US Bank 2015 Annual Report Download - page 61

holding companies and their subsidiaries, and the substantial
changes to that regulation.
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 manage the impact on 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.
Table 20 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 with desired interest rate risk characteristics
on its balance sheet, 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, 2015 and 2014, the
Company was within 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 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. Wholesale prepayment assumptions are based on
several key factors, including but not limited to, age, loan term,
product type and seasonality, as well as macroeconomic factors
including unemployment, interest rates and commercial real
estate price indices. These factors are updated regularly based
on historical experience and forward market expectations.
Mortgage prepayment assumptions are based on many key
variables, including, but not limited to, current and projected
interest rates compared with underlying contractual rates, the
time since origination and period to next reset date if floating rate
loans, and other factors including housing price indices and
geography, which are updated regularly based on historical
experience and forward market expectations. The balance and
pricing assumptions of deposits that have no stated maturity are
based on historical performance, the competitive environment,
customer behavior, and product mix. 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.
Management measures the impact of changes in market
interest rates under a number of scenarios, including immediate
and sustained parallel shifts, and flattening or steepening of the
yield curve. The ALCO policy limits the change in the 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 5.8
percent decrease in the market value of equity at December 31,
2015, compared with a 6.7 percent decrease at December 31,
2014. A 200 bps decrease, where possible given current rates,
would have resulted in a 7.0 percent decrease in the market
value of equity at December 31, 2015, compared with a
7.1 percent decrease at December 31, 2014. At December 31,
2015 and 2014, the Company was within policy.
TABLE 20 SENSITIVITY OF NET INTEREST INCOME
December 31, 2015 December 31, 2014
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
Net interest income .............. * 1.78% * 2.69% * 1.38% * 1.68%
* Given the current level of interest rates, a downward rate scenario can not be computed.
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