US Bank 2009 Annual Report Download - page 52

Interest Rate Risk Management In the banking industry,
changes in interest rates are a significant risk that can
impact earnings, market valuations and safety and soundness
of an entity. To minimize the volatility of net interest income
and the market value of assets and liabilities, the Company
manages its exposure to changes in interest rates through
asset and liability management activities within guidelines
established by its Asset Liability Committee (“ALCO”) and
approved by the Board of Directors. The ALCO has the
responsibility for approving and ensuring compliance with
the ALCO management policies, including interest rate risk
exposure. The Company uses net interest income simulation
analysis and market value of equity modeling for measuring
and analyzing consolidated interest rate risk.
Net Interest Income Simulation Analysis One of the primary
tools used to measure interest rate risk and the effect of
interest rate changes on net interest income is simulation
analysis. The monthly analysis incorporates substantially all
of the Company’s assets and liabilities and off-balance sheet
instruments, together with forecasted changes in the balance
sheet and assumptions that reflect the current interest rate
environment. Through this simulation, management
estimates the impact on net interest income of a 200 basis
point (“bps”) upward or downward gradual change of
market interest rates over a one-year period. The simulation
also estimates the effect of immediate and sustained parallel
shifts in the yield curve of 50 bps as well as the effect of
immediate and sustained flattening or steepening of the yield
curve. This simulation includes assumptions about how the
balance sheet is likely to be affected by changes in loan and
deposit growth. Assumptions are made to project interest
rates for new loans and deposits based on historical analysis,
management’s outlook and re-pricing strategies. These
assumptions are validated on a periodic basis. A sensitivity
analysis is provided for key variables of the simulation. The
results are reviewed by the ALCO monthly and are used to
guide asset/liability management strategies.
The table below summarizes the projected impact to net
interest income over the next 12 months of various potential
interest rate changes. The Company manages its interest rate
risk position by holding assets on the balance sheet with
desired interest rate risk characteristics, implementing certain
pricing strategies for loans and deposits and through the
selection of derivatives and various funding and investment
portfolio strategies. The Company manages the overall
interest rate risk profile within policy limits. The ALCO
policy limits the estimated change in net interest income in a
gradual 200 bps rate change scenario to a 4.0 percent
decline of forecasted net interest income over the next
12 months. At December 31, 2009 and 2008, the Company
was within this policy.
Market Value of Equity Modeling The Company also
manages interest rate sensitivity by utilizing market value of
equity modeling, which measures the degree to which the
market values of the Company’s assets and liabilities and
off-balance sheet instruments will change given a change in
interest rates. The ALCO policy limits the change in market
value of equity in a 200 bps parallel rate shock to a
15.0 percent decline. A 200 bps increase would have
resulted in a 4.3 percent decrease in the market value of
equity at December 31, 2009, compared with a 7.6 percent
decrease at December 31, 2008. A 200 bps decrease would
have resulted in a 2.8 percent decrease in the market value
of equity at December 31, 2009, compared with a
2.8 percent decrease at December 31, 2008.
The valuation analysis is dependent upon certain key
assumptions about the nature of assets and liabilities with
non-contractual maturities. Management estimates the
average life and rate characteristics of asset and liability
accounts based upon historical analysis and management’s
expectation of rate behavior. These assumptions are
validated on a periodic basis. A sensitivity analysis of key
variables of the valuation analysis is provided to the ALCO
monthly and is used to guide asset/liability management
strategies.
Use of Derivatives to Manage Interest Rate and Other Risks
To reduce the sensitivity of earnings to interest rate,
prepayment, credit, price and foreign currency fluctuations
(“asset and liability management positions”), the Company
enters into derivative transactions. The Company uses
50 U.S. BANCORP
Sensitivity of Net Interest Income
Down 50 bps
Immediate
Up 50 bps
Immediate
Down 200
bps
Gradual*
Up 200 bps
Gradual
Down 50 bps
Immediate
Up 50 bps
Immediate
Down 200
bps
Gradual*
Up 200 bps
Gradual
December 31, 2009 December 31, 2008
Net interest income . . . . . . . . . . . . . . * .43% * 1.00% * .37% * 1.05%
* Given the current level of interest rates, a downward rate scenario can not be computed.