What Should I Be Hedging –
Tangible Book Value or Economic Value of Equity?
And Should I be moving Available for Sale securities to Held to Maturity? Long term interest rate risk of a Financial Institution (“FI”) is better measured by Economic Value of Equity (“EVE”) sensitivity analysis rather than TBV changes. Hedging solutions that consider EVE sensitivity are more comprehensive than those that consider TBV changes exclusively. Tangible Book Value (“TBV”) includes changes in value of Available for Sale (“AFS”) securities, but does not consider changes in value of any other asset or liability. Accordingly, TBV excludes changes in value of core deposits and loans, which make up a primary funding and at least 70% of earning assets. Adoption of Basel III in the United States will allow banks (under $250 billion in assets) to continue to exclude changes in value of AFS securities from Tier 1 capital. As such, regulatory capital will not be affected by AFS securities changes for most FIs in the United States. Moving securities from AFS to Held to Maturity (“HTM”) limits the FI’s future alternatives for rebalancing the portfolio and managing liquidity needs. These limitations should be weighed against the accounting window dressing achieved by such a move. Regulators increased their focus on interest rate risk management in both recent guidance and examinations.