ALCO & Fair Value Reporting: Community Bank Best practices describes how community banks can meet and exceed bank regulatory requirements for an action-oriented ALCO

1. ALCO & Fair Value Reporting:
Community Bank Best Practices, 2013
(includes sample reports)
Fred Poorman Jr., CFA, Managing Principal
Lawrence Poppert III, CPA, Managing Principal
Michael Van Zandt, CPA, Principal
mvanzandt@bankriskadvisors.com
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2. introduction
Welcome
sessions is interactive
• please ask questions
• quick introductions
• please note your title & functional
responsibilities
• what issues you would like addressed
• we will note how the co-sourced process can
help with your function
• loan example:
• map your loan rating process to market-
based approach
• quarterly updates on market spreads by
rating grades, FICO/LTVS, etc.
• stress-testing based on ratings migration,
spread/LTV/FICO changes, etc.
2

3. Introduction
Welcome
session overview
• process issues
• model inputs
• model processing
• outputs & outcomes
• available reports
• annual ALCO reporting calendar for
regulatory compliance
• view risk & return on an integrated basis
• other issues
• liquidity risk
• credit risk
• enterprise risk
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4. introducing our firm
• Market/IRR risk
• Credit risk
• Liquidity risk
• Model risk
each business
segment has:
• Principal w/ CFA or
CPA designation
• 3 of 4 have
Quantitative Director
w/ PhD and practical
experience
• Next year:
Enterprise risk
People
• Principals average 25+ years experience
• Consultants average >25+ yrs. experience in
academia, audit, bank, regulatory, software, and
on Wall Street
• Backgrounds include ”C” level bankers, CPAs,
CFA, and PhDs
Processes
• process summaries are checklist-driven prepared
by Big 4 auditor.
• detailed process documentation; i.e. 200+ pages
for ALCO reporting.
• certain processes & deliverables have been
reviewed/validated by 3rd parties.
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5. firm is moving into
proprietary analytical
products:
• Core Deposits
analyses
• Loan prepayment
analyses
• Liquidity risk
reporting, scenario
analysis, and stress
testing
• Integrated financial
risk stress-testing
meets client and
international market
needs
systems licensed
• Bloomberg for investment analytics and data
• Moody’s (formerly Markit) for structured cash flow
(CMOs & ABS) analytics.
• SAS & JMP for statistically-driven behavioral loan
and deposit analyses
• Secure, encrypted SharePoint for collaboration
and doc transfer
• ZMdesk for ALCO, Economic Capital, Fair Value,
and Credit Risk reporting and analyses, OAS-
based valuations and stochastic analyses. “Tops
down” loan stress-testing.
• ZMnet powers www.onlineALMnetwork.com a
cloud-based solution since 2006.
• Sageworks Financial for ALLL preparation,
review and validation. “Bottoms up” loan stress-
testing and concentration analysis.
5

6. firm is adding Credit
division:
• CCR engagements
• EC engagements
• Loan grading, pricing,
and FTP
• Rollout ZM credit
capabilities to more
banks
• Have Quant PhD from
DB & NYU
• Principals to be
announced upon
completion of FDIC
assignments
• Integrated financial
risk stress-testing
proprietary product in
2013
more stuff
• business mix:
• 80% mid-size banks
• Begin marketing to community and large-
size banks in Q4 2012
• 95% domestic
• FL is largest domestic market
• active in European, Mid-Eastern & Asian markets
via presentations & publications
• Proposal pipeline includes banks in
Canada, France, Holland, India,
Indonesia, Israel, and Scotland
• new website by month-end
• onlineALM processing capabilities quadrupling; in
process now
• only firm doing parallel benchmarking validation
in mid-size bank market with a “comprehensive”
ALM model
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7. different U,S.
regulators have
different views of risks
different international
regulators have
different views of risks
Basel III is attempt to
ensure comparability
on both a national and
international basis
This applies to risk and
Capital.
9 Risk types (OCC/Treasury)
• Credit risk
• Interest Rate risk (market)
• Liquidity risk
• Price risk (market)
• Foreign Currency Translation risk (market)
• Transaction risk
• Compliance risk
• Strategic risk
• Reputation risk
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8. OCC focus
D.C. relationships
Examiner training
Open & ongoing
dialogue
All-day training session earlier this month
• OCC
• Director, Market Risk
• Capital Markets Specialists from 7
regional offices
• Bank
• CEO, CFO, Treasurer, analysts
• Mortgage Bank
• CEO, VP Capital Markets, analyst
• Bank Risk Advisors
• managing principal, market risk principal,
sr. consultant
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9. why take an integrated
view?
silo risk management
ignores interactions
between risk types
may result in risk
multiplication not risk
mitigation
accurate financial
product pricing and
valuation requires an
integrated approach
• engagements begin with education and
knowledge transfer
• ongoing process
• onsite training
• in-person, teleconference and web
conference ALCO presentations and
attendance
• New ALCO charter & policy
• ongoing focus on integrated approach
• banking & mortgage banking
• risk interactions and correlations
9

