Section 500 ASSET/LIABILITY MANAGEMENT POLICY

Transcription

1 Section 500 ASSET/LIABILITY MANAGEMENT POLICY General Policy Statement: The Asset/Liability Management Policy provides management with a framework for maximizing net interest margin, maintaining adequate sources of liquidity, and controlling interest rate risk. The general policy sets forth key Asset/Liability Management objectives and pricing guidelines. Guidelines: (1) THE TREASURER/CHAIRPERSON. The Board of directors delegates responsibility for funds management to Treasurer. However, the Board retains ultimate responsibility for the Credit Union s funds management program, reviewing their decisions to ensure compliance with applicable laws and regulations and prudent management practices. The Treasurer will facilitate coordination of investment and asset/liability goals. Meetings will be held as deemed necessary. (2) BOARD REVIEW. The Board will regularly review the following information to determine whether the Credit Union s asset and liability structure is likely to further key objectives: (a) (b) (c) (d) (e) Asset yields and liability costs; Budgetary projections of income, expenses, and profitability; Analysis of economic and competitive conditions and projections of current and future liquidity needs; Sources of funds available to meet liquidity needs, including the remaining maturities of all assets and liabilities; and Loan to deposit reports. (3) PRICING. Executive Committee (EC) recommends to the Board of Directors rates for loan and deposits after thoroughly analyzing conditions in the local economy, rates offered by the competition, and the effect on the net interest margin, return on assets, and capital. 1

2 EC shall have three members: the treasurer and two Board members. Two members of the EC will constitute a quorum. Pricing shall be based on the Credit Union s: (a) Reasonable return; (b) Overhead costs; (c) Credit risk; (d) Default risk (e) Marginal cost of funds; and (f) Fair return to its members. 2

3 Section 510 EXECUTIVE COMMITTEE S KEY OBJECTIVES General Policy Statement: Guidelines: The objectives of EC are set forth in the guidelines. (1) Monitor net interest spread; (2) Maintain adequate liquidity; (3) Optimize return on assets; (4) Protect principal; (5) Acquire adequate capital and reserve balances; (6) Identify, monitor and control the following risk exposure: (a) Interest rate risk. This is the risk that changing rates will adversely affect the Credit Union s financial performance. EC will compare and evaluate underlying payment streams, maturities, rates and risks inherent in assets and liabilities given current and anticipated changes in market interest rates. (b) Liquidity risk. This is the risk that current loans and deposit withdrawal demands will exceed the availability of liquid assets, in other words, assets with maturities of less than one year. EC, assisted by the manager or assistant manager, will supply the Board of Directors on a regular basis an analysis of projected sources and uses of funds, including a thorough evaluation of: (i) (ii) (iii) Projected loan demand; Maturing liabilities; Composition of member deposits; 3

4 (iv) (v) Composition of investment portfolio; Projected cost of funds. (c) Credit risk. This is the risk that the quality of the loan and investment portfolios will be impaired by deficient credit standards, poor judgment, or inadequate management review. The Board of Directors will control credit risk exposure by monitoring and controlling: (i) (ii) (iii) (iv) Lending policies and procedures; Trends in economic conditions; Financial condition of field of membership Concentrations. (d) Concentration risk. This is the risk resulting from concentration loans (investments) in single or related borrowers (issuers) or in particular geographic areas, or holding several obligations with similar characteristics. The Board of Directors will control concentration risk by carefully monitoring the composition of the investment and loan portfolio. (e) Default risk. This is the risk of loss on an investment due to an issuer s inability or unwillingness to meet contractual obligations or on a loan due to a borrower s inability or unwillingness to repay. Management will control default risk by implementing sound lending and collection policies. 4

5 Section 520 BUDGET ASSET/LIABILITY STRUCTURE General Policy Statement: The Credit Union budgets its asset/liability structure according to the following guidelines. Guidelines: (1) ASSET MIX. (a) Loans: Since loans to members are the Credit Union s primary asset, The Board s strategies should aim at meeting member s borrowing needs. i. Limits on maturity structure: Home Equity trust deed maturities should not exceed 20 years; and consumer vehicle loans should not exceed 6 years. ii. Loan to Deposit: Since the Board will rely on asset management to fulfill the Credit Union s liquidity needs, it will need to restrict loan growth which can be supported by available deposit funds. (b) Investments: The Credit Union s investment portfolio shall provide a secondary source of liquidity. The percentage of assets held in investment will depend on the amount of surplus funds available; those funds exceeding anticipated loan demand and deposit withdrawals. Investments will be made according to the Investment Policy. (c) Fixed Assets: Investment in fixed assets shall be limited to those necessary to carry out member services. (d) Cash: Cash and checking balances should be maintained at minimum levels sufficient to satisfy operating needs. (e) Asset Quality: The Board will monitor asset quality as described in the Investment and Lending Policies. (2) LIABILITY AND EQUITY MIX: Will consist of the following: (a) Deposit. (b)borrowings. (c)primary Capital. 5

