Modeling the Balance Sheet

Vast improvements in entry-level asset/liability modeling (ALM) software and the need to stay abreast of constantly changing interest rates have convinced more community banks to bring ALM in-house.

"Community bank ALM models have gotten a lot more capable of handling balance sheet behaviors, like prepayments of mortgages and different types of investment," said William McGuire, president and CEO of McGuire Performance Solutions, a Scottsdale, Ariz. consulting firm.

At the same time, they've become more cost effective. "There's never been a time when so much analytical capability can be put in the hands of a community banker for so little money," McGuire said. A number of highly functional systems are available in the $12,000-$20,000 range.

Those banks that understand their balance sheets have a better shot at riding out economic uncertainty. "Over the last 18 months or so, we've had a good roller coaster ride here," McGuire said. "Rates went up very quickly and went down even faster. People who don't have a quantitative handle on where their balance sheets are going are finding the future looking a little foggy."

Indeed, some banks have already seen the ALM light. An in-house A/L model is helping Tucker Federal Savings, Atlanta, not only with mandatory regulatory reporting, but for building next year's business plan and forecasting earnings. Tucker purchased it's A/L system a year ago from HNC Software, San Diego. Before that, A/L modeling was outsourced.

"It's important, when you have a complex balance sheet, to have an ALM model in-house," noted Lynn Courchaine, senior vice president, finance at $1.2 billion Tucker Federal. An in-house model helps banks customize assumptions on prepayment speeds and make better decisions, she added.

The system is being used for much more than calculating interest rate risk (IRR), Courchaine said. "The A/L model has helped us tremendously improve the business planning process and react quicker to changes in interest rates and in the economy in general."

"Every month," she continued, "there's some kind of rate cut, so we're able to go in very quickly and do some shocks tests to see what the risks are to the plan based on the interest rate environment."

The "what-ifs" are key to maximizing ROI from an asset/liability system. "Community banks benefit tremendously from the what-if scenarios and the balance sheet business plan modeling," Courchaine said. "You can model your business plan, shock your business plan, revise your business plan, more so than just the interest rate risk tests you have to do to satisfy regulators."

Through use of the model, Tucker Federal has been able to glean insights into core deposit trends for individual customers. "Our deposits were a lot longer lived than was traditionally believed, so we were able to reposition our balance sheet somewhat because we had longer funding than we originally thought," Courchaine explained.

Unfortunately, a lot of community banks don't have the resources to get the most out of an ALM system. "Community banks are still constrained on the productivity side-actually running the model and producing outputs against the right questions," McGuire said. "Not just regulatory interest-rate risk assessment, which is the most common application, but also asking what-if questions."

Those running the model often have other responsibilities, and have limited time for working in ALM. The solution is to create a checklist when first learning to run the model.

McGuire explained, "A/L models are still a specialized creature. There really is a learning curve to both running and using a model. "

Another problem is that some banks don't take the time to fully customize the assumptions for their bank, particularly on the deposit side.

"If you put good guess or generic inputs into the A/L," McGuire said, "you don't get the answer that corresponds with what the board of directors is seeing."