Empyrean Client Round Table Notes

Empyrean conducted four Client Roundtables over the last two weeks which were well-attended with an array of topics discussed. The scheduled time of 45 minutes for these roundtables turned out to be not enough time for these discussions.

The topics discussed at each roundtable varied with no one or two topics consistently dominating the discussions across the roundtables. We have summarized the discussions from the roundtables below to benefit all our clients.

  1. PPP loans and their funding. Participants discussed the treatment of PPP loans in the model and actions banks are taking to fund these loans. Funding for these loans can come though the PPPLF (PPP Liquidity Facility), for which the Fed funds PPP loans at 100% of their value for an interest rate of 35bp.

PPP loans have an expected life of 8 weeks to two years, interest and principle are guaranteed by the SBA, the interest rate is fixed at 1%, with all payments deferred six months for those loans which are not paid off quickly. A significant part of the economics of these loans for the banks are the fees paid to the banks by the SBA ranging from 5% for loans up to $350K to 1% for loans $2MM and larger. These loans are assigned a zero risk weight for capital purposes and when using the PPPLF, there is no interest rate or liquidity risk.

Because of the zero impact on any balance sheet metrics, some participants were considering keeping these loans off there ALM system. However, given there are net interest payments, fee accrual requirements, and the timing of the length of these loans is uncertain, many of the attendees were planning on modeling them on their ALM system using prepayment functionality to address the maturity uncertainty. One participant estimated that 20% of the loans would go the full two years to final maturity.

  1. NII Ramps. One group discussed how they implement interest rate ramps for measuring NII risk with most of the participants concurring on similar methodologies. Most start with their baseline which is a flat scenario (i.e., what interest rates are at the beginning of the measurement period) and run ramps up and down from this baseline.

Most agreed that an alternative of using forward rate curves added complexity with limited additional value and, hence, are not using forward rates. Ramps are generally conducted with equal increments of increase or decrease occurring over twelve months.

  1. Prepayment Speeds on Mortgages. This topic was raised in two of the roundtables, as participants commented on AD&Co’s and Bloomberg’s recent increases in prepayment speeds which are in the 20% to 40% range. There were lively discussions on these with some banks noting that they had started to increase spreads to slow the deluge of incoming prepayment applications. Others were tuning AD&Co speeds by working with the scaling factor and slide parameter to reflect views on their own portfolio. Additional commentary reflected concerns on getting treasury, finance, and the business lines coordinated on expected prepayment activity.
  2. Stress Testing. Regulators have been asking participant banks about how they are revising their capital and liquidity stress tests in response to this crisis. Most banks are relying on Moody’s to update COVID stress environmental factors, but are challenged in that Moody’s, like all forecasters, is changing its forecasts frequently, resulting in a moving target for the worst-case COVID scenario environment. Some banks are running their own ad hoc stress scenarios to push beyond what was their worst case a few months ago.
  3. Modeling Loan Forbearance. Participants discussed how to handle loans with interest and principal foregone for a period of months. A challenge is how to handle these for cash flow modeling and how to reflect a higher risk profile of these loans.We discussed ways to adjust cash flows for the forbearance and lower accrual rates for increased credit loss expectations
  4. Liquidity Actions. Participants discussed identification and use of new borrowing facilities in their contingency funding programs. There was consensus that during this period actions that normally would not be considered (e.g., discount window borrowing) were fully available with no regulatory stigma attached. Additionally, other liquidity providers like the FHLBs are accommodating frequent (i.e., weekly) collateral additions.
  5. Negative Rates. Participants are recognizing that negative rate scenarios are back in play and are not thrilled. However, most were flooring rate indices at zero as their loan agreements often have language with this provision.
  6. Other Topics Raised. As noted above, all the roundtables ran out of time before we were able to discuss all the topics raised. Some of the topics which were raised and either not discussed or only discussed briefly included:
    • CECL—Some of the banks are running credit cash flows on Empyrean for CECL, which seems to be the extent of treasury involvement in CECL described by participants
    • Merger Best Practices—A number of Empyrean clients are in the throes of merger implementation and were interested in others’ experiences. (We may schedule a separate roundtable for just this topic for these banks.) The largest challenge raised was maintaining data quality, integrity, and longevity in core systems feeding data into Empyrean
    • Liquidity Premium Spikes in FTP. Liquidity premiums have increased as credit spreads have spiked for bank funding which participants were concerned would impact FTP. [Note that this occurred in the 2008-09 financial crisis which caused liquidity premiums to be elevated for a period, which banks then unwound after premiums came back down.]
    • Libor Transition. SOFR was raised as a topic in one roundtable but was not discussed due to time limitations. We expect this topic to recur as (if?) a new normalcy is achieved in the economic environment.