ALM Strategies

Focus on ROE Not ROA
By Tom Parliment
July-August 1993

This article runs the math on why it is more important to focus on ROE than it is to focus on ROA.

Importance of leverage in managing ROE
An investment leveraging strategy

Using A Long-Long Strategy to Enhance the Bottom Line
by Tom Farin
July-August 1993

This is the Madison Bank & Trust (MB&T) Case Study. It does the following:

Introduces a mortgage lender with eroding ROA and ROE as a result of declining loan demand.
Uses marginal cost pricing to reduce the cost of funds.

Uses long-term FHLB advances to fund retention of long-term fixed-rate mortgages.

Developing a Dynamic Interest Rate risk Management Program - Part 1

by Tom Farin
September-October 1993

This is the first of a two part series on moving interest rate risk management from static to dynamic.

What we are attempting to measure
Interest rate risk management objective
Liability driven management approach
Economist approach
Farin/Parliment Retail/Wholesale approach
Uncovered option approach
Static vs dynamic interest rate risk management

This article is cross-listed in this section because it generally talks about a variety of interest rate risk management strategies.

Wine County Savings Case Study

Tom Farin and Tom Parliment
November-December 1993

This is the Wine County Savings case study. It covers:

Introduces an institution that needs to grow to optimize ROE and has growth inhibited by soft demand for its ARM products.
Grows asset side of balance sheet by retaining all fixed-rate mortgages.
Funds mortgages with term advances.
Shows the effect on both risk and return using dynamic income and market value testing.

Hedging Option Risk in Fixed-Rate Mortgages - With Core Deposits?

By Tom Farin
January-February 1994

In this article, Tom Farin looks at the effectiveness of using non-maturity deposits as a hedge against the interest rate risk in long-term assets like fixed-rate mortgages.

The basics - core deposits as a funding source for fixed-rate mortgages.
Price response of passbooks to changes in market rates.
Demand response of passbooks deposits to change in market rates.
Income simulation effects - spreads between passbooks and fixed-rate mortgages.

Reconsidering The Role of Fixed-Rate Mortgages In Your Portfolio

By Tom Parliment
January-February 1994

Tom Parliment looks at the pros and cons associated with retaining fixed-rate mortgages at the bottom of the interest rate cycle.

Advantages to consumers of short-term fixed-rate mortgages.
Advantages to lender.
- Shorter term leads to faster repricing.
- Ability to quickly build a portfolio during refinance booms.

Searching for the Virtuous FRM

By Tom Parliment
March-April 1994

Tom Parliment talks about the advantages and disadvantages associated with putting fixed-rate mortgages in your portfolio at the bottom of the interest rate cycle. Total rate of return analysis is used in ranking alternative loans that might be placed in an institution's portfolio under different interest rate environments.

Typical 10, 15, and 30 year FRM cash flows.
Valuing a variety of mortgage products under different rate environments.
Calculating TRR on these products under different rate environments.
Drawing conclusions from the analysis.

Over-Capitalized? Struggling With A Low ROE?

By Tom Parliment
May-June 1994

Tom Parliment extends his leverage discussion. He advocates using leverage to gradually increase earnings per share, resulting in a growth of an institution's stock price.

Tradeoffs in improving ROE
- Raising ROA
- Focus on gradual increases in EPS.
- Focus on retail leverage.
- Supplement with wholesale leverage.

Fort Knox Savings & Keep

By Tom Farin and Tom Parliment
July-August 1994

This case study looks at an overcapitalized institution and suggests a number of retail and wholesale strategies aimed at solving its financial performance problems.

Loan growth funded with wholesale borrowings
- Short-term fixed-rate mortgages.
- Home equity line bundle.
Leverage using a wholesale/wholesale strategy.
- Corporate debt.
- LIBOR ARM

Lessons in Leveraging - Managing EPS Through Low-Margin Transactions

By Tom Parliment
July-August 1994

In this article, Tom Parliment discusses the use of a number of investment transactions to leverage an institution, improving ROE. For each, he discusses the risks inherent in the strategy.

Examples applied to Fort Knox Savings case
Interest rate risk mismatch.
Incurring credit risk.
Floating rate CMO.
ARM securities.
PAC bond.

CD Wars - A Report From The Front - Part 1

Tom Parliment
November-December 1994

In this article, Tom Parliment reviews marginal cost pricing and evaluates the potential affect of competitive response to an institution's pricing initiatives on these marginal costs.

Marginal cost analysis verses relationship pricing.
Core deposit rate sensitivity.
CD rate sensitivity.
Paying up on existing money to raise new money.
Using CD specials as an alternative way of going after rate-sensitive funds.
Considering the impact of potential competitor response.

Directions In Strategic Thinking For Community Banking

By Tom Parliment
January-February 1995

Tom Parliment shares his thoughts on developing an effective business strategy for community banks. In doing so, he lays out a flow chart for thinking through how to become the customer's core bank.

The reason for competitive urgency.
Committing to become a core bank.
Defining key customer relationships.
Prioritizing products and services.
Prioritizing delivery systems and processes.
Building the capital budget and laying out the time line.

Learn To Sell Financial Options - Part 1

By Tom Parliment
April-May 2000

In this first part of a two part series, Tom Parliment introduces the concept of selling products containing imbedded options to consumers. Using a series of examples, he describes the options and explains how the need to be priced for them to be profitable financial instruments.

Why consumers often don't exercise options -- even when they go in the money.
How a financial institution can make money selling options to consumers.
Analyzing prepayment options on loans.
Analyzing embedded options on deposits - early withdrawal and bump-rate CD.
Option dilemma - what price to charge.

