BAS Case Study - March 2023
Board of Directors
Page 3 June 8, 2017
Prepayment speeds for a variety of mortgage products offered by the Bank were compared to available Fannie Mae and Freddie Mac data. The assumptions utilized in the model appear reasonable. Non-maturity deposits present a problem in calculating EVE, since there is no stated maturity to use in performing the discounted cash flow analysis. Shortening or extending the implied maturity can significantly change the EVE calculation. When core deposit decay rates are too short, the Non-Maturity deposits will be under-valued from an economic value standpoint and, thus, equity will be under-valued as well. Conversely, decay rates that are too long will over value the Non-Maturity deposits and ultimately over-value the economic value of equity. Presently, the Bank's Non-Maturity deposits average life range from 2 years for money market account to 6 years for savings accounts. The Bank employed The Baker Group to conduct a regression analysis of the deposit products. The assumptions utilized in the model appear appropriate and representative of a seasoned portfolio. The primary method used to calculate EVE in the model is discounted cash flow. Fair market values (FMVs) are determined by the model based on a discounted cash flow analysis. The discount rate used is the same as the key driver rate established for each account, adjusted for the assigned spread. Regulatory requirements for model validation require some form of back-testing be conducted in order to test the validity of the model. It was noted that The Baker Group prepares a back testing model. The summary compares model projected results to Bank actual results and calculates a percentage of accuracy. The projected results vs. the actual results appear to be in close proximity. Projected vs. actual results regarding net interest income deviated by 1.7 percent. It was noted that back-testing was discussed in general terms within the Interest Rate Risk Policy. The Baker Group does an adequate job of summarizing the Bank's exposure in a variety of charts,-graphs, and narratives that accompany the reports. These allow end-users wno may not be familiar with ALM concepts to quickly understand the Bank's current risk position and review this position against internal policy parameters. All key assumptions are also clearly documented. Based on the above, the integrity of the information subject to input and the reasonableness of the assumptions applied thereto appeared reasonable. We noted the Bank's net change in NII and EVE were substantially compliant with the parameters established within the policy. Specific to the EVE, isolated instances were identified in the +400 shock in which the change exceeded policy limits. No corrective action would be considered necessary as an immediate +400 basis point shock would be considered remote.
We reviewed the ALCO Minutes for 2016 to ensure that meetings on IRR analysis were reported on a periodic basis and properly documented.
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