Main Menu | Budgeting
The process of generating a budget for an institution involves making best guess assumptions on the growth of the institution, estimating non-interest income and expense, and attempting to predict future pricing rates and associated effects on prepayment of the existing volumes. Through the accurate interest income and expense assumptions generated by IRR-Solutions® II , projected bottom line results on a period by period basis will be obtained.
This process is similar to the periodic effort in accurately projecting the institution’s interest rate risk in the Advanced Income Shock module. However, while the interest rate risk process focuses typically on a 2 year rolling time frame and involves analysis of immediate shock results in various shock scenarios , the process of a budget focuses on results for the next fiscal year, with the ability to emulate rate changes throughout the budget periods. IRR-Solutions® II separates the modeling: In the Advanced Income Shock module, modeling is done for shock scenarios. In the Budgeting module, the modeling is done in budget simulations.
The process for establishing a model simulation involves setting assumptions for growth, reinvestment rates, index rates, and prepayments, as anticipated for the upcoming budget year. The growth assumption is shared with the Advanced Income Shock module (saving time in volume projection setup in the model). Once an acceptable set of projections has been produced (through an iterative process of adjusting the assumptions and reprocessing), a Budget Set representing the projections for the coming fiscal year can be saved. This Budget Set represents the institution’s “Budget” which can be used throughout the year for variance reporting against the institutions actual performance.
Once a Budget Set has been saved, it is static and will not be affected by any changes in the simulation assumptions of the model. However, multiple budget sets can be created representing revised budget assumptions and projections, or an existing budget set can even be revised by re-saving new projections.
The budgeting process in IRR-Solutions® II has been greatly improved by providing the ability to change reinvestment , index rates, and prepayment assumptions over time. This provides the ability to forecast market rate changes and resulting changes in prepayments, if applicable, into the budgeting process.
Along with the ability to project rate changes, the ability to simulate multiple rate environments also exists. Even though the actual budget will settle on a selected simulation for how market rates are expected to behave within the budget year, modeling the effects on the institutions bottom line in opposite environments from the expected can provide management with useful information regarding the institutions bottom line performance.
In order to accurately project new volume and their resulting earnings, IRR-Solutions® II uses a process of internally generating items representing the new volume for a given period. These internally generated or replacement items model the typical type of item that exists in the account. The characteristics of these items are based upon the average structure within the account. For example, if the average maturity of the fixed rate items in an account is 18 months, then each new fixed rate internal item is assigned a maturity of 18 months. A similar technique is used for adjustable rate items to define the average time to the next rate reset.
This process builds replacement item detail so that projected results can be modeled with potential rate changes in each projection period. Once replacement items mature, they are replaced with new replacement items at the pricing rate in effect for their replacement month. Adjustable rate items will reset their rate to the effective rate in the period of their adjustment month. Overall, this process gives IRR-Solutions® II a high level of projection accuracy with the information present from the institution.