses of Funds

• Proforma cash flow statements entails analyzing
  cash flows under normal and adverse business
  conditions.
• Understand the nature of your funding sources and
  uses within context of your business model.

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Contingency Funding Plans

• In preparing for battle I have always found that
  plans are useless, but planning is
  indispensable.
• Dwight D. Eisenhower

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CFPs

• Objective
• Help Ensure Sources of Liquidity are Sufficient
  to Fund Operations Meet Maturing Obligations
• Identifies Funding Gaps During Stress Scenario
  Specifies Steps to Take
• Planning Framework Possibility that Actual
  Needs Differ From Expectations

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CFPs - Promote Diversification of Funding
Retail and Wholesale

• Well Managed Wholesale Funding Strategies
• Promote Diversification of Sources
• Facilitates ability to meet liquidity needs
• Ameliorate Challenges of Attracting Core in
  Todays Market Environment

• But.Require Diligent Risk Management
• CREDIT SENSITIVE
• AVAILABILITY
• MARKET SHIFTS

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Availability of Funding

• Wholesale Funds Providers are Credit Sensitive
  Includes FHLB
• FHLB Imposes Credit Limits Monitors Financial
  Condition
• Generally limited to 30 of Assets
• Over 30 requires CAMELS 1 or 2
• Asset Quality Component 1 or 2
• Limit will generally not exceed 50
• Special Limits for Convertible Advances

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Market Shifts, Type of Funding, Liquidity
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Market Shifts, Type of Funding, Liquidity

• REPOS

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Market Shifts, Type of Funding, Liquidity

• REPOS -
• Duration and Price Sensitivity of Securities
  Matters Because of Maintenance Margin
• dP - modified duration x dy
• p
• Modified Duration Example Bond has duration
  10.6 yields increase from 9 to 9.5, change of
  0.0050 or 50 bps approx percentage change in
  price will be -10.6 (0.0050) -0.053 or -5.3
• Source Frank J. Fabozzi

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What Stress Events ?

• Transcends small community banks and large
  regional and complex institutions
• Plausible Events
• CAMELS DOWNGRADE
• PCA CAPITAL DOWNGRADE
• FORMAL ORDER
• LARGE DEPOSITOR WITHDRAWALS
• REPUTATIONAL/LEGAL RISKS BSA
• EARNINGS RESTATEMENT
• GOING CONCERN CLAUSE
• RATINGS DG BY NRSRO

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Stress Events Advances

• Remember Access has limits and remains a
  function of Credit Risk

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Stress Events Advances

• More on Availability -

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CFP - Specimen

• SAMPLE BANK CONTINGENCY FUNDING PLAN
• SHORT TERM FUNDING CRISIS
• LONG TERM FUNDING CRISIS
• Actions During a Moderate Risk Situation
• Responsibilities of Officers
• http//www.clevelandfed.org/crm/DISWIN/docs/Sample
  20Community20Bank20Contingency20Funding20Plan
  .doc

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Summary

• Liquidity is not an easily defined metric
• Risk Management Framework Needs to ID Risk
• Sources and Uses -/- CFPs are Integral
• Funds Providers are Credit Sensitive
• When You need it Most it May not Be Available
• Planning is Key