In his opening remarks at DCG’s 40th Annual Balance Sheet & Model Risk Management Conference, President & CEO Matt Pieniazek shared a picture of a sculpture displayed in our office’s main entrance. Aptly titled The Questioning Mind, the piece shows an individual’s face in the shape of a question mark: an everyday reminder for associates to stay inquisitive and never stop questioning what might seem to be true.
Matt urged all attendees to assume their own “Questioning Minds” while attending the next two days of presentations, breakouts, and peer discussions.
From the Editor
Last month, DCG hosted our 40th Annual Balance Sheet & Model Risk Management conference in Boston. The event brought together approximately three hundred professionals from Banks and Credit unions, including C Suite executives, Board members, and representatives from diverse functional areas.
The conference's goal has always been the same: to equip attendees with one “good idea” to take back to their institution and improve their business.
In reality, we’d like to think that most will walk away with a myriad of good ideas. Whether they emanate from a core session, an interaction within a peer group, or during a social hour conversation, the exchange of ideas and sharing of knowledge at the DCG conference is always palpable.
In this month’s Bulletin, we charged DCG Sr. Financial Analysts Tim Brennan, Ryan King, and Andrew Sokol with summarizing a few good ideas from the conference. Specifically, readers will note key takeaways from the evolving world of model risk management, liquidity / collateral management, the role of derivatives, the power of data analytics, and economist Chris Low’s keynote presentation.
For those unable to attend, I highly recommend a quick perusal of these summaries. We look forward to seeing you at the 41st Annual event next summer in Boston.
Vin Clevenger, Managing Director
The following summarizes some of the key themes from the conference:
Liquidity and Alternative Funding
Topics surrounding measuring and managing liquidity were in the spotlight, including: collateral diversification/management, monitoring of uninsured deposits, clearly defining operational vs contingency resources, and the importance of liquidity monitoring via a multi-level warning system.
In light of 2023’s bank failures and ongoing liquidity pressures in the industry, presenters also examined how the definition of liquidity has changed, with a renewed focus on being able to more readily access cash within a few days or even hours. It is important for groups to constantly measure their overall liquidity position as well as stress test their position.
Furthermore, the need to formalize contingency funding plans with access to various reliable funding resources to manage liquidity needs is critical in this operating environment. Pledging investments, loans, or both to the Fed frequently surfaced throughout the conference’s two days.
The roles of the Federal Home Loan Bank System and the Federal Reserve were also at the fore. Most agreed that FHLBanks will continue to be a reliable source of bank funding, and that there is evidence of a decrease in the “stigma” associated with borrowing from the Federal Reserve Bank.
Data Analytics
Executive Directors Keith Reagan and Justin Bakst stressed the importance of asking more questions about data and challenging the idea of the status quo. With current concerns about liquidity management, heightened regulatory requirements, and deposit pricing in a high-rate environment, it is more important than ever to take a hard look at prior assumptions and practices.
This is particularly relevant when looking at long-standing static assumptions in ALCO models. In the past, a blanket average life or beta on non-maturity deposits or prepayment speed on loans may have sufficed. However, this recent rising rate interest rate cycle has proven that 1) deposit rate betas are not linear, 2) deposit average lives are not static, and 3) prepayment speeds on loans vary greatly depending on a variety of factors. More dynamic assumptions will not only satisfy evolving regulatory requirements but will also give institutions a better understanding of their own balance sheet.
In many cases, ALCO models can change drastically with the implementation of dynamic assumptions, giving all stakeholders a more thorough understanding of their positions. Deposit and lending predictive analytics offer valuable insights into customer behaviors. Leveraging data-driven intelligence to proactively manage cost of funds may prove critical in a time when margins are under significant duress.
On the asset side, higher market rate conditions have resulted in competitive yields for good credits and cash flow extension. It is crucial to use a prepayments tool to gain more insight into expected cash flow in varied interest rate environments or a pricing tool to help ensure adequate compensation for the risk of lending in an uncertain environment.
Derivatives
Guest presenters from Chatham Financial emphasized that derivatives should be a tool available to all institutions as an insurance policy to reduce balance sheet risk. Much of the institutional reticence to transact may be the idea that “we missed our chance.”
However, institutions may have more of a chance than they think. To that end, Chatham presented their self-described “hairy" chart, which highlighted how “wrong” the forward markets have been in predicting market interest rates.
For example, in February 2022, the market had 150bps of hikes priced in, assuming Fed Funds would reach 2.00% by February 2023. The market missed by almost 250bps as the Fed tightened to 4.50% over that time.
