Huntington National Bank 2010 Annual Report Download - page 93

embedded options, such as borrowers’ ability to prepay residential mortgage loans at any time and depositors’
ability to redeem certificates of deposit before maturity (option risk), changes in the shape of the yield curve
where interest rates increase or decrease in a non-parallel fashion (yield curve risk), and changes in spread
relationships between different yield curves, such as U.S. Treasuries and LIBOR (basis risk).
Our board of directors establishes broad policy limits with respect to interest rate risk. ALCO establishes
specific operating guidelines within the parameters of the board of directors’ policies. In general, we seek to
minimize the impact of changing interest rates on net interest income and the economic values of assets and
liabilities. Our ALCO regularly monitors the level of interest rate risk sensitivity to ensure compliance with
the board of directors’ approved risk limits.
Interest rate risk management is an active process that encompasses monitoring loan and deposit flows
complemented by investment and funding activities. Effective management of interest rate risk begins with
understanding the dynamic characteristics of assets and liabilities and determining the appropriate interest rate
risk posture given business segment forecasts, management objectives, market expectations, and policy
constraints.
An asset sensitive position refers to a balance sheet position in which an increase in short-term interest
rates is expected to generate higher net interest income, as rates earned on our interest-earning assets would
reprice upward more quickly than rates paid on our interest-bearing liabilities, thus expanding our net interest
margin. Conversely, a liability sensitive position refers to a balance sheet position in which an increase in
short-term interest rates is expected to generate lower net interest income, as rates paid on our interest-bearing
liabilities would reprice upward more quickly than rates earned on our interest-earning assets, thus compress-
ing our net interest margin.
INCOME SIMULATION AND ECONOMIC VALUE ANALYSIS
Interest rate risk measurement is performed monthly. Two broad approaches to modeling interest rate risk
are employed: income simulation and economic value analysis. An income simulation analysis is used to
measure the sensitivity of forecasted net interest income to changes in market rates over a one-year time
period. Although bank owned life insurance, automobile operating lease assets, and excess cash balances held
at the Federal Reserve Bank are classified as noninterest earning assets, and the net revenue from these assets
is recorded in noninterest income and noninterest expense, these portfolios are included in the interest
sensitivity analysis because they have attributes similar to interest-earning assets. EVE analysis is used to
measure the sensitivity of the values of period-end assets and liabilities to changes in market interest rates.
EVE analysis serves as a complement to income simulation modeling as it provides risk exposure estimates
for time periods beyond the one-year simulation period.
The models used for these measurements take into account prepayment speeds on mortgage loans,
mortgage-backed securities, and consumer installment loans, as well as cash flows of other assets and
liabilities. Balance sheet growth assumptions are also considered in the income simulation model. The models
include the effects of derivatives, such as interest rate swaps, caps, floors, and other types of interest rate
options.
The baseline scenario for income simulation analysis, with which all other scenarios are compared, is
based on market interest rates implied by the prevailing yield curve as of the period-end. Alternative interest
rate scenarios are then compared with the baseline scenario. These alternative interest rate scenarios include
parallel rate shifts on both a gradual and an immediate basis, movements in interest rates that alter the shape
of the yield curve (e.g., flatter or steeper yield curve), and no changes in current interest rates remaining
unchanged for the entire measurement period. Scenarios are also developed to measure short-term repricing
risks, such as the impact of LIBOR-based interest rates rising or falling faster than the prime rate.
The simulations for evaluating short-term interest rate risk exposure are scenarios that model gradual
+/-100 and +/-200 basis points parallel shifts in market interest rates over the next one-year period beyond the
interest rate change implied by the current yield curve. We assumed market interest rates would not fall below
0% over the next one-year period for the scenarios that used the -100 and -200 basis points parallel shift in
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