By Terry Treadwell, CPA
While many credit union executives are concerned with the continuing erosion of net interest margins, some are still skeptical that formalized asset/liability management and interest rate risk modeling have a practical use in the management of their institutions. But before we get into the debate of whether interest rate risk modeling has practical benefits—let me ask—when was the last time you really studied your credit union's ALM-related policies? I don't mean reading them—I mean studying them—to make sure you have a working framework for all your credit union's balance sheet management strategies.
For many community banks, I am observing the only reason ALM policies exist is because of the examiner issues that would be created if the policies weren't there. ALM policies are simply being copied and pasted from templates rather than being used to develop a working framework for balance sheet management strategies.
An effective set of ALM related policies should outline:
A. The composition of an ALM Committee. Typically, the CEO, CFO, chief lending officer, chief branch officer and head of marketing, at a minimum, should sit on an ALCO. Board members should also be invited to participate.
B. Specific items ALCO should review. Financial comparison with budget, economic conditions, real estate market, progress on previously determined strategies, liquidity position, net interest margin changes over period, current interest-rate risk exposure, interest-rate risk outlook, investment portfolio, loan and deposit pricing, wholesale funding alternatives, balance sheet and related earnings forecasts should all be under the ALCO's purview.
C. Measurement of interest-rate risk levels. Include measurements to be used as well as your established tolerance limitations. One of the most important (and useful) is net interest margin and net income variability in a shocked interest-rate environment. This will help develop an understanding of a "worst-case" scenario. Other useful measurements to benchmark are economic value of equity and asset/liability gaps.
D.
Guidelines for investments. These should include authorities and individual purchasing/sales limits, permissible investments and limits, sector limitations and required ratings where applicable, maturity requirements and approved dealers. Also address the requirements of FASB's Statement of Financial Accounting Standards 115, regarding how you classify your investments on CU financial statements.
E. Correspondent banking relationships. Include selection and termination criteria, assessment of the correspondent's capital adequacy, credit exposure limits, monitoring and auditing process.
F. Liquidity and funding oversight. Address overall funding strategy (sources of funds), liquidity guidelines, early warning indicators of liquidity risk (measurements to track), contingency funding plan, credit union wholesale/alternative borrowings lines and required liquidity reports.
Policies should also outline how often the ALCO should meet—personally, I prefer monthly. Especially if you need to work on refining your ALM processes, quarterly meetings are not often enough.
Once you have taken the time to really study your ALM policies, watch this space for my next installment. We'll look at some practical benefits of strategic modeling—how ALM can help you manage your balance sheet for improved performance.
Terry Treadwell is an associate of Stogniew and Associates, providing internal audit and consulting services to credit unions and community banks. She has over 15 years experience in ALM and can be reached via e-mail or at 727.787.7400.
Read more on ALM in this Credit Union Management magazine archive.