6 General Policy Statement: Guidelines: Section 530 LIQUIDITY MANAGEMENT The Board adopts the following liquidity management policy to better accommodate decreases in Credit Union deposits and fund increases in loans. Further, the Board acknowledges that liquidity is essential to compensate for expected and unexpected balance sheet fluctuations and to provide funds for growth. (1) ASSET MANAGEMENT. Liquidity needs will be met by adjusting the Credit Union s asset structure through the sale or planned runoff of readily marketable assets. Since the Credit Union tends to have little influence over the size of total deposits, the Board will primarily rely on liquid assets to fund increases in loan demand. The Board will concentrate on adjusting the price and availability of credit and the level of liquid assets held in response to changes in member asset and liability preferences. The amount of liquid assets the Credit Union will hold depends on the stability of its deposit structure and the potential for rapid loan portfolio expansion. Generally, the Credit Union s deposit accounts are composed primarily of small stable accounts; a relatively low allowance of liquidity will be required. A higher allowance for liquidity is required when: (a) Recent trends show substantial reduction in large accounts; (b) Unused lines of credit or commitments to lend; and (c) Strong relationships exist between member share and draft accounts with employers who have financial problems. (2) ASSET MARKETABILITY. The Board will determine how salable the Credit Union s assets are in terms of both time and cost. To maximize profitability, the Board must carefully weigh the full return on liquid assets (readily marketable assets) against the higher return associated with less liquid assets. Income derived from higher yielding assets may be offset if a forced sale is necessary because of adverse balance sheet fluctuations. 6

7 (3) LIABILITY MANAGEMENT. From time to time, liquidity needs may be met by adjusting the Credit Union s liability structure by attracting rate sensitive borrowers and accessing approved lines of credit. (4) LIQUIDITY RATIO. The Board strives to maintain a good liquidity ratio. This ratio is subject to change depending on: (a) Present and anticipated asset quality; (b) Present and future earnings capacity; (c) Historical funding requirements; (d) Current liquidity position; (e) Sources of funds; (f) Anticipated future funding needs; and (g) Options for reducing funding needs or attracting additional funds. (5) LIQUIDITY MEASURES. The Board will measure liquidity trends based on the following indicators: (a) Short-term Investments to Total Assets. The ratio shows how much of the Credit Union s assets can be readily converted into cash. Short-term investments are securities with remaining maturities of 1-year or less. (b) Short-term Investments to Volatile Liabilities. The ratio indicates how much of the Credit Union s volatile liabilities such as CD s of $100,000 or more are matched by short-term assets. (c) Net Loans to Core Deposits. The ratio shows how much of the loan portfolio is funded by stable deposits. Core deposits are share and passbook deposits and CD s less than $100,000. (d) Volatile Liability Dependence. The ratio shows the degree to which volatile liabilities fund long-term assets. This figure is the result of dividing the difference between volatile liabilities and temporary investments by loans and longer-term investments. (e) Net Loans to Deposit. The ratio shows how much of the Credit Union s deposits are lent out and the Credit Union s ability to fund additional loan volume with these deposits. 7

8 (6) LIQUIDITY CRISIS MECHANISMS. The following mechanisms will trigger when liquidity ratios approach risk limits: (a) Contingency funding Plan. The Board may access any of the following sources of funds whenever prudent. (i) (ii) (iii) Established Lines of Credit. The Board has approved borrowing amounts at the following institution(s): ALLOYA Corporate Credit Union. Secondary Market Loan Sales. Short-term Investment Sales. (b) Seasonal Demands. If the Credit union cannot meet seasonal demands through deposits, it will borrow from its established line credit with the corporate credit union. (c) Procedures. The Board will develop sound procedures for liquidity crisis management, including but not limited to designating who executes the contingency funding plan, who determines the amount to borrow, and who contacts large depositors and assures them that the situation is under control. 8

