What’s wrong with traditional analytical models?

How is the Invictus Capital Assessment Model (ICAM)™ different from other bank models?

What are "characteristics" of balance sheet assets that the Model measures?

What are the stresses that the Invictus Model measures?

Are regression-based models helpful in any measure today?

Where did the Invictus Capital Assessment Model™ come from?

What can Invictus do for bank directors in particular?

Is director liability increasing?

How does Invictus operate with banks?

 

What’s wrong with traditional analytical models?

The obsolete data points on which they are based. Even if you look at the most negative cases of sensitivity analysis performed on banks prior to mid-2008, rarely will you find predictions of the unique rate-liquidity changes and deterioration in assets that are commonplace on balance sheets today. "Normal" models did not predict them because they were not constructed to do so. Because of the dramatic paradigm shift in today’s banking environment, as macro predictors, regression-based modeling systems are for the most part obsolete.

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How is the Invictus Capital Assessment Model (ICAM)™ different from other bank models?

The interrelationships between assets and liabilities and the rates and returns associated with them are extremely complex and subject to a host of vagaries of the marketplace. Several modeling systems have developed extremely sophisticated algorithms and relationships to deal with these varying circumstances, which means if you feed in extensive, detailed data on interest rates, liquidity, and a variety of disintermediation options, you can get a near-infinite range of forecasts of bank performance and capital adequacy. But they come with a catch. Because they’re typically based on regression analysis, they depend on data developed in so-called "normal" economic times that no longer exist in today’s crisis-ridden financial environment. That makes it extremely difficult for management and the board to rely on their accuracy, to analyze the robustness of the bank’s balance sheet, to find its hidden weak points, or to devise policies that will allow it to stand up to the adverse credit and market forces asserting themselves today.

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What are "characteristics" of balance sheet assets that the Model measures?

"Characteristics" refer to the normal features and attributes of all bank assets. Real estate loans are typically collateralized, so "collateral" would be a normal characteristic of such a loan. Portfolios have a multitude of financial characteristics, of course, and the Invictus Model identifies them all.

The Invictus Model subjects the balance sheet to assumptions of economic stress that potentially exploit asset vulnerabilities and cause impairment. In other words, "characteristics" in the Model pinpoint inherent asset weaknesses that tend to remain unaffected in robust economic markets, but are potentially deleterious to value in bad markets.

The fact that all assets have a potential for an "upside" and a "downside" is, of course, ordinary and in the nature of banking. But in a recessionary environment, prudent banks — and their regulators — want to know how serious these potential vulnerabilities are, particularly at the enterprise level as it moves forward in the next two years. The Invictus Capital Assessment Model™ provides that information to the bank with a level of accuracy and clarity not found in any other model in the marketplace.

Naturally, the extent to which asset vulnerabilities are exploited by a bad economy, frozen credit markets, or other outside forces depends on a variety of factors that must be considered and measured. Today’s high level of asset "toxicity" resulting from the collapse of meaningful ratings and illiquid markets is, generally speaking, the cause of existing and potential erosion of bank capital.

Similarly, liabilities dependent on a high degree of funding liquidity are highly problematic in today’s frozen liquidity markets. For example, a portfolio heavy with loans made in one economic sector, or made in one narrow geographic sector, will be particularly vulnerable to economic downturns in those sectors. Loans made to thinly-capitalized borrowers, and loans containing lax terms and conditions, will also be fragile in a recessionary economy.

The list of characteristics inherent in assets subject to being "stressed" is consider¬able. The urgent task before banks today is to identify the vulnerabilities of their particular portfolios and take the necessary steps to deal with them before they turn lethal under the pressures of economic and market threats.

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What are the stresses that the Invictus Model measures?

"Stresses" as used in the Invictus Capital Assessment Model™ are the pressures and external events a bank faces as a result of a recessionary economy, tightened credit markets, increased regulation or legislation, reduced liquidity, and other external financial events assaulting the institution. In other words, they are any external events or conditions over which the bank has little or no control, and which pose potential threats to, or stresses on, the bank’s balance sheet. The ICAM model shows where these stresses and characteristics intersect and calculates the net cumulative effect they will have on regulatory capital.

With this picture in hand, we are able to help management and the board identify ways to deal with the most acute vulnerabilities the Model reveals - but also with the smaller, less dramatic vulnerabilities that, when taken together, can create serious capital shortfalls. Only with the "x-ray vision" of the analysis — one unique to the Invictus Model — can a bank insure its survivability and long-term sustainability.

Every bank is unique, and so are its problems. The Invictus approach is to understand the precise profile of the bank, assess its strengths and weaknesses, and, in collaboration with management and the board, devise answers to the questions this process raises. Our experience as seasoned bankers — and professionals in support of banker — uniquely qualifies us to get the job done.

