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Part B Covers pages 201-205

Part B Covers pages 201-205. Repricing Gap Example. Assets Liabilities Gap Cum. Gap 1-day $ 20 $ 30 $-10 $-10 >1day-3mos. 30 40 -10 -20 >3mos.-6mos. 70 85 -15 -35

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Part B Covers pages 201-205

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  1. Part B Covers pages 201-205

  2. Repricing Gap Example AssetsLiabilitiesGapCum. Gap 1-day $ 20 $ 30 $-10 $-10 >1day-3mos. 30 40 -10 -20 >3mos.-6mos. 70 85 -15 -35 >6mos.-12mos. 90 70 +20 -15 >1yr.-5yrs. 40 30 +10 -5 >5 years 10 5 +5 0

  3. Applying the Repricing Model • Example II: If we consider the cumulative 1-year gap, DNII = (CGAPone year) DR = (-$15 million)(.01) = -$150,000.

  4. Equal Rate Changes on RSAs, RSLs • Example: Suppose rates rise 1% for RSAs and RSLs. Expected annual change in NII, NII = CGAP ×  R = -$15 million × .01 = -$150,000 • With positive CGAP, rates and NII move in the same direction. • Change proportional to CGAP

  5. Unequal Changes in Rates • If changes in rates on RSAs and RSLs are not equal, the spread changes. In this case, NII = (RSA ×  RRSA ) - (RSL ×  RRSL )

  6. Repricing Gap Example AssetsLiabilitiesGapCum. Gap 1-day $ 20 $ 30 $-10 $-10 >1day-3mos. 30 40 -10 -20 >3mos.-6mos. 70 85 -15 -35 >6mos.-12mos. 90 70 +20 -15 210225 >1yr.-5yrs. 40 30 +10 -5 >5 years 10 5 +5 0

  7. Unequal Rate Change Example • Spread effect example: RSA rate rises by 1.0% and RSL rate rises by 1.0% NII =  interest revenue -  interest expense = ($210 million × 1.0%) - ($225 million × 1.0%) = $2,100,000 -$2,250,000 = -$150,000

  8. Unequal Rate Change Example Spread effect example: RSA rate rises by 1.2% and RSL rate rises by 1.0% NII =  interest revenue -  interest expense = ($210 million × 1.2%) - ($225 million × 1.0%) = $2,520,000 -$2,250,000 = $270,000

  9. Unequal Rate Change Example Spread effect example: RSA rate rises by 1.0% and RSL rate rises by 1.2% NII =  interest revenue -  interest expense = ($210 million × 1.0%) - ($225 million × 1.2%) = $2,100,000 -$2,700,000 = -$600,000

  10. Repricing Model – 1 Year Cum Gap Analysis

  11. Repricing Model – 1 Year Cum Gap Analysis

  12. Difficult Balance Sheet Items • Equity/Common Stock O/S • Ignore for repricing model, duration/maturity = 0 • Demand Deposits • Treat as 30% repricing over 5 years/duration = 5 years 70% repricing immediately/duration = 0 • Passbook Accounts • Treat as 20% repricing over 5 years/duration = 5 years 80% repricing immediately/duration = 0 • Amortizing Loans • We will bucket at final maturity, but really should be spread out in buckets as principal is repaid. Not a problem for duration/market value methods

  13. Difficult Balance Sheet Items • Prime-based loans • Adjustable rate mortgages • Put in based on adjustment date • Repricing/maturity/duration models cannot cope with life-time cap • Assets with options • Repricing model cannot cope • Duration model does not account for option • Only market value approaches have the capability to deal with options • Mortgages are most important class • Callable corporate bonds also

  14. Prime Rate Vs Fed Funds 1955-2009

  15. Prime Rate Vs Fed Funds 1997-2009

  16. Prime Rate Vs Fed Funds 2007-2009

  17. Repricing Model – 1 Year Cum Gap Analysis

  18. Repricing Model – 1 Year Cum Gap Analysis

  19. Repricing Model – 1 Year Cum Gap Analysis

  20. Repricing Model – 1 Year Cum Gap Analysis

  21. Repricing Model – 1 Year Cum Gap Analysis

  22. Comparison of 1980 Bank vs S&L

  23. Comparison of 1980 Bank vs S&L

  24. Restructuring Assets & Liabilities • The FI can restructure its assets and liabilities, on or off the balance sheet, to benefit from projected interest rate changes. • Positive gap: increase in rates increases NII • Negative gap: decrease in rates increases NII • The “simple bank” we looked at does not appear to be subject to much interest rate risk. • Let’s try restructuring for the “Simple S&L”

  25. Weaknesses of Repricing Model • Weaknesses: • Ignores market value effects and off-balance sheet (OBS) cash flows • Overaggregative • Distribution of assets & liabilities within individual buckets is not considered. Mismatches within buckets can be substantial. • Ignores effects of runoffs • Bank continuously originates and retires consumer and mortgage loans and demand deposits/passbook account balances can vary. Runoffs may be rate-sensitive.

  26. A Word About Spreads • Text example: Prime-based loans versus CD rates • What about libor-based loans versus CD rates? • What about CMT-based loans versus CD rates • What about each loan type above versus wholesale funding costs? • This is why the industry spreads all items to Treasury or LIBOR

  27. *The Maturity Model • Explicitly incorporates market value effects. • For fixed-income assets and liabilities: • Rise (fall) in interest rates leads to fall (rise) in market price. • The longer the maturity, the greater the effect of interest rate changes on market price. • Fall in value of longer-term securities increases at diminishing rate for given increase in interest rates.

  28. Maturity of Portfolio* • Maturity of portfolio of assets (liabilities) equals weighted average of maturities of individual components of the portfolio. • Principles stated on previous slide apply to portfolio as well as to individual assets or liabilities. • Typically, maturity gap, MA - ML > 0 for most banks and thrifts.

  29. *Effects of Interest Rate Changes • Size of the gap determines the size of interest rate change that would drive net worth to zero. • Immunization and effect of setting MA - ML = 0.

  30. *Maturities and Interest Rate Exposure • If MA - ML = 0, is the FI immunized? • Extreme example: Suppose liabilities consist of 1-year zero coupon bond with face value $100. Assets consist of 1-year loan, which pays back $99.99 shortly after origination, and 1¢ at the end of the year. Both have maturities of 1 year. • Not immunized, although maturity gap equals zero. • Reason: Differences in duration** **(See Chapter 9)

  31. *Maturity Model • Leverage also affects ability to eliminate interest rate risk using maturity model • Example: Assets: $100 million in one-year 10-percent bonds, funded with $90 million in one-year 10-percent deposits (and equity) Maturity gap is zero but exposure to interest rate risk is not zero.

  32. Modified Maturity Model Correct for leverage to immunize, change: MA - ML = 0 to MA – ML& E = 0 with ME = 0 (not in text)

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