In early 2023 the market was pricing in 3 rate cuts by January 2024.
At the outset of 2024, there were 150bps of expected cuts, which, as of the writing of this Bulletin, does not look as though it will materialize.
Clearly, neither the markets nor the Federal Reserve has ever been able to “predict” interest rates; therefore, understanding how they may fit into your business is critical. The reality is that perhaps because of an adherence to a rate “forecast,” institutions may be neglecting balance sheet opportunities.
Model Risk Management (MRM)
Attendees were immersed in MRM with a pre-conference program led by Quantitative Consultant Hannah Glasrud (recognized as one of ABA’s Women in Model Risk Management this year) focused on model definition, AI/ML, effective challenge, and getting an MRM program off the ground. This interactive session laid the groundwork for DCG’s team to bring clarity to key issues facing the industry from an MRM perspective.
Quantitative Consultant Sam Chen began with an in-depth discussion on AI/ML models and their growing use within the industry today. Bankers will need to get past their “AI-phobias” and understand how best to incorporate AI and ML into their organization, as it appears they are here to stay. DCG’s CECL expert Chase Ogden led several sessions focused on ongoing performance monitoring for CECL models and model documentation as key takeaways. Chase emphasized that models are only useful if they are reliable, so you need to ensure they remain “fit for use” – now that CECL has been implemented, the institution’s work is not done.
A common MRM theme was the necessity of maintaining sound model documentation by providing a thorough “blueprint” of how a model came to be. It is imperative that model owners document both “how” and “why” decisions are made within models. To avoid headaches down the road, a rigorous documentation process is one way to help enable continuous oversight of model performance, limit risk, and ensure models provide results institutions can have confidence in.
Economist Keynote
Chris Low, Chief Economist of FHN Financial, kicked off the final day of the conference with his views on the US economy and the path of the Federal Reserve’s monetary policy. Chris has been in the business since the 1980s, and he reflected on how truly unique this interest rate cycle is compared to prior cycles in his career.
Notwithstanding the record length of the yield curve inversion and low consumer, manufacturing, and service sector sentiment, Chris believes that the data (sticky inflation, strong GDP, and a resilient labor market) will keep the FOMC from cutting its benchmark rate in 2024. The main reasons the Fed would cut are significant job losses and/or inflation that is clearly coming down to target, both of which had yet to materialize as of the June conference date.
Per Chris, the disconnect between consumer and business confidence and economic data is due to the market discounting the impact of immigration and aggressive fiscal spending, which are bolstering job numbers and supporting corporations.
In Chris’ experience, an un-inversion of the yield curve usually occurs because the Fed has over-tightened, but he believes we are in the rare instance where the market has it wrong, and the un-inversion will be due to the market realizing the economy can handle higher rates causing the yield curve to bear-steepen.
Chris also was also featured on DCG’s podcast, “On the Balance Sheet,” which was recorded live on-site. He discussed fair value on the ten-year note and expected Fed officials to ‘jawbone’ longer-term rates upwards throughout the rest of the year. (Listen HERE for the full discussion.)
“Ask the Consultants”
The conference concluded with a panel of consultants from across the DCG organization responding to questions submitted by attendees, covering a range of topics including the trend towards dynamic modeling, a deep dive into the “loss-trade,” and duration extension within the asset base. The conversation repeatedly pivoted to the necessity of being able to “tell your story.” There is no one-size-fits-all when it comes to liquidity/IRR/capital management, and being able to understand and convey what sets an institution apart is crucial.
“The important thing is to never stop questioning. Curiosity has its own reason for existing.” – Albert Einstein
The “Questioning Mind” reminds us that it’s critically important to challenge business practices and commonly held beliefs. We hope this month’s Bulletin helps you ask the right questions.
We look forward to seeing you in person at DCG’s 41st Annual conference next June 2-3, 2025.
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ABOUT THE AUTHORS
Tim Brennan is a Senior Financial Analyst at Darling Consulting Group. He earned a B.S. in Finance from Boston College and joined DCG in 2018.
Ryan King is a Senior Financial Analyst at Darling Consulting Group. He joined DCG in 2018. Ryan holds a B.A. in Finance from Salisbury University and is currently earning his MBA at UMass Amherst's Isenberg School of Management.
Andrew Sokol is a Senior Financial Analyst at Darling Consulting Group. He joined DCG in 2018 from Putnam Investments, where he worked in mutual fund sales. Andrew earned a B.A. in Finance from UMass Amherst, where he was a member of the men's lacrosse team.
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