Plansmith Blog

The Asset Liability Committee, ALCO, is often best characterized as observers of the margin rather than controllers of margin behavior. Why, after all the meetings, sophisticated computer software, consultants and regulatory pressure, do ALCOs fail management? Because unlike a financial institution failure, it continues to function, it simply just does not make a difference. There is motion with no progress.

As providers of community bank and credit union planning software and consulting services for over 40 years, it is our mission to help our clients make the entire planning and management process both efficient and effective. To that end, we conduct ongoing research into the challenge of building an effective ALCO.

We have been able to identify three reasons for ALCO failure:

1) Unclear purpose

2) Wrong tools

3) Wrong people

In the first part of this series, we will be addressing the issue of having an unclear purpose.

Clarity of Purpose

To quote Alice in Wonderland’s Cheshire Cat "if you don’t know where you are going, then any road will take you there." Does your community bank's ALCO have a destination or goal? While developing the goal, the first controversy we usually meet is whether the ALCO is limited to margin issues, or should it deal with decisions related to the entire institution? As we talk to bankers, we find that many ALCO meetings become loan meetings; others complain that they become embroiled in complex investment products. The largest segment of ALCO’s review their gap reports, discuss data inaccuracies, and review rates then adjourn.

The first step toward creating an effective ALCO is to define its goals and objectives. Why are we here? What is our purpose? How will we know we are truly effective? What is asset-liability management anyway? How do we do this job? Who should be on this committee? What resources do we have available to us?

Once the strategic issues are resolved, other questions should be considered. What is the best margin we can achieve in this environment? Most institutions would gladly take a 5% margin, but it is probably impossible in their market, in this environment. Other considerations include calculating the required margin. There is a minimum margin that can be computed by adding capital formation requirement, dividends, net overhead, loan losses and taxes, i.e., all those cash flows the margin must support. These considerations help us quantify the goals and even suggest strategies to reduce the pressure on the margin and establish realistic margin goals.

In addition to a strategic plan, the ALCO need an ALCO policy to serve as a guide as the ALCO moves forward. Most recently developed ALCO policies include measurement of risk using simulation results and margin minimum and maximums, or possibly allowable margin changes under multiple rate scenarios, high, low and most likely.

Finally, an ALCO action plan should be the product of the meeting. Always conclude your ALCO meetings with specific set of actions to be executed by designated individuals operating within a specific timetable. Even if everything is going according to plan and the committee elects to do nothing, that is an action plan and should be noted in the minutes. With this simple discipline, you will reap substantial rewards for your efforts.

Check back for parts two and three of this series, "Why ALCOs Fail: The Wrong Tools" and "Why ALCOs Fail: Staffing the ALCO" .

The road to profitability begins with a very simple concept. An asset is acquired at a certain value X and it is sold at a value Y where Y is greater than X and the difference between the two gets you going. This is a concept that is very simple indeed. But this post isn’t a narrative about the arithmetic involved in generating profits; rather it is a discussion that begins with examining the nature of the assets being bought and sold, which is money.

Non-financial businesses ranging from the humble lemonade stand to the behemoth WalMart are easy to understand. The assets being transacted are, for the most part, quite tangible. It is easy to understand that something is manufactured, it is delivered to a retail place of business, it is stored in a warehouse as a portion of inventory, it is displayed on a shelf and it is ultimately purchased by people like you and me to put in a bag to take home. The equivalent chain of distribution can be identified in banking but there is one big difference that makes it all the more complicated. It is the fact that the product, being money in its many different forms, is not something you see, feel, taste, hear, or smell in any direct way.

If you are a parent, you use "what if" scenarios every day with your child. What if you get lost? What if you saved your allowance rather than spend it? What if your friends ask you to…? What if you study for that test? What if a stranger offers you a ride?

Wow - what a fantastic trip to the 2014 ICBA in Honolulu this past March. It was a long way to travel but given this year’s weather, a little time in the sun mixed with one of my favorite conventions could not have come at a better time.

I would like to extend a sincere thank you to all of our clients and prospective clients that stopped by the Plansmith booth and took a few minutes to talk with me and my colleague, Ron Trice. In an era of endless emails, conference calls and web presentations it is always nice to put a face to a name and shake hands with all of you. If you didn’t come by the booth but happened to see the two tall guys in the loudest most obnoxious Hawaiian shirts ever - yes, that was us.

Tell me about your business. What is your organization like today? How did it get there? How is it managed? Where do you see it going and how are you planning to get there? What obstacles are in your way? Tell me about your business.

When I ask this of a financial institution, I usually receive balance sheets and risk reports. Most people immediately think ‘numbers’ when you mention planning. I challenge you to think differently, think communication. Tell me about your business.

Tom Parsons and I had the pleasure of attending the CUNA Government Affairs Conference in our nation’s capital. It was a great opportunity show support for our many credit union clients as well as learning more about the many challenges they face.

Opening night featured a performance by singer Eddie Money, which literally had the Washington Convention Center "shaking to the beat of the night". Day two presented a strong stream of visitors to the many exhibitor booths spread out around the convention center floor. It was great to finally put a few client faces to the many voices that we speak to regularly. We met a number of new credit unions that were interested in our solutions for managing risk and active planning. It was fun being able to run our Financial Compass model for these individuals, right there on the convention floor. Some really seemed impressed by our ability to quickly provide a two and three year rolling forecast for their organization. Impressive perhaps, but after all, "the future is ours to see".

Last week we covered the first half of the OCC letter requesting information from client banks on their interest rate risk (IRR) model. Along with the letter, you may have run across some forms to be filled in with results from your model. This post and the accompanying webinar are meant to clarify the letter and terminology. Separately, but related, we have produced a video and guide for completing the OCC EV IRR Data Form for Financial Compass Clients (to be released soon).

A new request list and questionnaire from the OCC is making its way around the banking community and the NCUA has issued one of its own. Regardless of who you answer to, expect more scrutiny on your asset liability management (ALM) model. For some of you this might be "old hat", but we’ve fielded calls by clients asking for interpretation of the IRR Data Collection. So, Plansmitties, and even non-Smitties, take note: there is a letter with your name on it and we’re here to help.

I’m compelled to relate planning to everyday activity – after all, just because we are bankers, doesn’t mean we don’t experience life’s little pleasures (or displeasures) any more than, say, your average commuter. Today, while legally stopped in a left turn lane, waiting for traffic to clear before proceeding to Plansmith’s office, a man honked and gesticulated wildly because I didn’t pull into the intersection and ready myself for the turn. Never mind I couldn’t make the turn anyway. Conclusion: he didn’t plan well. If he was in a hurry, he should have planned to leave earlier, thereby beating me to the turn light where he, too, would sit and wait for traffic to clear. Maybe he took a different route from home, or maybe I did, causing this situation (I did stop at the dry cleaners – HA! solved).