Liquidity & Capital Management

David Hart

SunTrust Bank

May 11, 2017

2

Past and Current Events (2007-2017)

• 2007-2010: The Great Recession

• 2012 – 2014: Bank financial performance metrics show improvement

– Profitability, Capital Adequacy, Liquidity, and Asset Quality

• Significant regulatory and legislative changes are in progress,

particularly with regards to Capital Adequacy of banks. Key

legislation includes Dodd-Frank, Volcker Rule, Basel III and others

• 2015 - 2017: Top line revenue growth/expense management is a major

focus/challenge

• Oil price volatility – direct and indirect impact of energy industry

• Real estate markets rebounding

• Technology – Mobile capabilities, Cyber-Security, non-traditional

competition (FinTech players, BitCoin, etc.)

• 2017 – Trump era begins

3

Liquidity and Capital Management

Impact on Stakeholders

• Shareholders

• Regulators

• Depositors

• Borrowers

• Employees

• Community

4

Liquidity and Capital Management

A Complex Continuum

Credit Risk

Interest

Rate Risk

Concentration

Risk

Earnings

Risk

Regulatory

Risk

Strategic Planning

ALCO Planning

Cyber-Security/

OPS Risk

5

Liquidity Management

Key Issues

• Understand the impact of changes in the

balance sheet over time.

• Identify behavior patterns and volatility

of key accounts.

• Forecast sources and uses of funds. In

essence, an exercise in cash budgeting.

6

Sources and Uses of Funds

An Accounting Perspective

Double entry bookkeeping

prescribes keeping the equation

in balance.

How do changes in these accounts

impact liquidity?

Assets = Liabilities + NW

7

Sources and Uses of Funds

Relationship to the Balance Sheet

SOURCES USES

Assets

Liabilities

Net Worth

Assets

Liabilities

Net Worth

8

Sources and Uses of Funds

Key Areas to Emphasize

SOURCES USES

• FF Purchased

• Repos

• Loan Payoffs

• Sell Securities

• Deposit Increase

• Profits

• Issue Debt

• Issue Equity

• FF Sold

• Reverse Repos

• Loan Proceeds

• Purchase Securities

• Deposit Runoff

• Losses

• Repay Debt

• Dividends

• Stock Buyback

9

Refer to SunTrust Banks, Inc. Annual Report

Balance Sheet

10

The Key to Sustained High Performance

A Balancing of the Risks

Credit Risk

Liquidity Risk Interest Rate Risk

Define your risk management profile!

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Liquidity Planning

Managing the Liquidity Gap

• Short-term horizon

– Maintain required reserves over a two week

maintenance period

– Invest or borrow for surplus/shortfall

• Long-term horizon

– Forecast liquidity surplus/shortfall on a

monthly basis for the upcoming year

– How will you manage liquidity needs?

12

Liquidity Planning

Overview of Reserve Requirements

• Regulation D

– Implemented by the Federal Reserve to maintain

liquidity and confidence in the banking industry

– Reserve requirements are the amount of funds that

a depository institution must hold in reserve

against specific deposit liabilities

• Current Reserve Requirements - 2017

Tranche

“Exempt”

“Low Reserve”

“Normal Reserve”

Deposit Levels

Up to $15.5MM

>$15.5MM<$115.1MM

Over $115.1MM

Reserve Requirement

0%

3%

10%

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• Deficit/Surplus Forecasting

Liquidity Planning

Liquidity Gap Management

Sources

Total

Uses

Total

Surplus/Shortfall

0 - 30 Days 31 - 90 Days Over 90 Days

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Liquidity Management

Liquidity through Borrowing

• Whether short-term or long-term, access to various financing vehicles is dependent on maintaining solid financial performance. Key areas of emphasis include:

– Liquidity

– Capital Adequacy

– Asset Quality

– Profitability

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Liquidity through Borrowing

Key Measurements of Liquidity

The ability to meet short-term obligations

Pledged Securities Total Securities

Back-up Lines of Credit

100+ Time Deposits Total Deposits

Loan Deposit

MV of Securities BV of Securities

Typical Range

< 50%

< 20%

60% - 90%

95% - 105%

As needed

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Liquidity through Borrowing

Key Measurements of Capital Adequacy

To provide a sufficient buffer against loss to ensure soundness

Tier I Capital

Average Assets

Total Capital

Risk-Based Assets

“Adequate”

4%

4%

8%

“Well”

5%

6%

10%

Tier I Capital

Risk-Based Assets

Note: Capital adequacy guidelines are under regulatory review..

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Liquidity through Borrowing

Key Measurements of Asset Quality

To manage the balance between risk and return

Typical Range

.75% - 2.00%

100% - 200%

1.25% - 2.50%

.25% - 1.00%

.25% - .75%

NPL + OREO Loans + OREO

90 + Day Del.

