7 Reports Your ALM Model Can Provide to Manage Changes Ahead

Chris Acker
September 14, 2020
Read Time: min

What kind of reports can your ALM model provide?

I’m often asked by asset/liability management professionals for advice on using ALM models to generate reports that provide meaningful information to aid in managing the financial institution. What types of reports would be most helpful to run, and why? In this document I will talk through which reports can be the most help and why.

A balance sheet and an income statement certainly provide information. But what happens in a different rate environment? What happens when interest rates are changing and the institution’s prepayment speeds also change? What happens to the financial institution’s interest margin, the balance sheet and ultimately, what happens to net income as these changes unfold?

Impacts of changes can be tough to discern

While reports using immediate and permanent rate shock fill a regulatory need, they are not very useful or don’t provide much insight for the bank or credit union. Rates change over time and not all rates move by the same amount or in some case in the same direction, and their impact on the balance sheet, income statement, and economic value of equity (EVE) can be difficult to discern.

For example, if an institution has a $1 million bottom line in a flat-rate environment and interest rates run up 20 or 30 bp over the course of a year, will I see what’s happening if I run a one-year forecast? Not really. I need the ability to look out two or three years to see what the full impact of those rate changes might be. What if the rates moved differently than this? I need the ability to run a forecast that shows what would happen in multiple environments with different interest rate changes and different shapes of yield curves so that no matter how interest rates unfold there is a level of comfort that the results will be within the different rate environments that have been run. 

Another example of how a balance sheet and income statement alone are insufficient to provide helpful insight would be the impact of Paycheck Protection Program loans on financial institutions. Banks and credit unions are making those loans and collecting the fees, but those PPP loans are not impacting those financial institutions much right now. But if those loans are not forgiven, wouldn’t it be helpful to see the impact on the income statement and balance sheet?

Several reports in your ALM model can provide valuable insight that will help assess the impact of changes before they hit the balance sheet or income statement. An institution can use these reports to give the management and board results by making adjustments in their business plan to ward off big hits in their bottom line and to seize opportunities competitors might miss.

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Set up ALM model reports once; use them monthly

Once any of these reports has been set up in your ALM model, using it each month is easy and reduces the chance that a setting may get missed or changed. Here are seven useful reports and the insight they’ll provide:
  1. Income statement run under multiple rate environments over a two- or three-year time horizon. This will allow you to see the impact on the interest margin and net income as the rate environments unravel over time. These rate environments need to include not only immediate and permanent rate shocks, but gradual and non-parallel rate scenarios as well.
  2. Forecast yield report. This will show how the yields on the interest-bearing assets and liabilities are moving under the different rate movements. There would also be some other ratios running down to return on assets (ROA), so this would be helpful for showing the impacts of the rate changes.
  3. Net interest income volatility. The result in this report will show comparisons of the net interest income under different rate environments. It will be clear where potential issues might arise and under what type of rate shocks, allowing management to look at possible adjustments to help mitigate them.
  4. Forecast ratio analysis. This report will show how different ratios, yields, and funding costs are performing over a scenario under a rate environment. The types of ratios shown include:
  • profitability (net interest margin, non-interest margin, ROA, ROE)
  • balance sheet (loans/assets, loans/deposits, and deposits/assets)
  • capital ratios (book capital/assets, Tier 1 risk based capital, Tier 1 leverage capital, and total risk based capital)
This is very helpful when running what-if scenarios changing the balance sheet mix or under different rate environments.
  1. Forecast income statement decision matrix. Much like the net interest income volatility report, this report runs the entire income statement under multiple rate environments for comparisons of each account line in the income statement. Also like that report, this one would help point out where issues might arise and under what kind of rate movement.
  2. Current market value. This report takes your current position and runs a mark-to-market analysis of each account in the chart under immediate and permanent rates. It will show the value of each account with its current cash flows and interest rates vs. what the market is indicating the current rates are in the market; they are shocked up and down by the immediate and permanent rates selected. When complete, the report shows what the impact would be to the institution’s equity position in each environment. It will allow an institution to identify potential issues and provide an opportunity to adjust the business plan accordingly.
  3. Forecast market value report. Running a forecast market value report allows you to see the impact of various influences over time. This report could show the impact of changes to your business plan on the balance sheet and the total equity position over time – out three months, six months, one year or two years. Those impacts might include prepayment slowdowns or changing interest rates on certificates, loans, and non-maturity deposits.  A forecast market value report can help management and the board see if changes in a strategy could be of benefit to the institution. This is an excellent tool to run multiple strategies to see if the institution would perform better or worse, given the changes in the strategy.
As mentioned earlier, once you set up these reports in your ALM model, it’s easy to use them each month. And with these reports, a financial institution will be better prepared to face the changing times ahead. It will have the ability to test strategies to see what changes could benefit the bank or credit union as the future continues to change. Do your competitors have that advantage?
About the Author

Chris Acker

Chris has more than 35 years of financial industry experience, starting in banking. As a Senior Advisor at Abrigo, he consults with clients on interest rate risk and other ALM concerns in an effort to make the ALCO processes more effective. Chris helps clients develop workable strategies and risk management processes to improve financial performance, regulatory compliance, and overall solutions to their business challenges. At Farin, now part of Abrigo, Chris assisted in the development of proprietary ALM simulation models, SAM and Foresight, which are used by more than 600 financial institutions. He has also developed educational programs on asset/liability management for major banking industry schools and conferences across the United States. Chris serves on the faculty of the Graduate School of Banking at the University of Wisconsin-Madison and has served as faculty at the Credit Union National Association (CUNA) Management School in Madison, Wisconsin.

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