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Current interest rate risk trends: A peer group comparison

As we look ahead to what 2020 might bring, it’s a good time to reflect on how the changing interest rate environment has affected the interest rate risk exposure at financial institutions.

Over the past year we saw the yield curve decline. The Fed Funds Target Rate decreased 75 bps from the end of 2018 to the end of 2019 with other points in the yield curve declining by as much as 95 bps. At the beginning of March, we saw another 50 bps cut in the Fed Funds Target Rate and a further decline in rates.

This lower rate environment has led many financial institutions to keep assets short in hopes of a reversal in the interest rate trends, while others have held the balance sheet steady or extended slightly in hopes of tempering further declines if rates should continue to fall. So how has this new rate environment impacted interest rate risk and how does your bank compare to peers? Let’s take a look.

We compiled the results of all the rate sensitivity analyses (RSA) performed for clients using December 31, 2019, data. Our analysis included 90 clients enrolled in our SilverBasic level of service and 43 clients enrolled in our SilverAdvanced and gold-level services that have submitted data for December reporting to date. The results have been broken down by total assets. Here is the breakdown (Source: UMB internal data).

The vast majority of the financial institutions we serviced for December 31, 2019, had total assets between $50 million and $250 million. Industry wide, loans-to-total assets has trended up. As the tables above show, the smaller institutions tend to have fewer loans as a percentage of total assets and more securities as a percentage of total assets as compared to larger institutions.

The following tables show the average estimates generated by our Earnings at Risk and Economic Value of Equity simulations for all 133 institutions, except where indicated. For all institutions, these simulations assumed a static balance sheet (i.e., no growth, account balances maintained for the duration of the analysis) and instantaneous, parallel shocks to all rate curves and indices as of December 31, 2019 (e.g., U.S. Treasury, LIBOR, FHLB Advance, prime rate, Fed Funds, etc.). All other model assumptions varied for each institution.

It is important to remember that individual institution estimates may vary greatly based upon the underlying assumptions of the model. Sample size per stratum also has an impact on the results. We left space at the bottom of each table for you to input your institution’s results so that you can easily compare them to our sample.

Earnings at Risk

The following tables show the results of the Earnings at Risk simulations performed using December 31, 2019, data. The estimates represent 12-month projections based on static balance sheets and market interest rates as of December 31, 2019. All tables in this section are sourced from UMB internal data.

Economic Value of Equity

The following tables show the results of the Economic Value of Equity simulations performed using December 31, 2019 data (note: Economic Value of Equity = Net Present Value of Assets – Net Present Value of Liabilities). All tables in this section are sourced from UMB internal data.

 

Current Trends

The results of the Earnings at Risk simulations show that, given the structure of their balance sheets as of December 31, 2019, most of our clients are at greater risk for a decline in net interest income should market interest rates decline sharply over the next 12 months. But, they may see gains in net interest income should market interest rates increase sharply over the next 12 months. This is a similar profile to what we have seen for banks for quite some time; however, some repositioning of balance sheets has resulted in smaller gains in income in the rising rate scenarios and lower declines in the falling rate scenarios.

The results of the Economic Value of Equity show that, given the structure of their balance sheets as of December 31, 2019, most of our clients are at greater risk for a decline in fair value should market interest rates increase sharply. Overall, Economic Value of Equity volatility decreased, and leverage ratios remain high.

Industry-wide trends for net interest margin and return on assets over the last five quarters reflect how the changing rate environment has affected profitability. If the current lower rate environment persists, we would expect both ratios to decline in 2020. Our clients are showing projected net interest margin to be slightly higher than where the industry ended 2019, while return on assets is slightly lower.

Source:  S&P Global Market Intelligence, 2020

 How well is your balance sheet positioned for the changing rate environment? The interest rate outlook has already changed from the end of the year. The Fed’s 50 bps rate cut earlier this month has made this a particularly good time to be evaluating the structure of your balance sheet. While no one has a crystal ball letting us know which direction interest rates will go, we can manage the balance sheet to minimize interest rate risk in changing rate environments.

If you have any questions, or if you wish to discuss the topics featured in this analysis in greater detail, please contact your UMB investment officer or financial services group analyst for more details.

Important disclosures

This communication is provided for informational purposes only. UMB Bank, n.a. and UMB Financial Corporation are not liable for any errors, omissions or misstatements. This is not an offer or solicitation for the purchase or sale of any financial instrument, nor a solicitation to participate in any trading strategy, nor an official confirmation of any transaction. The information and opinions expressed in this message are solely those of the author and do not necessarily state or reflect the opinion of UMB or UMB Financial Corporation. UMB Bank n.a., 928 Grand Boulevard, Kansas City, MO 64106.

Products offered through UMB Bank, n.a. Investment Banking Division are: NOT FDIC INSURED | MAY LOSE VALUE | NOT BANK GUARANTEED

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