ISGAP Management

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Transcript ISGAP Management

Interest Rate Risk Management: ISGAP

Learning Objectives

 

Define the repricing gap measure of interest rate risk.

Understand the process of ISGAP management

Managing Interest Rate Risk

 Changes in interest rates:    cause variability in net interest income (NII) and net interest margin (NIM) impact value of financial assets, liabilities, and reinvestment returns cause repricing of loans, securities, and deposits impacting NII Copyright 2014 by Diane S. Docking 3

Interest Rate Risk Management aka: ALM

  Purpose:   To Control a Bank’s Sensitivity to Changes in Market Interest Rates and Limit its Losses in its Net Income or Equity To formulate strategies and take actions that shape a bank’s balance sheet in a way that contributes to its desired goals.

  To maximize the bank’s margin or spread.

To maximize the stock value at an acceptable level of risk.

Done by an Asset/Liability Committee (ALCO)  In general, a short-run management tool:  Construct a sources and uses of funds statement.

 NIMs are controlled by this management.

Def n : Net Interest Margin & Net Interest Income

NIM

 NII

Total Earning Assets

or NIM  NII Total Assets * where:

NII



interest income



interest expense

Def n : Interest-Sensitive Assets (ISA or RSA*) 

Interest rate is subject to change/repricing within a year:

   Short-Term Securities and Loans Variable-Rate Securities and Loans Current portion of Fixed-Rate Securities and Loans to be received *Interest or Rate sensitive Copyright 2014 by Diane S. Docking 6

Def n : NON Interest-Sensitive Assets 

Interest rate is NOT subject to change/repricing within a year:

  Cash in vault Reserves at Fed**   Fixed-rate L-T loans and securities (except current portion coming due next year if know this) PP&E  Other non-earning assets: intangibles, accruals, prepaids, etc.

**Reserves at Fed currently earn 0 - .25%; began in 2008.

Def n : Interest-Sensitive Liabilities (ISL or RSL*) 

Interest rate is subject to change/repricing within a year:

    Borrowings from Money Markets Short-Term Savings Accounts** Adjustable rate Money-Market Deposits Variable-Rate Deposits *Interest or Rate sensitive **% that is “core” is not rate sensitive Copyright 2014 by Diane S. Docking 8

Def n : NON Interest-Sensitive Liabilities 

Interest rate is NOT subject to change/repricing within a year:

ISGAP



GAP = ISA - ISL

Other Interest-Sensitive Gap Measurements

To compare 2 or more banks, or track a bank over time, use the:

Relative ISGAP

ratio =

Gap$/Total Assets or

Interest Sensitivity ratio

= RSA$/$RSL$.

Example: Relative GAP Ratio

Relative GAP ratio - computes a standardized gap so you can compare different banks of different sizes.

Example: ISGAP Measures

RSA = $100 million RSL = $70 million TA = $300 million therefore: ISGAP = 100 – 70 = $ million

(positive)

Relative ISGAP = 30/300 =

% (positive)

ISRatio = 100/70 =

(> 1)

-Sensitive

Bank: Positive Dollar Interest-Sensitive Gap Positive Relative Interest-Sensitive Gap Interest Sensitivity Ratio Greater than One RSA = $100 million RSL = $140 million TA = $300 million therefore: ISGAP = 100 – 140 =

(negative)

Relative ISGAP = -40/300 =

(negative)

ISRatio = 100/140 =

million % (< 1)

-Sensitive

Measuring effect of interest rate changes The change in the dollar amount of net interest income (  NII) is: 1.

If rates on assets and liabilities move the same: $  NII = ISGAP$ (  i) 2.

