Asset Liabilities ALM

8/3/2019 Asset Liabilities ALM

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Chapter 4

Asset-Liability Management

(ALM)Required Readings: Peter S.Rose, Chapter 6, 7, 8


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Chapter Contents ALMs purpose

How interest rate risk impact banks income?

Interest rate risk: GAP and using GAP to

measure interest rate risk to banks income

Using Duration forALM


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Asset-Liability Management

Whats ALM?


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Yield to Maturity (YTM)

!

!n

1tt

t

YTM)(1

CFPriceMarket


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Bank Discount Rate (DR)

MaturitytoDays#

360*

FV

PricePurchase-FVDR!

Trong : FV equals Face Value


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Conversion of DR into YTM YTM equivalent yield =

(100 purchase price)/Purchase Price *

(365/days to maturity)


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Example Suppose, a 100$ security is now sold on the

market at price of $96 with days to maturity

of 90 days. Whats DR, the YTM equivalent yield?


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Example DR = (100 96)/100 * 360/90 = 0.16

Equivalent YTM = (100 96)/96 *365/90 =

0.1690

Actual YTM =

PV = -96, FV = 100, N = 90/365, I = ?

I = 18%


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Thu nhp t li rng (NII) v Thu nhp

t li cn bin (NIM)

exp

as

Interestincome Interest ensesNIMTotalearning sets

!

NII: Net interest income


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Interest Rate Risk

Price Risk

When Interest Rates Rise, the Market

Value of the Bond orAsset Falls

Reinvestment Risk

When Interest Rates Fall, the Coupon

Payments on the Bond are Reinvested at

Lower Rates


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Interest Rate Risk:

Reinvestment Rate Risk If interest rates change, the bank will have to

reinvest the cash flows from assets or refinance

rolled-over liabilities at a different interest rate inthe future.

An increase in rates, ceteris paribus, increases a banks

interest income but also increases the banks interestexpense.

Static GAPAnalysis considers the impact ofchanging rates on the banks net interest income.


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Interest Rate Risk:

Price Risk If interest rates change, the market values of

assets and liabilities also change.

The longer is duration, the larger is the change invalue for a given change in interest rates.

Duration GAP considers the impact of

changing rates on the market value of equity.


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Interest Rate Risk Banks typically focus on either:

Net interest income or

The market value of stockholders' equity

GAPAnalysis A static measure of risk that is commonly associated with

net interest income (margin) targeting

Earnings Sensitivity Analysis Earnings sensitivity analysis extends GAP analysis by

focusing on changes in bank earnings due to changes ininterest rates and balance sheet composition


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Rate sensitive Asset/Liabilities (RSAs

vs RSLs) and Non rate sensitive (NRS) RSAs/ RSLs are assets or liabilities whose interest return or

cost vary with interest rate movements over the same timehorizon. E.g; short term securities.

RSAt Rate Sensitive Assets

Those assets that will mature or reprice in a given time period (t)

RSLt Rate Sensitive Liabilities

Those liabilities that will mature or reprice in a given time period (t)

Non rate sensitive (NRS) are assets or liabilities whoseinterest return or cost vary with interest rate movements overthe same time horizon. E.g; Vault cash


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What Determines Rate Sensitivity? An asset or liability is considered rate sensitivity if

during the time interval:

It matures It represents and interim, or partial, principal payment

It can be repriced

The interest rate applied to the outstanding principal changes

contractually during the interval

The outstanding principal can be repriced when some base rate

of index changes and management expects the base rate / index

to change during the interval


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Example on RSAs/RSLs

Assets Liabilities

1. Short term consumer loans (1 year

maturity) 50 Equity Capital (Fixed) 20

2. Long term consumer loans (2 year

maturity) 25 Demand deposits 40

3.Three-month Treasury Bills 30 Passbook savings 30

4. Six-month Treasury Notes 35 Three month CDs 40

5. Three year Treasury Bonds 70

Three month Banker

acceptances 20

6. 10 year, fixed rate mortgages 20 Six month CP 60

7. 30 year, floating rate mortgages

(rate adjusted every nine months)

40One year time deposits 20

Two year time deposits 40

270 270

Within 1 year, Determine the RSAs =? RSLs = ? Hows about NRS for assets and liabilities?