Total Loans

LLR NPL

LLR Total Loans

Net COs Avg Loans

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Liquidity through Borrowing

Key Measurements of Profitability

To maintain solvency and continue as a viable, on-going entity.

ROE

ROA

NIM

Non-interest Income

Non-interest Expense

Typical Range

12.0% - 20.0%

.75% - 1.50%

3.00% - 5.00%

Various

Various

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Capital Planning

Key Issues

• What compromises bank capital and why

is it important?

• What is the magic number or optimal

capital position for a bank?

• How does a bank manage its capital

position over time?

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Bank Capital Definitions

• A Balance Sheet figure

• Similarities to traditional Net Worth

• Total capital equals Tier 1 + Tier 2

Tier 1

(Core) Capital

• Common stock

• Some preferred

• Paid-in Capital

• Retained Earnings

• Other

Tier 2

(Supplemental) Capital

• ALLL

• Hybrid Capital

• Other

Tangible Common Equity (TCE) = Total equity – intangible

assets – goodwill – preferred stock

21

Bank Capital

Primary Functions

• Buffer against losses

• Liquidity enhancement

• Impacts growth and risk-taking

– Internal, sustainable growth

– Risk-based concepts

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Bank Capital

Impact of Size

• Lending constraints

– Legal limits and house

limits

– Participations

• Returns to shareholders

• Impact on asset growth

BANK BALANCE SHEET

Assets

Cash

Securities

Loans

PP&E

Liabilities

Deposits

Other Obligations

Net Worth (5-10%)

MANUFACTURER BALANCE SHEET

Assets

Cash

A/R

Inventory

PP&E

Liabilities

Accounts Payable

Other Debt

Long-term Debt

Net Worth (30 - 50%)

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Return on Equity

How does Leverage Fit In?

ROE = ROA x EM = Net Income Assets

Assets Equity

x

(Profitability) (Leverage)

ROA = PM x AU = Net Income

Total Rev.

Total Rev. Assets

x

(Profitability) (Efficiency)

ROE = PM x AU x EM = x x

(Profitability) (Efficiency) (Leverage)

Net Income Total Rev.

Total Rev. Assets

Assets Equity

$5,000 $7,000 Net Worth (Equity)

$8,000 $9,000 Total Revenues

$1,000 $1,000 Non-interest Income

$7,000 $8,000 Interest Income

$715 $1,000 Net Income

$100,000 $100,000 Total Assets

BANK B BANK A (000’s)

ROE = PM x AU x EM

PM x AU x EM = ROE

Bank A’s ROE =

Bank B’s ROE =

(Profitability) (Efficiency) (Leverage)

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Bank Capital

Risk-Based Concepts

• To require more capital for greater risk

– $100MM in T-Bills vs $100MM in CRE

• To capture off-balance sheet risk

• To limit the impact of “quasi” capital

relative to total capital

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Bank Capital

Risk-Based Requirements

• On-balance sheet activities – 4 Buckets of Risk

Step 1: Categorize Asset

– Category 1: 0%

– Category 2: 20%

– Category 3: 50%

– Category 4: 100%

Step 2: Asset x Risk% x Required Capital %

• Off-balance sheet activities

Step 1: Convert the face amount of the off-balance sheet item to an on-balance sheet credit equivalent amount (CEA)

Step 2: Categorize the resulting CEA into its proper risk category as discussed above

Step 3: Converted Asset x Risk % x Required Capital %

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Bank Capital

Key Concepts

• Banks with “greater risk” assets are now

differentiated with risk-based guidelines

• Off-balance sheet items are captured

• Limitations

– Total Tier 2 is limited to 100% of Tier 1

– ALLL in Tier 2 is limited to 1.25% of total

risk assets

– Must maintain a “leverage” ratio

– Certain intangibles which are allowed are

limited to 25% of Tier 1

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Bank Asset Risk Weights

Loans:

Installment Loans 100%

C&I 100%

Residential Loans 50%

Investments:

U.S.Treasuries 0%

U.S.Agencies 20%

Agency CMO 20%

G.O. Municipals 20%

Revenue Municipals 50%

Money Mkt Securities 20%

Other Assets:

Cash and Due From 0%

Fed Funds Sold 20%

Premises and Equipment 100%

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Refer to Hard Copy

Risk Adjusted Exercise

31

Refer to Hard Copy

Risk Adjusted Exercise

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Liquidity & Capital Planning

Consequences of Poor Management

• Regulatory Implications – Forced to submit plans

– Disallow Acquisitions/branches

– Insurance premium issues

• Financial Implications – Higher interest expense

– Volatility of earnings

– Lower stock price

– Less expensive target

– Potential failure

• Other implications – Employees

– Community