The effects of a depreciating investment portfolio

Since March 31, 2015, the 10-year Treasury has moved from 1.934 percent to 2.478 percent on June 10, 2015.  During this time, most banks have experienced a decrease in market value of their securities portfolio.  Additionally, the Fed continues to debate on when the time is right to start increasing the Fed Funds rate.  With news of consumer sentiment up, unemployment numbers down, and housing up, it is only a matter of time before we see our first increase.  What this all seems to be doing is causing some examiners to have anxiety about your investment portfolio and what is going to happen to your capital, liquidity, and earnings when rates rise.

Some of our clients have been asked by regulators to set policy parameters around the percent change of the investment portfolio as it relates to capital and earnings.  The basis for this recommendation comes from the OCC Bulletin 2004-29, or the FDICFIL-46-2013.  It looks as if the message behind this bulletin or FIL is to make sure bank management understands the risks within the portfolio as it relates to capital, liquidity, and earnings.  Given the way the investment portfolio works, it is very challenging to set parameters specifically on the investment portfolio as it relates to capital without also looking at what is happening on the liability side of the balance sheet.  This practice would place a bigger risk to the bank because when rates go up, you could be selling at the worst possible time, ultimately affecting capital, liquidity, and earnings.  In this bulletin, the OCC talks about the importance of monitoring depreciation within the investment portfolio and it does talk about the importance of measuring the overall EVE, or MVE for BancPath®, position, but it doesn’t say that there needs to be a policy parameter for the amount of depreciation in the portfolio as it relates to capital.  It warns of extending the duration of the portfolio to chase yields, and that management should be aware of what that practice might do to the overall position of the balance sheet in changing rates.

If you haven’t taken a look at your policy parameters as it relates to the condition of your bank or the position of your balance sheet, then it might be time for a revisit to reconfirm them or adjust them accordingly.  Additionally, to show to regulators that this has been thoroughly thought out, if your liquidity contingency funding policy doesn’t include the depreciation of the investment portfolio in a rising rate environment and how management would handle the change in liquidity from that impact, then I would recommend adding that scenario.  By taking these steps, regulators should get the impression of a comprehensive approach to managing the balance sheet and overall ALM.  Also, don’t be afraid to document in the minutes the discussion within ALCO about the steps you are taking to control the duration of the portfolio.>

The BancPath® reports have the capability to handle these recommendations in an easy-to-use format.  The ALM world is continually evolving into more complexity, and we continue to strive to stay ahead of the curve.  If you are feeling the pressure from examiners, concerned about how you are positioned for a rising rate environment, or just want to know more, then you can reach us at (800) 226-1923.