9 Section 540 INTEREST RATE RISK MANAGEMENT General Policy Statement: Interest rate risk results from the possibility that market interest rates may change. The Board of Directors acknowledges that the Credit Union assumes an inevitable amount of interest rate risk during the ordinary course of business. Interest rate changes may impact earnings and capital adversely, the Credit Union adopts an interest rate risk management policy. The policy strives to identify the Credit Union s sources of interest rate exposure. Guidelines: (1) INDENTIFICATION OF INTEREST RATE RISK. The Credit Union has identifies five sources of interest rate risk: (a) Repricing Risk; (b) Reinvestment Risk; (c) Basis Risk; (d) Yield Curve Risk; and (e) Option Risk. (a) Repricing Risk. Repricing Risk results from the timing differences that exist in the pricing of assets and liabilities. (b) Reinvestment Risk. Reinvestment Risk results from the uncertainty of future interest rates at which the Credit Union can reinvest its cash flow from maturing assets and the periodic interest payments received on earning assets. On the other side of the balance sheet, the fact that the Credit Union cannot foresee the rates it will have to pay to renew maturing liabilities creates Reinvestment Risk. (c) Basis Risk. Basis Risk arises from the fact that over the course of the interest rate cycle the market rates or various indexes used to price assets and liabilities do not change at precisely the same time or in the same magnitude. This results in individual yield curves that do not move concurrently or in a parallel fashion. Basis Risk can cause the Credit Union s interest margin to contract or widen. For example, the rates earned on certain loans may be tied to a financial institution s prime rate and funded with liabilities that are priced off the Treasury or secondary market CD yield curves. Typically, when interest rates move, these individual pricing 9

10 indexes will not change at the same time or in the same proportion. This could adversely impact net interest income. (d) Yield Curve Risk. Yield Curve Risk is the risk that arises from variation in the movement of interest rates across the maturity spectrum. Yield Curve Risk differs from Basis Risk in that it refers to changes in the relationships between spot interest rates of different maturities of the same index or market; i.e., the differences between the two and ten year Treasury rates. These relationships often vary since the shape of the yield curve for a specific instrument can change dramatically during the course of an interest rate cycle by becoming steeper, flatter, or negatively sloped. (e) Option Risk. Option Risk refers to the changes in earning that can result if members exercise their options against the Credit Union. Member options may be explicit or embedded in the balance sheet. Explicit options give the holder the right to buy or sell a financial instrument at a specified price within a specified period of time. Embedded options are implied options such as the member s right to prepay a loan without a penalty or a member s option to withdraw funds early from a time deposit account. Typically, members exercise these options in response to interest rate changes at a time when it is profitable for them, not the Credit Union. For example, when interest rates decline, mortgage borrowers are likely to exercise their option to prepay their old higher rate loans. If members refinance their mortgages elsewhere or switch to mortgage products with a shorter maturity, these prepayments could shorten the average life of the loan portfolio and impact income. Conversely, when interest rates rise, fewer loan members will repay their lower rate loan. A decline in prepayments lengthens the average maturity of the Credit Union s loans. (2) RISK LIMITS. The Credit Union s Board of Directors monitors the following risk limits: (a) One-year GAP (b) Earnings-at-Risk (c) Capital-at-Risk (3) MANAGEMENT SYSTEMS. The Credit Union management systems consider the impact of future interest rate changes on earnings as well as the economic values of capital. Management will present the following reports to the Board periodically: 10

11 (a) Interest Rate Risk Exposure Reports. Reports assessing the Credit Union s exposure to interest rate risk given the investment portfolio, maturing liabilities, and economic trends. (b) GAP Management Report. The GAP report measures risk to net interest income arising from current positioned assets, liabilities and off-balance sheet contracts carried at historic cost. (c) EAR Management Report. Since GAP limits by themselves do not directly identify earnings exposure, the Credit Union translates its GAP report into an Earnings at Risk report ( EAR ) that allows management to focus attention on the variation in net interest income. The report estimates the impact on net interest margin given a change in interest rates and current asset liability positions. The report allows the Credit Union to project how changes in interest margin will affect capital. (d) Simulation Models and Market Value Sensitivity Programs. The Board of Directors recognizes the GAP and EAR reports primarily focus on repricing risk and afford little assistance in the assessment of reinvestment, basis, yield curve, and option risk. Thus, the Board may periodically review performance interest rate risk management and implement additional systems such as simulation models and market value sensitivity programs, when the need justifies the cost. 11