Relationship Between ISGAP and Changes in NII

ISGAP + + 0 0



i + + + -



NII

Example: ISGAP Management

Solution to Example: ISGAP Management Rate-Sensitive Assets =

RSA

= ___________ Rate-Sensitive Liabs =

RSL

= __________

GAP

Solution to Example: ISGAP Management

if i

 5%  Asset Income Liability Costs ∆ NII OR = +5%  = +5%  = $1.6m



$32.0m

$49.5m

$ 2.5

∆ NII = GAP  ∆i=  $17.5m  5% = +$ 1.6m

= +$ 2.5m

=  $0.9m

= 

$0.9m

Since RSL > RSA, i



results in: NIM



, NII

Example 2: ISGAP management

Waller Bank has the following financial information: Assets: Annual Income* Cash $ 5 million T-bill securities, 90-day @6% $ 20 million T-bonds, 5 year @ 8% $ 8 million Loans, 10 year, FR @8.125% $ 80 million Other assets Total Assets $ 7 million $120 million $ 0 $ 1.20 million $ 0.64 million $ 6.50 million $ 0 . $ 8.34 million Liabilities & Equity Capital: Demand deposits, no interest $ 5 million Time deposits, 30-day @ 4% $ 90 million Time deposits, 5 year @ 6% $ 15 million Total Liabilities Total Equity Capital Annual Expense* $ 0 $ 3.60 million $ 0.90 million $110 million $ 4.50 million $ 10 million NII $ 3.84 million $120 million *Assume rollover at current rate of any S-T asset or liability.

Example 2: ISGAP management (cont.)

a) b) c) d) What is the bank’s NIM?

If interest rates rise 2% next year, what will be the NIM?

What if interest rates on assets increase only 90% the rate of liabilities?

Explain how the bank could “insulate” itself against changes in interest rates.

Solution for Example 2: ISGAP management a) NIM = NII/TA = $3.84/$120 =

_________

b) ISGAP = ISA- ISL = 20 – 90 = _________________ $  NII = ISGAP$ (  i) = -$70 million (+.02) = _____________________; therefore, New NIM assuming TA do not change = ($3.84 - $1.4)/$120 = $2.44/$120 =

_____

Solution for Example 2: ISGAP management (cont.) c) If interest rates on assets increase only 1.8% then: $  NII = RSA$ (  i A ) - RSL$ (  i L ) = [$20 (.018)] – [$90 (+.02)] =.36 – 1.8 =

_________________

New NIM assuming TA do not change = ($3.84 - $1.44)/$120 = $2.40/$120 =

_____

Solution for Example 2: ISGAP management (cont.) d) Needs to increase ______and/or decrease ______ to bring ISGAP = 0.

HOW?

Aggressive Interest-Sensitive Gap Management • If interest rates are expected to increase in the near future, the bank could • use a

positive

management.

dollar gap as an aggressive approach to gap • If interest rates are expected to decrease in the near future, the bank could • use a

negative

dollar gap (so as rate fell, bank deposit costs would fall more than bank revenues, causing profit to rise).

Expected Change in Interest Rates Rising Market Interest Rates Best Interest Sensitive Gap Position Aggressive Management’s Likely Actions ________ IS Gap Increase in ________ Decrease in _______ Falling Market Interest Rates ________ IS Gap Increase in ________ Copyright 2014 by Diane S. Docking Decrease in _______ 25

Measuring interest rate sensitivity and the dollar gap

 Incremental gaps  Measure the gaps for different maturity buckets (e.g., 0-30 days, 30-90 days, 90-180 days, and 180-365 days).

 Cumulative gaps  Add up the incremental gaps from maturity bucket to bucket.

 The total difference in dollars between those bank assets and liabilities which can be repriced over a designated time period.

Computer-Based Techniques and Maturity Buckets

Measuring interest rate sensitivity and the dollar gap

 Defensive versus aggressive asset/liability management:    Defensively guard against changes in NII (e.g., near zero gap).

Aggressively seek to increase NII in conjunction with interest rate forecasts (e.g., positive or negative gaps).

Many times some gaps are driven by market demands (e.g., borrowers want long-term loans and depositors want short term maturities.

Problems with Interest-Sensitive Gap Management 1.

Time horizon problems related to when assets and liabilities are repriced. Dollar gap assumes they are all repriced on the same day, which is not true.

     For example, a bank could have a zero 30-day gap, but with daily liabilities and 30-day assets NII would react to changes in interest rates over time.

A solution is to divide the assets and liabilities into maturity buckets (i.e., incremental gap).

Interest Rates Paid on Liabilities Tend to Move Faster than Interest Rates Earned on Assets Interest Rate Attached to Bank Assets and Liabilities Do Not Move at the Same Speed as Market Interest Rates Point at Which Some Assets and Liabilities Are Repriced is Not Easy to Identify

Problems with Interest-Sensitive Gap Management 2.

  Focus on net interest income rather than shareholder wealth.

Dollar gap may be set to increase NIM if interest rates increase, but equity values may decrease if the value of assets fall more than liabilities fall (i.e., the duration of assets is greater than the duration of liabilities).

Interest-Sensitive Gap Does Not Consider Impact of Changing Interest Rates on Equity Position 3.

Financial derivatives could be used to hedge dollar gap effects on equity values.