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Interest rate GAP/ Dollar GAP/

Funding GAP/Maturity GAP) GAP = RSAs RSLs

Cummulative GAP(CGAP): measures the

difference between RSA

and RSL over a more

extended period

( ) ( )i i i i i iNII GAP R RSA RSL R( ! ( ! (

( )i i NII CGAP R( ! (


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Example on Interest sensitive GAP

Days

Assets maturing

or Repricing

within

Liabilities

maturing

or Repricing

within

Increme

ntal

Gap

Cummul

ative

Gap

1 day 20 30 -10 -102-30 days 30 40 -10 -20

31-90 days 70 85 -15 -35

91-180 days 90 70 20 -15

181-365 40 30 10 -5

1 year -5

years 10 5 5 0

260 260


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Example A bank makes a $10,000 four-year car loan to a

customer at fixed rate of 8.5%. The bank initially funds

the car loan with a one-year $10,000 CD at a cost of

4.5%. The banks initial spread is 4%.

What is the banks one year gap?

4 year Car Loan 8.50%

1 Year CD 4.50%

4.00%


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Example Traditional Static GAPAnalysis

What is the banks 1-year GAP with the auto

loan? RSA1yr= $0

RSL1yr = $10,000

GAP1yr= $0 - $10,000 = -$10,000

The banks one year funding GAP is -10,000

If interest rates rise (fall) in 1 year, the banks margin will

fall (rise)


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Other Gap Measurements

Relative

Interest-

Sensitive Gap SizeBank

GapISDollar!

Interest

SensitivityRatio

sLiabilitieSensitiveInterest

AssetsSensitiveInterest

!


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Asset-Sensitive Bank Has:

Positive Dollar Interest-Sensitive Gap

Positive Relative Interest-Sensitive Gap

Interest Sensitivity Ratio GreaterThan

One


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Liability Sensitive Bank Has:

Negative Dollar Interest-Sensitive Gap

Negative Relative Interest-Sensitive Gap

Interest Sensitivity Ratio Less Than One


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Factors Affecting Net Interest

Income Changes in the level of interest rates

Changes in the composition of assets and

liabilities

Changes in the volume of earning assets and

interest-bearing liabilities outstanding

Changes in the relationship between the yieldson earning assets and rates paid on interest-

bearing liabilities


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Example Consider the following balance sheet:

Assets Yield Liabilities Cost

Rate sensitive 500$ 8.0% 600$ 4.0%Fixed rate 350$ 11.0% 220$ 6.0%

Non earning 150$ 100$

920$

Equity

80$

Total 1,000$ 1,000$

GAP = 500 - 600 = -100

NII = (0.08 x 500 + 0.11 x 350) - (0.04 x 600 + 0.06 x 220)

NIM = 41.3 / 850 = 4.86%

NII = 78.5 - 37.2 = 41.3

Expected Balance Sheet for Hypothetical Bank


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Examine the impact of the following

changes A 1% increase in the level of all short-term

rates?

A 1% decrease in the spread between assetsyields and interest costs such that the rate on

RSAs increases to 8.5% and the rate on RSLs

increase to 5.5%? A proportionate doubling in size of the bank?


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1% increase in short-term ratesAssets Yield Liabilities Cost

Rate sensitive 500$ 9.0% 600$ 5.0%

Fixed rate 350$ 11.0% 220$ 6.0%

Non earning 150$ 100$

920$

Equity

80$

Total 1,000$ 1,000$

GAP = 500 - 600 = -100

NII = (0.09 x 500 + 0.11 x 350) - (0.05 x 600 + 0.06 x 220)

NIM = 40.3 / 850 = 4.74%

NII = 83.5 - 43.2 = 40.3


With a negative GAP, more

liabilities than assets reprice

higher; hence NII and NIM fall


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1% decrease in the spreadAssets Yield Liabilities Cost

Rate sensitive 500$ 8.5% 600$ 5.5%

Fixed rate 350$ 11.0% 220$ 6.0%

Non earning 150$ 100$920$

Equity

80$

Total 1,000$ 1,000$

GAP = 500 - 600 = -100

NII = (0.085 x 500 + 0.11 x 350) - (0.055 x 600 + 0.06 x 220)

NIM = 34.8 / 850 = 4.09%

NII = 81 - 46.2 = 34.8


NII and NIM fall (rise) with a

decrease (increase) in the

spread.