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Are regression-based models helpful in any measure today?

They can still be useful in quantifying specific risks and modeling pro forma results in the right circumstances, once the bank has evaluated its options and made basic policy choices to protect itself. The Invictus model is not meant to replace regression-based models entirely, but to precede their use in today’s uncommon markets.

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Where did the Invictus Capital Assessment Model™ come from?

When the credit crisis hit in the fall of 2008, the principals of Invictus heard two things from managers and directors that were keeping them awake at night. First, they wanted a mechanism to let them assess the bank’s strengths and weaknesses in a broad-based way, not by tweaking assumptions in individual categories of asset and liabilities. In other words, they wanted to see the bank from 30,000 feet up so they could identify vulnerabilities that were ballooning — or were likely to balloon — before significant and irreversible impairment occurred. Second, they wanted to know how to minimize their personal exposure to shareholder and depositor lawsuits.

To give them the big picture, we needed a reliable, accurate analytical tool and a clear, easy-to-understand way of presenting its findings. We looked for a system that could do the work and present the results in a three-dimensional graph, or gradient. And we wanted a system that would show the whole balance sheet — where it was headed in light of the particular external threats the bank was facing, and most important, how those affected the bank’s regulatory capital.

We wanted a system that could ask and answer the same key questions the bank needed to ask and answer if it was being stress tested by its regulators. If the bank a failed to deal with a troublesome category of nonperforming assets, what effect would that have on the bank’s regulatory capital? How long would impairment take? What decisions could be taken by management and the board now in order to prevent a financial tsunami later?

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What can Invictus do for bank directors in particular?

Outside board members tend to have nonbanking backgrounds, which means they’re usually chosen for their overall business acumen, experience, and prominence in the community, not their technical banking expertise. Traditionally, they have reviewed and approved management’s plans without independent analysis. According to industry sources, including bankers, regulators, and attorneys, those days are now gone. Today, regulators and litigation trends require a more engaged dialogue between management and outside directors, not only to help set the direction of the bank, but to protect themselves from legal exposure.

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Is director liability increasing?

Directors and management are both coming under fire by the SEC, shareholders, depositors, advocacy groups, regulators, the courts, D&O underwriters, the press, and lawyers. During the S&L crisis in the early nineties, there was a lag time between the apex of the crisis and the lawsuits that were filed later. Most industry observers expect the same lag to occur in the current financial environment. Assuming that is so — which is a prudent assumption to make — the bank must follow the advice of counsel and protect itself with good faith forward planning, including stress testing and risk management of the kind Invictus offers.

When it comes to directors, a failure to set acceptable levels of risk and authorize the use of the analytical tools needed to manage it have become fodder for critics and litigants. National accounting firms and leading bank counsel contend that risk management is of critical importance to all banks’ sustainability. As a result, risk committees are arguably the most important committee of the board.

In cases where directors are being accused of setting deficient policies that, in truth, were not unreasonable at the time they were made, the Invictus Capital Assessment Model™ is a powerful tool for recapturing the record of the bank’s good faith and providing the bank and its counsel with valuable expert opinion.

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How does the Invictus System operate with banks?

The ICAM model provides the framework beginning with a detailed stress testing capability. By focusing on the balance sheet, the Invictus team assists the bank in analyzing and reviewing all areas in which the bank could experience regulatory capital declines in a stressed environment. More importantly, the ICAM model identifies the timing of the degradation, giving management that one additional valuable piece of information - "How long do we have before we violate capital requirements?"

A typical engagement with a bank includes using the ICAM to provide a complete and detailed analysis of all factors contributing to the reduction of regulatory capital, the timing of crossing below regulatory minimum requirements (the Point of No Return or PNR), and point at which regulatory capital reaches its lowest point in the forecast horizon (the Point of Maximum Stress or POMS).

The findings will guide our next steps.

If the results indicate a relative strength of the bank’s assets, we will advise the management and board about communications with their stakeholders, regulators and D&O insurers. We will also work with them to flag any potential areas to monitor as part of their risk management processes. Additionally, we will discuss the opportunities or concerns associated with any capital-related strategic decisions they may be considering.

If the results indicate a less than favorable capital adequacy scenario, Invictus advisers (with decades of experience in commercial banking, credit, investment banking, research, insurance and regulatory areas) can provide a series of realistic, practical solutions. These curative options consider both the projected capital shortfall AND the timing and include:

• Analyzing and executing acquisition or disposition of assets of business lines.
• Identifying and executing funding strategies.
• Establishing enterprise value.
• Executing acquisitions and mergers.
• Iimproving information flow to regulators and insurers.

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