No One Way To Manage A Balance Sheet. No Such Thing As A Bad Loan.

Callahan’s chief analyst shares his takeaways from ALM First’s Financial Forum.

 
 

On the second day of ALM First’s Financial Forum in San Diego this week, I had the opportunity to attend five sessions throughout the day. Similar to ALM First’s winter conference, the sessions for day two were divided into two tracks, with one geared towards board members and the other tailored to finance executives.

I elected to attend sessions in the finance track, and as a result, enjoyed a deep dive into a range of asset liability management topics, covering specifics such as “Pillars of High Performing Institutions” and “Applications of Hedging Strategies”.

 

 

Optimizing Balance Sheet Performance Through A Quantitative Lens

The presenters in the “Pillars” session reinforced how high-performing institutions consistently optimize balance sheet performance, use a quantitative lens (note: no emotions allowed) to evaluate opportunities. High performers also have systems and processes in place to enable their institutions to capitalize on opportunities in a timely and efficient manner. Key to the session was a thoughtful argument to the notion that excess capital, while nice to have, can be a costly and an inefficient result of mismanaged resources.

Understanding Relative Risk In Pricing Decisions

A discussion around product pricing was particularly relevant. In a changing market, institutions need to ensure they understand the components of asset yields and are adjusting their pricing decisions to maximize the aggregate value of their assets. One way to do this is through an ROE calculator which computes the relative return for the risk assumed on a product specific basis. Inherent to this concept is the idea that there are no such thing as bad loans, just bad rates which don’t adequately account for the risks of that product and in turn can lead to poor performance in a sale situation (think: declining indirect margins and participation sale losses).

There are no such thing as bad loans, just bad rates which don’t adequately account for the risks of that product and in turn can lead to poor performance in a sale situation.

Investment Portfolio Management

In the second half of the morning I attended the presentation “Managing the Balance Sheet”. Things got started with an introduction to the concept of portfolio management within an asset liability management framework. In simple terms, investment strategies should be developed in relation to the risk profile of the broader balance sheet, and the cultivation of a fixed income portfolio should be done in a manner which matches — or extinguishes — the duration of an institution’s liabilities.

Related to this concept is how institutions select investments. The session presented the concepts of opportunity cost in asset selection (foregone benefit) and alternative values (holistic benefits), in explaining the need to consider the balance sheet from multiple perspectives. On one hand, finance professionals must understand the marginal value — and risk — of an asset, while they also should view the balance sheet in aggregate and be aware of how this value can shift depending on the construction of the assets and liabilities selected.

Managing Risk Through Hedging Strategies

The final session of the day, “Applications of Hedging Strategies”, was a crash course in the use of hedging in a risk management framework. Key to this concept was that risk is not something to be avoided, but rather, managed using a combination of analytics, education, and a soundly vetted process. As someone with a limited technical background in derivatives, I found the material to be surprisingly digestible and logical. We started with an overview of hedging and differentiating different types of hedges, and their subsequent applications, including interest rate swaps, options (caps & floors), and treasury futures.

No One-Size-Fits-All Approach

As the event wrapped up, attendees walked away with a plethora of insights and strategies imparted on them over the last three days. Of note, the message I left with was that there isn’t just one way to manage a balance sheet, nor should there be as every institution has different needs, goals, and capabilities. However, the adoption and implementation of a sound risk management framework, paired with careful analytical consideration to asset selection based on risk-adjusted spreads and post-selection review, will better position credit unions for success.

Also read: "Deposit Repricing, Liquidity, And Other Challenges Ahead"

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Sept. 20, 2018


Comments

 
 
 
  • Well written Sam!
    Anonymous