Selling Retail Options: Part Two

By Tom Parliment
July-August 1995

In the second part of this two part series, Tom Parliment lays out how to value options embedded in retail financial instruments.

Frequent user discounts.
Estimating value of prepayment and variable-rate options.
Estimating value of prepayment and pop-rate options on deposits.

Community State Bank Case

Tom Farin
July-August 1995

This case study looks at an overcapitalized shop with a significant amount of interest rate risk in rising rate environments.

Case overview.
Financial goals.
Proposed solutions.
- Non-conforming fixed-rate lending.
- Expansion of HELOC penetration.
- Use of CD specials.
- Stock dividend strategy.
- Pop-rate CD.

Outsourcing - Wave of the Future?

By Tom Parliment
September-October 1995

In this article, Tom Parliment looks at advantages associated with outsourcing back room operations at the institution. As part of the article, he touches on the advantages and disadvantages of outsourcing A/L analysis.

The emerging competitive environment.
Key issue: how will small to medium financial institutions offer a full array of services at competitive costs?
How outsourcing may allow small to medium sized institutions to meet this competitive challenge.
How might A/L analysis be outsourced while still allowing management to run what-if scenarios.

Differentiated Pricing In Segmented Markets

By Tom Parliment
November-December 1995

Parliment examines the advantages associated with pricing deposits differently in different markets. Marginal cost analysis is used to show how decentralized pricing can be used to enhance the bottom line.

Calculating marginal revenues and costs market by market.
Exploiting favorable markets.
plementing the theory.

Managing The Value of Your Bank

By Tom Parliment

In this article, Tom Parliment lays out the math for determining whether stockholders should retain bank stock (Hold) or sell bank stock (fold). Both valuation theory and assessing issues that will affect future values are discussed.

Keys to valuing a bank
- Project earnings.
- Reviewing generic market valuation data.
- Estimating trading value.
- Estimating acquisition value.
- Calculating alternative rates of return.
- Deciding whether to 'hold' or 'fold'.

This article is included in this section as it forms the basis for the strategies developed in the next article.

Tom’s Bank - A Case Study In Managing Franchise Value and Stockholder Return

By Tom Farin
January-February 1996

This article introduces a case study institution, Tom's Bank. It then looks at a number of strategies management might employ in turning a 'Fold' into a 'Hold'. Tom Parliment's valuation techniques are applied throughout the article.

Problems with excess capital - it has little value.
Market value enhancing strategies.
- Dividend strategies.
- Stock buy-back.
- Earnings enhancement.
- wth/leverage strategies.
- Tom's master solution.

The Internet: The Great Equalizer For Small Financial Institutions

By Tom Farin
March-April 1996

In this article, Tom Farin evaluates effect of the Internet on the ability for small to medium sized institutions to compete.

Expanding market areas.
Internet CD specials.
Reestablishing your presence at the point of sale.

Meeting The Competitive Challenge - A Manifesto For Insured Depositories

By Tom Parliment
March-April 1996

Tom Parliment discusses a number of issues and trends financial institutions must deal with if they are to prosper in coming years.

Profitability - the competitive pacemaker.
Interest margins will be under downward pressure forever.
Fighting to maintain margins.
Managing margins through efficient pricing.
Searching for non-interest income.
Exploding the size advantage myth.
The answer is leverage.

A Mutual Golden Nugget?

By Dave Koch
March-April 1996

Dave Koch lays out an approach credit unions might take in determining how to reward members for participation by paying special dividends.

Mutual dividends - the premise
Mutual dividends - the process.
Determining pay out amount.
The payments.
Putting it all to work.

Mississippi Federal Bank Case Study

By Tom Farin
January-March 2001

This case study introduces a leveraged shop with a significant interest rate risk issue. The case also identifies a number of pricing problems. Many of the articles in this issue relate to the case.

Current situation.
Regulatory pressure on interest-rate risk.
Stockholder pressure on earnings.
ALM dilemmas and strategy objectives.

Market Value – It’s Not Just a Regulatory Compliance Tool!

By Tom Farin

In this article, Tom Farin discusses the value of both income simulation and market value analysis in evaluating risk/return tradeoffs in alternative strategies for improving an institution's performance. Along the way, he explains, models and evaluates a solution to the short-term problems in the MissFed case.

Historical perspective of regulatory initiatives on market value
Alphabet soup of terms - MVPE, NPV, EVE, Value at Risk
Why market value measurement systems were imposed.
What income simulation won't tell you.
MissFed Case solution - an example.
Market value risk - long term effect of rate shocks on income.
Moving toward dynamic analysis.
- Income simulation.
- Market value testing.

Managing Market Value Risks: Miscellaneous Strategies

By Tom Parliment
January-March 2001

Tom Parliment attacks the solution proposed by Tom Farin in the market value article. he then proposes the use of a structured FHLB advance that increases MissFed's option risk. He then uses a simulation model to evaluate the effect of the strategy on both income and market value risk, proving, at least in this case, his solution is superior.

Mortgages create asymmetrical market value risk.
Mississippi Fed - the base case.
Tom Farin's matched funding solution.
Dr. Tom's add more optionality solution.
The risk/return tradeoffs - food for thought.

Retail Strategies for the New Millennium: Face Up, Fess Up, and Overcome

December 2002

Tom Parliment presents his retail rules for community institutions.

Reinventing Your ALCO Process

December 2002

Tom Parliment discusses how to make pricing decisions that will drive profits to your bottom line.