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ALCO Update

ALCO Update. ALM in the Current Economic and Regulatory Environment. May 9, 2012. Mark Haberland , Managing Director. mhaberland@darlingconsulting.com. Agenda/Outline. Banking Industry Environment & Implications for Strategy Development Balance Sheet Management

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ALCO Update

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  1. ALCO Update ALM in the Current Economic and Regulatory Environment May 9, 2012 Mark Haberland, Managing Director mhaberland@darlingconsulting.com

  2. Agenda/Outline • Banking Industry Environment & Implications for Strategy Development • Balance Sheet Management Strategies For Challenging Times • Regulatory Advisories on Liquidity & Interest Rate Risk (Update From “The Field”) • Best Practices • Q & A

  3. Current Environment: Regulatory • Despite Advocacy Efforts, Tough Exams Prevail…. • Making Difficult to Work with Borrowers w/o Major Write-downs (Disincentive) • Negative Towards “Wholesale Funding” • Dislike Certain Business Strategies • Mixed Messages Between Agencies • Documentation, Documentation, Documentation …

  4. Current Environment: Regulatory Regulator’s “Perfect Bank”

  5. Bank Earnings: Risk/Return Risks • Credit • Rate Risk • Liquidity Risk • Leverage Return = Net Interest Income

  6. Current Environment: Political • Mixed Messages Continue • Dodd – Frank Bill • 300 – 600 New Regulations? • No Deadlines Met • Anti-Business Environment • Gridlock? (e.g. Budget Cuts vs. Taxes) • “Politics” Impeding Progress

  7. Current Environment: Economic Outlook UNCERTAINTY Creating Strong Head Winds??? • Sustained High Unemployment • Inflation: Fact or Fiction? When? • State/Municipal Financial Issues • Real Estate Uncertainties • Residential • Commercial • Global “Issues” • Etc. Result: Weak Loan Demand in Most Markets and Irrational Pricing

  8. Current Environment: Rate Outlook • Interest Rates: Tale of Two Worlds • Short Rates (Fed between Rock & Hard Place) • On Record: Low Until Mid-2013 • Longer-Term Rates: Volatility • Long End: Likely Steepen (a lot?) Before Fed Tightens

  9. Current Impact on Banks • Pressure on Gross Revenues • Weak loan demand • Unattractive investment yields • “Parked” cash building for many • Fee income down • Pressure on Cost of Funds • Can’t get below zero • Potential for rate sensitivity and disintermediation • Regulatory dislike of “non-core” funding • Pressure on Expenses • Regulation/Compliance/Documentation

  10. Some Likely Outcomes • Higher Cost of “Doing Business”(Regulation/Supervision/FASB) • Higher Cost of Liquidity • Higher Capital Requirements (and cost) • Slower Growth / Less Leverage • Lower Returns on Invested Capital • Difficulty Attracting Capital Continued Consolidation

  11. Industry Dynamics Will Change • Lower Returns/Profits • 11-12% ROE the “New 15%” • Fewer, Larger Banks • Mergers of Small Banks • More “Consumerism” • Less Consumer Choice? • More Expensive Services?

  12. So, What IS a Banker to Do???

  13. Viable Strategies …How You Look! Depend Upon….

  14. Strategy/Business Development: 1st Step MUST Create Clarity • Capital • Asset Quality • Liquidity • Interest Rate Risk • Earnings

  15. Strategies: Navigating Through the Current Environment • Liquidity Issues • Deposits • Lending • Investments • Rate Risk Management • Capital Planning

  16. Banks “AWASH in LIQUIDITY” …And No End in Sight !

  17. Deposit Growth Funding Shortfalls - a “Norm” in Economic Growth Periods • September 11 • Tech/Mkt crash • Internet • Recession Source: HighlineFI *Through June 2011

  18. Deposit Strategy • ALL BANKS Have Deposits That WILL LEAVE!!!! • Whom Are You Attracting…or Holding Onto? • How do you know? • At What Cost? Better the “Devil You Know?”

  19. Too Much Cash “Invest” or Must Reduce Cost! • Impact on Strategy? • Deposits • Lending • Investments • Overhead Reduction

  20. Reducing Cost of Funds • Prepare Marginal Cost of Funds • Quantify/Model Results

  21. Marginal Cost of Funds

  22. Deposit Pricing in Perspective • $90 million in NOW @ 0.10% 0.01% • $265 million in Savings @ 0.20% 0.10% • $150 million in MMDA @ 0.75% 0.55% 13bp Average Cost Relief = $646,000 (e.g. 9bp,10bp,20bp respectively) Better than reaching for yield?

