Pub. 10 2019 Issue 1

Spring 2019 23 West Virginia Banker Recommendation #2: Banks would also be well served to calculate their local rate cap. Again, this analysis is not overly complex but is quite helpful in working with examiners through both the liquidity risk analysis and stress testing mitigation strategy. Now to the more complicated part of Liquidity Risk. Examiners expect banks to distinguish their funding base into the relevant Core, Non- Core, and Wholesale categories. There are a number of important nuances to consider when execut- ing on this segregation. First, and as previously mentioned, management should be prepared to share with the examiners their analysis of depos- its that exceed the local rate cap and those deposits that exceed the national rate cap. These distinctions could result in the placement of some small deposits, normally captured in the Core bucket, into the Non-core bucket. Second, management should have a developed strategy on how the bank uses technology to attract deposits, which will contribute to the determination of whether such funds are core or non-core. More importantly though, banks need to have a mechanism to distinguish which funding sources (e.g. Core, Non- Core, or Wholesale) are Stable versus Volatile. There are multiple factors that must be considered in this distinction of Stable funding, depending on whether such funds are Wholesale, Non-core or Core. The resultant calculation ultimately allows the bank to accurately assess its reliance on volatile funds to support longer term assets, an area that receives significant scrutiny in recent examinations. Recommendation #3: Using sup- portable and documented data, banks should break down their funding base (Core, Non-core, Wholesale) into Stable and Volatile categories. Recommendation #4: Banks should establish appropriate policy thresh- olds for wholesale funding, high cost deposits, municipal deposits, brokered deposits, volatile funding, etc. While the regulators have not es- tablished specific mandates, the RFI feedback shows that banks with on balance sheet liquidity in excess of 10% avoid regulatory criticism. Since this analysis removes pledged (even if unencumbered) securities from the calculation, banks should carefully assess the best strategic alternatives when collateral is required. Recommendation #5: Whenever pos- sible, banks should use the FHLB LOC product to secure municipal deposits. Recommendation #6: Since liquidity is under such intense examination scru- tiny, banks should pledge the maximum amount (as determined by its risk appe- tite statement) of their loan portfolio to the FHLB regardless of their perceived borrowing needs. The availability of the borrowing capacity is heavily scrutinized by the examiners as part of their liquidi- ty risk analysis. Interest Rate Risk with a Flattening Yield Curve Examination data suggests that regu- lators are focused on a number of risks within this category. First, and most obvi- ous, is whether Boards have appropriate- ly established acceptable risk parameters for positive and negative interest rate shocks to both 12 and 24-month Net Interest Income (NII) as well as the Eco- nomic Value of Equity (EVE). Next, and equally obvious, is whether banks are op- erating within the risk thresholds estab- lished by the Board. Remember that this analysis should initially be performed in a “static” environment, but well managed banks also must assess risks and strategic options in a “dynamic” environment. Examination scrutiny in the Sensitivity analysis tends to be focused on the key assumptions: Beta, Decay, and Prepay- ment Speeds. These assumptions need to be well documented and clearly cap- tured in ALCO committee reports and Board meetings. Recommendation #7: Banks must regularly “back test” their financial performance and establish acceptable variance metrics to assess the reasona- bleness of their key assumptions. These key assumptions should also undergo a stress test at least annually. Recommendation #8: The bank’s inter- est rate risk policy should clearly identify the bank’s risk appetite (e.g. policy limits) in balancing product duration for yield in the current flattening curve environment. Asset Quality Concerns Examiners seem to be questioning how long this economic expansion will continue and the potential impact to the quality of the loan portfolio when a downturn occurs. There is no evidence in RFI Survey results that examiners are predicting a recession, instead only raising the concern and investigating whether banks have strategically con- sidered “what if” scenarios. There is regulatory concern regarding the competitive environment for quality The resultant calculation ultimately allows the bank to accurately assess its reliance on volatile funds to support longer term assets, an area that receives significant scrutiny in recent examinations.  Bank Exam Monitor Continued on Page 24