ORLANDO, Fla.–CFOs here were given some reminders and best practices when it comes to stress-testing practices.
Speaking to the CUNA CFO Council, Christine Mills, managing director with MountainView McGuire Performance Solutions (which is transitioning to the name Mountainview Financial Solutions), reminded that regulatory guidance mandates the range of interest rate scenarios assessed should be sufficient to identify basis risk, yield curve risk, and embedded options.
“With the last one the key thing is we’re often not looking at a range that is sufficient enough to assess that exposure,” said Mills.
The two goals of an interest rate risk assessment are, according to Mills:
- To answer the question, Where am I exposed? “Are my assets primarily fixed with a heavy exposure to options (prepayments) and therefore exposed to rising rates?” she asked. “Are my assets longer term and priced to the long end of the curve and therefore exposed to a flattening yield curve?Mills said a credit union must ask itself if it is heavy on fixed assets whether or not its profile shows that it is liability sensitive. Or, if it has a heavy variable rate assets, does its profile show it has asset sensitivity?
- Understanding what drives assumptions. “Asset/liability analysis is riddled with assumptions,” said Mills. “What assumptions drive my IRR profile? What really moves the needle for your institution? The key here is quantify and educate. You must quantify the exposure to assumptions and educate the exposure to the ALCO.”
Mills said sensitivity testing alters key inputs/ assumptions to assess the resulting impact to results and helps to monitor the model’s sensitivity to key inputs and assumptions on an ongoing basis.
“Regulatory guidance is clear that the implications for the credit union’s IRR positions from alternative loan prepayment, core share deposit repricing or runoff (decay) values, and selected other IRR inputs need to be examined periodically,” she told the meeting.
Assumptions need to be sensitivity tested and stress tested as part of “what if” analysis, she reminded.
Mills, who has numerous bank clients, said that when it comes to assumption testing around non-maturity shares, “Bank examiners are convinced that every single bank does not have high enough betas on their deposit accounts and as soon as rates go up everyone is fleeing the market.”
But even in a rising rate environment, Mills said she believes “we’re in a new normal. I think Boomers are staying. You may need to reprice faster than you think, but there is a flight to safety.”
But that flight may take place within the institution, added Mills, as members move funds to higher paying accounts and create internal share disintermediation.
“We are approaching all-time lows right now with CDs as a percentage of total assets,” said Mills. “So if your shares were to move to CDs, replicate that, and see what it does to your profile.”