Why the larger change?


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Proportionate doubling in sizeAssets Yield Liabilities Cost

Rate sensitive 1,000$ 8.0% 1,200$ 4.0%

Fixed rate 700$ 11.0% 440$ 6.0%

Non earning 300$ 200$1,840$

Equity

160$

Total 2,000$ 2,000$

GAP = 1000 - 1200 = -200

NII = (0.08 x 1000 + 0.11 x 700) - (0.04 x 1200 + 0.06 x 440)

NIM = 82.6 / 1700 = 4.86%

NII = 157 - 74.4 = 82.6


NII and GAP double, but NIM

stays the same.

What has happened to risk?


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RSAs increase to $540 while fixed-rate assets decrease to$310 and RSLs decrease to $560 while fixed-rateliabilities increase to $260

Assets Yield Liabilities Cost

Rate sensitive 540$ 8.0% 560$ 4.0%

Fixed rate 310$ 11.0% 260$ 6.0%Non earning 150$ 100$

920$

Equity

80$

Total 1,000$ 1,000$

GAP = 540 - 560 = -20

NII = (0.08 x 540 + 0.11 x 310) - (0.04 x 560 + 0.06 x 260)

NIM = 39.3 / 850 = 4.62%

NII = 77.3 - 38 = 39.3


Although the banks GAP

(and hence risk) is lower,

NII is also lower.


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Changes in Portfolio Composition and

Risk To reduce risk, a bank with a negative GAP

would try to increase RSAs (variable rate

loans or shorter maturities on loans andinvestments) and decrease RSLs (issue

relatively more longer-term CDs and fewer

fed funds purchased)

Changes in portfolio composition also raise or

lower interest income and expense based on

the type of change


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Summary of GAP and the Change

in NII

GAP

Change in

Interest

Income

Change in

Interest

Income

Change in

Interest

Expense

Change in

Net Interest

Income

Positive Increase Increase > Increase IncreasePositive Decrease Decrease > Decrease Decrease

Negative Increase Increase < Increase Decrease

Negative Decrease Decrease < Decrease Increase

Zero Increase Increase = Increase NoneZero Decrease Decrease = Decrease None

GAP Summary


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Exercise on IS GAP, NIIAssets Liabilities and Equities

Rate sensitive 200 (12%)

Non rate sensitive 400 (11%) Non earning 100

Total 700

Rate sensitive 300 (6%)

Non rate sensitive 300 (5%)Equity 100

Total 700

Q: Determining the GAP? Net interest income? Net interest margin? How

much will net interest income change if interest rates fall by 2%?

What changes in portfolio composition would you recommend to management

if you expected interest rates to increase?


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Three problems with IS GAP Time Horizon

Market value effects

Focus on Net interest income


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Duration GAP analysis What is Duration and its measurement?

Networth of the bank (NW)

Duration GAP and hedging interest rate riskwith duration

Weaknesses of duration GAP


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Duration and its measurement

1

1

*

(1 )

(1 )

n

tt

n

tt

ExpectedCF t

YTMD

ExpectedCFYTM

!

!

!

A loan with annual interest

payment @10% for 5 years,

the loan principal is $1000.

What is the Duration of theloan if the current market price

is $1000?

How is the loan price vary if

the interest rates increase by

1%?

1

P iDx

P i

( (!


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Net Worth of the bank

NW A L!

NW A L( ! ( (


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Duration GAP Duration GAP =

Duration of asset

portfolio Duration of

bank liabilities

The bank tries to

manage duration gap

approaching zero Positive duration gap

Negative duration gap

1

n

i

Durationofeachassetxmarketvalue

AssetportfolioDurationTotalmarketvalueofallassets

!!


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Weaknesses of duration GAP?

Documents

Asset Liabilities ALM