Make the ALCO Process Meaningful, Not a Checkbox!

We are fortunate enough to work with many community banks in several states.  We lead or participate in ALCO meetings almost every single day and are constantly working with bankers to prepare and respond to examiner’s very detailed questions.  While helping bankers meet their regulatory requirements is satisfying, it is far more rewarding to help bankers efficiently manage their banks.

It is somewhat ironic that most prospective clients have a sizeable checklist that an ALM model must meet, including explicit methodology to measure many forms of Interest Rate Risk (IRR).  Yet, almost inevitably, many clients (there are some outstanding exceptions) fall into the routine of checking the boxes on their ALCO laundry list (primarily IRR guidelines) and moving on, far short of actively managing the balance sheet.

Our model (as do most) creates a literal “treasure trove” of data that can easily form the basis of both long and short term strategies to increase both spread and margin.  In short, the data should be used to manage the banks pricing and positioning on both sides of the balance sheet.  This active management, as you know, requires focus and commitment along with the belief that your bank’s balance sheet is a product of management and not just an institution created by responses to competition.

The most effective ALCO meetings are those that have the authority to determine and implement strategies including pricing decisions.  Secondly, an ALCO should be in the “moment” and use the latest relevant information available, not a strategy put together by the budgeting committee last fall.  Finally, someone should monitor previous strategies closely and be keenly aware of current pricing and balances.  In short, an effective ALCO should have the following components:

  1.  Authority:  The ALCO should have the authority to make balance sheet decisions.  As elementary as it sounds, the ALCO should not just discuss “possible strategies” but have the ability to implement real change.
  2. Pricing Power:  The most effective ALCO’s have the ability to price various products as well as the ability to implement specific strategies.  The “pricing” committee, if any, should be a part of the ALCO.  In fact, the pricing committee should be the ALCO.
  3. Scorekeeper:  The ALCO should have someone assigned to monitor previous strategies and report on their “effectiveness.”  The decision to enhance or scrap a strategy should be based on results, not a “feeling” about its merit.
  4. Product Expert:  Someone on the ALCO should know the current rate and deposit history for all deposit categories.  This expertise should include a clear understanding of each tiered product and not only the rate for each tier but the balances and number of accounts in each.  The “expertise” should include various wholesale alternatives including the cost and current wholesale balances and wholesale ratios.
  5. Cashflow Needs:  Assign a member of the committee to present the cashflow needs for the relevant period including loans in the pipeline, expected loan prepays, maturing wholesale deposits and deposit expectations. Prepays, loan maturities and amortization should be included.
  6. Big Picture Person:  Someone should “keep track” of current events both nationally and locally.  For instance, the Fed’s latest declaration of “patience” should be a part of the ALCO’s input.  This information could be the basis of a decision to grab more wholesale funds rather than grow additional retail deposits.  If the Fed decides not to raise overnight rates in the near future, it may signal that wholesale funds may be the best funding solution.
  7. Liquidity and Balance Sheet Expert:  Assign someone on the committee to understand the liquidity worksheet, including the “severe stress event” worksheet.  This is critical to proactively understanding the impact current decisions will have on the liquidity ratio and severe stress worksheet.  A review of current ratios related to funding as well as other significant ratios, such as spread and margin, is critical to the success of any new strategies.

Actually, we believe all of the areas above are necessary to run an efficient ALCO meeting. Hopefully, everyone on the committee will have a part to play.

In summary, use the data provided by your ALM provider to more efficiently manage your balance sheet and structure your ALCO for success.

It will pay off in the long run.