FMS/AMIfs Annual Conference – Workshop and Presentation Summaries
I spent much of last week in Tempe, Arizona at the FMS/AMIfs Annual Conference. This is an event I have attended for the past several years to explore and present on topics in financial performance and risk management. This year, I exhibited at the event, conducted a 1/2-day pre-conference workshop and delivered a general session with one of my clients.
The pre-conference workshop, which was held on Wednesday morning, was entitled “How Funds Transfer Pricing is Essential to Meaningful Risk and Profitability Analysis.” It described how FTP is necessary for a robust analysis and decomposition of earnings at any depository institution, regardless of size or charter type. I explained how FTP should be used to quantify the amount of depository earnings that arise from IRR and LR exposures; without a properly-constructed FTP process, earnings that should be otherwise be attributed to these risks are incorrectly attributed to other business activities such as lending and deposit gathering. I also explained that a key benefit of a well-functioning FTP process is that the lending and deposit gathering business units are immunized against IRR and LR. This latter point is extremely important as a well-functioning FTP process requires that the business segments overcome the intransigent view that FTP is an arbitrary tax on their earnings.
Now that interest rates have increased and are expected to continue increasing, institutions that do not have a well-functioning FTP process are likely to find that earnings attributed to their lending and deposit gathering business units are getting squeezed; this is happening because the business units have not been effectively immunized against IRR and LR. Additionally, because of the improper attribution of earnings, management attempts to get back to budgeted/forecast earnings levels will almost certainly fail or lead to a sub-optimal increase in risk taking; in fact, any decisions or downstream business processes that rely upon accurate measures of business segment or product profitability will be adversely impacted. These include, but are not limited to, capital allocation, compensation and incentive schema as well as strategic balance sheet management decisions.
The general session on Friday morning, which was delivered with Brian Gilbert, ALM/FTP Manager at Pinnacle Financial Partners in Nashville, Tennessee, was entitled “Developing and Implementing a Comprehensive Model of NMD Behaviors.” I have worked with Brian for much of the last year implementing a NMD model which is unique in the industry in that it contains a fully-integrated FTP engine. It was specifically designed to solve one of the biggest challenges associated with NMD modeling – aligning the treatment of re-pricing and liquidity cash flows across all risk and profitability applications. Virtually all third-party studies and stand-alone models, whether developed externally or in-house, are silent on FTP. This means that the attribution of value through FTP and other compensation schema is an afterthought and will not be consistent with the treatment of NMDs in IRR and LR models. At institutions where this problem exists, the process for ascribing value to deposits conflicts with their treatment in risk models; two different treatments cannot both be correct – either the profit math or the risk math is incorrect, or both are incorrect. No doubt, evidence of this dichotomy will become increasingly evident as depositories come under increasing pressure to raise deposit rates faster than anticipated.
It was great seeing everyone at the conference. If you missed it, make an effort to attend next year. See you then.