10. why take an integrated
view?
silo risk management
ignores interactions
between risk types
may result in risk
multiplication not risk
mitigation
accurate financial
product pricing and
valuation requires an
integrated approach
• the traditional franchise hedge of mortgage
banking is that origination/sales & servicing
are natural value hedges
• rates increase
• origination/sales value declines
• servicing value increases
• rates decrease
• origination/sales value increases
• servicing value decreases
• an updated franchise hedge of mortgage
banking is that core deposits are natural
value hedges
• rates increase
• origination/sales value declines
• core deposit values increases
• rates decrease
• origination/sales value increases
• core deposit value decreases
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11. co-sourcing and team
approach
• Bank
• Bank Risk Advisors
• ZMFS
Bank team
• ALCO
• Finance
• Mortgage Banking
• Board
Bank Risk Advisors team for your community
bank
• Greg Driscoll, Principal
• Lawrence Poppert, Managing Principal
• Michael Van Zandt, Principal
ZMFS
• Full-featured ALM with OAS capabilities
• www.onlineALMnetwork.com
• Priced @ $25,000/yr. (included)
11

12. process issues
• model inputs
• data inputs
• granular data inputs for bank
• data inputs for mortgage bank
– monthly: some granular some
summary
– annual: all granular to validate
summary approach
12

13. process issues
• model inputs
• assumption inputs
• capital markets by Bank Risk
Advisors, reviewed by Bank
– many automated via Bloomberg
– others use third parties like Level
One for mortgage inputs
• all other assumptions by bank &
mortgage bank reviewed by Bank
Risk Advisors
13

14. process issues
• model processing
• About ZMFS
• Started as Pinehurst Analytics Liability
Management Systems (PALMS), a
spin out from Smith Breeden
– Focused on FHLBs and others
– Purchased by Fiserv in 1998
– Spun out in 2003
• ZMFS
– Z(hoa) M(iner) Financial Systems
original clients include:
» FHLBs
» Broker/Dealers
» Banks
» Fund Managers
» Bank Risk Advisors
• Have expanded market presence in
banks, Cus, broker/dealers. Fund
managers, and consultant
14

15. process issues
• model processing
• About ZMFS & Bank Risk Advisors
• Principals and staff have worked
together for 15+ years
• ALMnetwork/BRA assisted ZMFS with
production release of ZMnet
• Quantitative Director of BRA, through
his own company, wrote ZMdesk
user’s manual and validated v3.5
prepayment model
• Ongoing development and technology
partnership
• About Bank Risk Advisors’ independence
• Ongoing relationship with Fiserv since
1987
• Previous beta client of
SunGard/Bancware and others
• Ongoing relationship with Thomas Ho
Co.
15

16. process issues
• model processing
unique two-tier
architecture with:
1. ZMdesk with ALM &
Trading views
2. ZMnet, seen as
onlineALMnetwork
(2006)
• ZMnet, seen as
onlineALM (2007)
• ZMnet, others (2008-
2012), including
Corp CUs
• www.onlineALMnetwork.com
• ZMnet v3.3
• Mike, who is the best in the business
will demo the current implementation
• www.ALMnetwork.onlineALM.com
• ZMnet v3.5
– New prepayment model
– Enhanced planning capabilities
– Additional stress-testing and
sensitivity analysis functionality
• Mike will demo the new version
• ZMdesk v3.5
• “Comprehensive model” with Trading
& ALM views
• Credit functionality (PD, LGD,
transition matrices and vectors)
• Mike will demo if you wish
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17. reporting
Welcome
report notes
• proprietary ALM reports available on
SharePoint
• 100+ reports available @
www.onlineALMnetwork.com
• reviewed with Finance/Treasury and
Mortgage Banking teams
• reviewed twice with ALCO, with more to
come
• reports used as inputs for liquidity
reporting, scenario analysis, stress-
testing, and survival horizon analysis
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18. reporting
18

19. reporting
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20. Lots of summary
reporting
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21. Lots of detailed
reporting
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22. reporting pipeline
ALCO report
• 10 page summary
• 60 pages of detailed
reports
online reports
• >100 reports
quarterly Fair Value
reports
• 50 pages of process
and third party
sources
• 20 tabs of
spreadsheets for
review
Annual ALCO calendar examples
• Quarterly fair value report
• Deposit sensitivity analysis for rates and
attrition
• Prepayment sensitivity analysis
• OAS/credit stress testing
• Stochastics (100 or 1000)
• Basis risk
• Annual/quarterly/monthly back-test
• Annual budget/strategic planning
analytics
• Ad hoc analysis
• Monthly/quarterly forecast vs. static
balance sheet
• Daily rate update with re-forecast and
analysis (almost real-time ALM)
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23. People +
Process +
Systems =
Best practices at a
value price
People
• Summit NJ team from 10 years ago
• Team from community and mid-size bank
backgrounds
Process
• Documented processes provided to bank,
auditors, and regulators
• Training provided to bank personnel to
generate reports, do “what ifs”, and create
annual and strategic plans
• Scalable design, including liquidity, credit,
enterprise, and capital stress-tests
Systems
• Leading edge systems
• Cloud-based ALM modeling since 2006
• Full featured ALM model included
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