How Will Tax Reform Impact Financial Institutions’ Investment Portfolios?

January 2018

With the President signing off on the Tax Cuts and Jobs Act on December 22nd, 2017 (effective January 1st, 2018), financial institutions (FIs) must determine how the changes will affect the business as a whole, as well as the outlook for their investment portfolios. The implications of the tax overhaul are widespread, and conducting a thorough analysis of your current investment portfolio is important to ensure that your firm is properly positioned.

This bulletin will provide you with an overview of some of the key changes made by the legislation, and the effect these changes may have on your fixed income portfolio.

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Cost of Funds Pressure

 

December 2017

 

Financial institutions have had success in keeping their cost of funds in check even after the Federal Reserve has raised short-term interest rates over the past few years. However, many financial institutions continue to use the same deposit betas in their interest rate risk modelling and financial forecasts that they utilized prior to the Federal Reserve rate hikes. The fact that these deposit betas have not been realized has been a large benefit to the financial institutions’ bottom lines.

 
 
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Optimize Your Balance Sheet

 

September 2017

 

The FASB’s Accounting Standards Update (ASU) on derivatives and hedging provides much anticipated improvements to the hedge accounting framework in ASC 815. Financial institutions and other users of hedge accounting will benefit from the changes in the ASU. The effective date for public business entities will be fiscal years beginning after December 15, 2018 with early adoption permitted upon issuance of the final ASU (including interim adoption). Chatham Financial has followed this project very closely over the past several years and has had a significant role in working with the FASB to help shape the new guidance. Chatham can help identify the potential impact the new guidance may have on your hedging program.

 
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Assessing the impact of the FASB’s proposed changes to the hedge accounting rules under ASC 815

 

August 2017

 

Are you ready for the change? The FASB has been working on making changes to the hedge accounting guidance in ASC 815 for more than two years. Those changes will soon become effective and are geared towards bringing hedge accounting more in line with risk management activities. Potential changes to existing processes and strategies will present companies with new challenges and opportunities — is your hedging program optimized to take advantage of the changes when they go into effect?

 
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Liability Sensitive Financial Institutions – Improvements to Cash Flow Hedge Accounting

 

June 2017

 

The majority of medium-size commercial banks and most community banks are exposed to rising interest rates due to the natural composition of their balance sheet. They are often faced with high demand for fixed rate lending while they may not be able to secure long term fixed-rate financing of their own. As a result, they may alter their interest rate risk position by entering into pay-fixed, receive-floating interest rate derivatives to hedge their risk. These hedges are typically designated in cash flow hedging relationships against a variety of floating rate liabilities.

 
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Asset Sensitive Financial Institutions – Improved Cash Flow Hedge Accounting Standard

 

June 2017

 

Financial Institutions that are exposed to falling interest rates often enter into receive-fixed interest rate swaps to preserve their Net Interest Margin. These hedges are typically designated in a cash flow hedging relationship against two types of floating rate assets: (1) pools of LIBOR indexed assets and (2) pools of PRIME indexed assets. The effectiveness of these hedging relationships is directly related to what is recognized under Accounting Standards Codification (ASC) 815, Derivatives and Hedging as a benchmark interest rate. Currently LIBOR, OIS, and US Treasury are identified benchmark interest rates, which allows benchmark risk designations to ignore any credit spread variations in the hedged population. This means that for cash flow hedging relationships where a derivative is designated against floating rate assets, LIBOR indexed assets achieve superior effectiveness and financial reporting as compared to PRIME indexed assets where credit spreads cannot be ignored. This is one of the concerns the new hedging standard improvements will address that will help better align the economic results of an entity’s risk management activities with its financial reporting.

 
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The FASB Approves Proposed Changes to Hedge Accounting

 

June 2017

 

On June 7, 2017, all seven FASB board members confirmed their intention to vote to approve the proposed changes to the hedge accounting guidance in ASC 815. Formal voting is expected to occur via written ballot within the next few weeks and final guidance is expected to be issued in August. The mandatory effective date of adoption for public business entities will be fiscal years beginning after December 15, 2018 with early adoption permitted as early as upon issuance of the final guidance, which is a change from the previously expected early issuance date of fiscal years beginning after December 15, 2017. The new standard will better align economic results of an entity’s risk management activities with its financial reporting and make targeted improvements to simplify hedge accounting. This bulletin provides an overview of the proposed changes to Accounting Standards Codification (ASC) 815, Derivatives and Hedging that are relevant to financial institutions. Each of the changes has a positive impact on the application of hedge accounting. Individual strategies are impacted differently.

 
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The Risk of Embedding Your FX Provider

 

June 2017

 

In this article we will outline risks that are more prevalent today for financial institutions who outsource their FX via a correspondent provider and embed that provider into their back-end wire system. If your financial institution outsources the sending of your customers’ foreign currency wires to a correspondent provider, it is possible that the provider is embedded in your processes. This is especially likely if your wires are keyed into your back-end wire system and an exchange rate is automatically applied to the wire once it is keyed.

 
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As Currency Risk Grows at US Companies, a Top-Down Approach is a Bank’s Best Defense

 

May 2017

 

Financial institutions will commonly offer their more sophisticated commercial customers the opportunity to use interest rate derivatives to protect themselves from the potential risk of rising rates which would lead to an increase in debt service costs. While interest rate risk is on the radar of the financial institution’s relationship manager, currency risk which could also pose a cash flow concern is not.

 
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Increase Your FX Penetration and Better Serve Customers

 

May 2017

 

For many financial institutions in the US there is a natural bias toward sending wires in US dollars even to international destinations. Best guesstimates tell us that about 95% of bank accounts outside the US are denominated in some currency other than USD. Yet at many banks the percentage of wires going to international destinations in a foreign currency is in the single digits. Not only do customers independently tend to send USD rather than foreign currency, sometimes it is the bank itself that advises they do so. We call this the USD Compulsion.

 
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