Letters of the Alphabet

Susannah Marshall | Commissioner | Arkansas State Bank Department

We all know that there are certain letters of the alphabet that are very important to the banking industry. The integral letters are C-A-M-E-L-S, and they are the foundation for bank regulators and the supervisory process. I am sure that everyone is very aware of what these letters stand for: Capital Adequacy - Asset Quality –Management – Earnings - Liquidity and Funds Management - Sensitivity to Market Risk. While these letters encompass the aggregate risk for an institution and are each significant in analyzing the overall condition of an institution, in this article I want to focus on the last three letters.

I think we can all agree that we are operating in a very challenging economic and business cycle. So many issues we are facing today have not been present in recent history: the rising rate environment, lingering supply chain pressures, labor market shifts and staffing shortages, the Russia-Ukraine war, bond market fluctuations and the list goes on. Each of these issues are impacting our economy and the banking industry both nationally and here in Arkansas.

I am pleased to report that the overall health and financial condition of Arkansas banks remains very positive through midyear 2022. Despite the unplanned volume of deposit and asset growth during the pandemic, regulatory capital levels remain favorable, and we continue to outpace the national average in the leverage ratio. Recently completed examinations continue to reflect solid performance and strength within loan portfolios. Overall, classified assets remain minimal which positions our institutions well for the uncertainty of prospects and performance metrics. Management, which is always an evaluation of executive management and the board, has continued to evolve and engage on topics in a strong fashion. Ongoing supervisory matters are addressed in a timely and efficient manner. I encourage each management team to spend the remainder of this year reviewing and addressing any outstanding supervisory findings from your recent examinations and audits.

With that summary of the letters C-A-M, I turn your attention to the last three letters. The letters E-L-S represent some of my areas of focus and concern in the coming months. Earnings performance has been favorable and consistent during the past two years, which has been a very pleasant surprise especially considering the historically prolonged low-rate environment. Despite the recent rate increases, which would generally lead to an increase in income in an asset sensitive institution, I remain concerned about the additional pressures and rising costs on a bank’s profit margins. Earnings performance will continue to be pressured due to increased deposit costs and availability, rising overhead and personnel expenditures, and the likelihood for increased provision expense with the implementation of CECL, to name a few.

Over the past two years, the mention of liquidity and funds management among bankers has resulted in a common theme of too many deposits and not enough loan demand. However, I am beginning to see and hear that the “excess” deposit base is changing. Before March 2020, I was concerned about the availability of liquidity and core funding sources. I believe we can quickly find ourselves in a position where ample, affordable and stable funding sources may not be as readily available. Now, is the time to evaluate your bank’s future liquidity prospects and needs and begin to make any adjustments to your asset-liability management and contingency funding plans, today.

Currently, sensitivity to market risk is leading to a higher risk profile in many institutions. The impact of rising rates on both sides of the balance sheet warrants constant attention, analysis and strong risk management practices. Effective management of interest rate risk must include the timely evaluation and analysis of accurate data and the measurement of that data in relation to board approved risk tolerances. Management’s ability to appropriately identify, measure, monitor and control interest rate risk and implement needed actions will be a key focus of the regulatory process in the coming months.

As I visit with Arkansas bankers, I receive the same comments and concerns regarding Earnings, Liquidity and Funds Management and Sensitivity to Market Risk. We encourage you keep elevating the discussions and responses internally and with your regulators as we all work to navigate this challenging environment.