Asset Liability Management plays a key part in a Kansas community bank’s success story.
It’s not easy for a struggling community bank to work its way off a problem bank list, much less emerge as a profitable, highly rated institution with multiple locations and more than 500 percent growth in assets.
But that is precisely what happened after a group of bank employees and community leaders formed an Employee Stock Ownership Plan (ESOP) in 1993 to purchase a family-owned Kansas community bank on the brink of closure.
One of those employees — the one who now serves as the bank’s president and CEO — remembers those difficult early years.* “Our first goal was to address the bank’s credit problems and get off the problem list,” he recalled. “It wasn’t easy. But we did it, and within five years, we were paying dividends again.”
Still, credit, liquidity and interest rate risks remained. “We remembered what happened when the savings and loan industry took on too much interest rate risk in the 1980s, and we wanted to avoid that,” the president said.
To assess its interest rate risk, the bank’s leadership conducted regular reviews of loan and deposit pricing. But their in-house capabilities were limited. “We couldn’t make dynamic projections that assessed how our net interest income would be impacted by changes in interest rates,” the bank president explained. “We needed more sophisticated modeling, which is why we turned to Commerce for help.”
That was more than 20 years ago. Commerce Bank’s Capital Markets Group (CMG) has provided Asset Liability Management (ALM) services to the bank ever since.
The ALM difference.
Each quarter, the CMG loads current financial data provided by the bank into their simulation model to quantify the potential impact to earnings and capital using multiple interest rate projections. “By plugging in various rate scenarios to see how they impact our income, we can assess our interest rate risk,” the bank president explained.
“In addition to running a variety of ‘rate shock’ scenarios, the ALM model goes a step further and identifies the most likely scenario, given current economic conditions",” he continued.
“The CMG’s quarterly reports also include updates on interest rates and the economy, as well as a back test that assesses the accuracy of the previous quarter’s forecast. “Many times, the predictions are off by less than 1 percent,” the bank president noted.
CMG presents these findings, along with specific ways to mitigate interest rate risk and enhance profitability and liquidity, to the bank’s executive team. “Our Commerce consultant has real-life experience in managing interest rate risk, having done it himself for a large bank earlier in his career,” the bank president said. “He understands our job and bolsters our confidence that we are making good decisions.”
“By applying what we learn, we’ve been able to multiply our yield on investments substantially,” the bank president continued. “Without Commerce’s help, for example, we might be reluctant to keep a 15-year fixed-rate loan on our books. But now we can look at the model and see that holding a certain number of these loans is not especially risky in the current environment. In fact, they can and have enhanced our profitability quite a bit, compared to other investment options.”
“When we opened our first checking account with Commerce in 1993, we were a problem bank facing possible closure,” the bank president said. “Since then, we’ve grown from $40 million in assets to more than $200 million, while adding four additional locations across four counties.”
“Commerce has played a big role in our success,” he said. “We couldn’t be more pleased with our partnership.”