  23. Issue: EVERYONE Wants Deposits Is “Cost of Funds Management” (e.g. Lowering Deposit Rates) INCONSISTENT with a “Deposit Growth Strategy??”

  24. Deposit Strategy • Franchise Value (CORE Deposits) • Profitable Relationship Focus • Targeted Customers/Markets • Cost of Funds Management

  25. Meaningful Sales Culture: A Necessity • Must Become More “Retail-Oriented” • Customer Knowledge • Market Knowledge • Product Knowledge

  26. Deposits: Other Thoughts • Early Withdrawal Penalties are Very Important in Current Environment

  27. Loan Pricing Trends…

  28. Loan Discussion Items • Fixed Rate Pricing Strategy (e.g. CRE) • Competition…tighter spreads for “best credits” • Using Swap Curve as “frame of reference”

  29. Fixed Rate Pricing in Perspective

  30. Fixed Rate Commitments in Perspective 27bp x 5 Years = 135bp cost to hedge exposure to “naked” commitment

  31. What Customer Wants, Customer Gets!?! Most Borrowers Want Fixed Rate (5-10 Yrs) You Must Be Willing To Accommodate

  32. Lending Strategies • Term Funding • “Back-to-Back” Swaps Depends on Current Risk Position

  33. CRE: Strategic Issue • Implications if “High” CRE Concentration Relative to Capital Levels • Q: What Do You Do?

  34. Loan Discussion Items • C&I Lending Pressures • Floors (Levels) Declining • Spreads Tightening • Libor-based Pricing Note: Widen spreads relative to floors

  35. Loan Discussion Items • Residential Lending • Portfolio vs. Sale Strategy • Conforming vs. Non-Conforming • Consumer Lending • HELOC • Auto

  36. Lending: Not a Game of Chance • Underwriting Discipline • Pricing for RISK • Importance of “Total Relationship” vs. Simply “Getting the Loan” • A Source of Non-Interest Income

  37. Investment Strategy Cash, Low yield Agencies, Corporates, Munis or High Premium MBS? Determining the Lesser of Evils…

  38. Investment Strategy • The “Value” of Current Earnings? • Collateral Requirements?

  39. Investments: All About the Cash Flow

  40. Investment Considerations • Amortizing Cash Flow • Limited Extension Risk • Minimize “Binary” Cash Flow Extremes (e.g. short callables w/ long maturities) • Appetite for Credit Risk ? • Floaters • CMOs?: impact of caps • SBA?: premium risk • Fixed to Floaters?

  41. DELEVERAGE: Risk-Return • Security Sales…What DO With Cash? Buy Securities Again? • Pay Down Borrowings/Brokered? • Drive Out Higher Cost Funding...Especially “Fair Weather Friend” Money? • Prepay Fixed Rate Borrowings? • Impact on Earnings?

  42. Deleverage: Cost-Benefit

  43. Investments: Don’t Get “Trapped” …When Rates Rise • Price Risk: Impact on Capital • Tangible Capital • Importance of Cash Flow to Fund Loan Growth & Likely Deposit Outflows

  44. Interest Rate Risk Liability Sensitive

  45. Underestimating Exposure? Deposit Assumptions

  46. “Insurance” Issues • Important Q: How Much Do I Need? • Should I Extend Funding “Now?” • Record Low Rates…But, How Long Rates Remain Low? • Margins are Declining and 2012 is Not Looking Better… • Can I Afford Not To? “Coulda, Shoulda, Woulda” • Would Like to, but Don’t Have Any Short Term Borrowings

  47. “Insurance” Choices • The CD Myth…Not a Viable Solution Without Stiff Early Withdrawal Penalties • If No S-T Borrowings…Drive Out Higher Cost Funding (Especially “Fair Weather Friend” Money) • Replace with Term Funding (at no cost?): MIN 5 years, Longer Better • Structured Funding? (e.g. “Knockouts” at FHLB) • If Have S-T Borrowings Pay for Extension by Lowering Deposit Rates • Restructure Advances? • Horse May Already Be Out of Barn…EXPENSIVE • Swaps (and Caps) Increasingly Important • Accounting Issues • Counterparty Risk • Regulatory Concerns

  48. 5 Yr. Funding Extension: Cost-Benefit

  49. Relative Cost of Fixed Rate Funding

  50. “Insurance” Choices (continued) • Floating Rate Lending Opportunities • Role of Interest Rate Swaps in Lending: Revisit • Floating Rate Investments • Rising Rate Readiness Strategies for Deposits

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