I got feedback from two clients on my previous post about the gap report and callable securities.  One was the client in question, the other from someone who read the post.  (That blows my theory of zero readers out there.)  Both conversations where of the “Yea, but…” variety.  In other words, “I agree, but your wrong to dismiss the gap report”.

Just so we’re clear, I hate the gap report as an interest rate risk tool.  I have ever since we got out of the in-house modeling business to focus on our out-sourced service A/L BENCHMARKS.  I was even a big advocate of removing it from our report set altogether.  The trouble was we started to hear, “Well, the Olson model can’t even produce a basic gap report, how good can it be?” or similar comments.  So the gap report stayed.

My pet-peeve is that I’m still asked about it all the time.  I constantly hear from bankers, examiners and auditors who want us to “correct” our gap report.  Here’s a list of common complaints we get about the gap report we provide in A/L BENCHMARKS:

• it doesn’t match my call report (RC-B, RC-C, and RC-E);

• it doesn’t match the gap report we prepare internally for liquidity purposes;

• you should include non-interest bearing DDAs;

• you should include cash;

• you should gap all callable bonds at their next call date;

• you shouldn’t represent amortizing flows for loans and MBS/CMOs (but I should still represent prepayments! Huh? How’s that for inconsistency!);

• the decay buckets used for EVE simulation don’t show-up on your gap report;

This is only a partial list.  The funny thing is for every, “you should include DDA”, I’ve also heard, “you shouldn’t include DDA”.  I’ve heard a similar contradiction for every point listed above.  It’s definitely been frustrating, especially when you hear some of this from bank examiners.

There is no standard gap report folks.  Everybody has their own rules.  I thought the industry had reached that conclusion long ago, back in 1996 with the JPS on Interest Rate Risk:

Bank management should ensure that risk is measured over a probable range of potential interest rate changes, including meaningful stress situations. In developing appropriate rate scenarios, bank management should consider a variety of factors such as the shape and level of the current term structure of interest rates and historical rate movements. The scenarios used should incorporate a sufficiently wide change in market interest rates (e.g., +/- 200 basis points over a one year horizon) and include immediate or gradual changes in market interest rates as well as changes in the shape of the yield curve in order to capture the material effects of any explicit or embedded options.

You just can’t do that with any derivation of gap report.