Our annual peer group comparison gives you an overview of how your institution compares to your peers from an interest rate risk perspective. As the composition of the balance sheet changes and interest rates evolve, your interest rate risk profile is also affected.
Interest rates, while up from 2020 levels, remained stubbornly low throughout 2021. The target federal funds rate remained unchanged at 0%-0.25%. The two-year point of the curve rose from 0.125% in December 2020 to 0.694% in December 2021, while the 10-year point of the curve rose from 0.918% to 1.51%. The yield curve steepened at the start of the year, bringing some respite; however, the long end of the curve had come down by the end of the year.
Heading into 2022, the target federal funds rate has remained unchanged so far. Yet, rates across the rest of the yield curve are up across the board. Looking ahead, the consensus is that rates will rise. At the end of the year, Fed Funds Futures had forecast three rate hikes by the end of 2022.
As of this writing, Fed Funds Futures is forecasting six rate hikes by the end of 2022. The forecast is for the rest of the yield curve to similarly rise. While interest rate risk models are used to manage risk for all rate scenarios, and forward rate estimates are just that, given the current path of expected rates, special attention must be granted to the scenario +100 base points.
We have completed December 2021 Risk Sensitivity Analyzes (RSA) for 118 clients at the time of this bulletin’s publication. For comparison purposes, we have broken down the results by asset size. A smaller sample size can be more easily skewed, so keep that in mind if you’re in a group that has a smaller number of peers.
The deposits that flooded onto balance sheets in 2020 mostly remained in place. As the yield curve steepened, financial institutions put this money previously held in overnight funds to work, primarily in the investment portfolio. While the loan to total assets ratio has declined over the year for many clients, the securities to total assets ratio has increased.
At the end of the year, the median ratio of securities to total assets for all December reporting clients was 28.35%.
Earnings at risk
When looking at interest rate risk results, it is important to remember that an individual institution’s estimates can vary significantly depending on the underlying assumptions of the model. The results of the earnings-at-risk simulations show that, given the structure of their balance sheets as of December 31, 2021, most of our clients are positioned to see an increase in their net interest income if market interest rates were expected to increase over the next 12 years. month.
Day-to-day cash balances have declined for most of our clients as institutions have invested those dollars. This results in a slightly lower sensitivity to assets. Falling rate cuts continue to be tempered given the current rate environment and instruments reaching natural lows fairly quickly.
The prolonged low interest rate environment led to slight declines in the net interest margin projected in the reference scenario. The additional slope of the yield curve did not create a large enough movement to have much impact.
The projected average return on performing assets for all customers is 3.102% in the base case (3.377% in the +100 basis point shock). This is down 37 basis points from December 2020, predicting the impact that the continued low rate environment has had on asset returns.
The cost of funds also fell as banks reacted to the low rate environment. Unfortunately, with rates so low, there isn’t as much room for liabilities to fall before reaching the bottoms, which squeezes margins.
Economic value of equity
The following tables present the results of the economic value of equity (EVE) simulations carried out using data as of December 31, 2021. (Note: economic value of equity = net present value of assets – net present value of liabilities). Overall, EVE’s volatility has increased due to the tendency to invest dollars that were previously held in overnight funds. This has extended the duration of the assets, which creates a larger mismatch with the duration of the liabilities, resulting in higher volatility. It should be noted that the EVE volatility described below remains within healthy and acceptable levels. Leverage ratios increased across the board.
If interest rates rise over the next year, we expect prepayment times, both from the loan and investment portfolios, to slow, which would add some stretch to assets. In this same rate environment, on the liability side of the balance sheet, we would expect some decline in dollars held in non-maturity deposits, as these dollars are transferred to term deposit accounts or leave the financial institution entirely as depositors seek higher funds. Return. Higher decay rates on non-maturity deposits would shorten the term of the liability. If these scenarios prevailed, expanding assets and shrinking liabilities would lead to lower earnings gains in rising rate environments and higher volatility in EVE.
With the expected rising rate environment, is your institution positioned to benefit from an earnings outlook? What is your potential capital risk? How does your financial institution compare to your peers? Asset-Liability Management modeling continues to serve as a valuable and strategic tool for better decision-making and balance sheet management for all pricing environments.
Find out how UMB Bank’s capital markets division fixed income sales and trading solutions can support your bank or organization, or Contact us be put in touch with a member of the team.
All graphs and data above are from UMB internal data and reports.
This communication is provided for informational purposes only. UMB Bank, na, UMB Financial Services, Inc. and UMB Financial Corporation are not responsible for errors, omissions or inaccuracies. This is not an offer or solicitation to buy or sell any financial instrument, nor a solicitation to participate in any trading strategy, nor an official confirmation of a any transaction. The information is believed to be reliable, but we do not guarantee its completeness or accuracy. Past performance is not indicative of future results. The figures quoted are indicative only. UMB Financial Corporation, its affiliates and its employees are not intended to provide tax or legal advice. Any tax material or statement is not intended or written for use, and may not be used or relied upon, by such taxpayer for the purpose of avoiding tax penalties. Any such taxpayer should seek advice from an independent tax adviser based on their particular circumstances. The opinions expressed here are those of the author and do not necessarily represent the opinions of UMB Bank, na, UMB Financial Services, Inc. or UMB Financial Corporation.
The products offered by UMB Bank, na Capital Markets Division and UMB Financial Services, Inc. are:
NOT FDIC INSURED | MAY LOSE VALUE | NO BANK GUARANTEE