602-840-0606
Toll-Free: 800-238-7475
contact@cmyers.com
602-840-0606
Toll-Free: 800-238-7475
contact@cmyers.com
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Net Economic Value: 1 Tip on Effective Discount Rates
ALM Blog PostsThere are many tools that can be used to perform a model reasonableness check, or a model validation. Below we share a simple “sniff test” to help credit union CFOs and financial analysts assess one key assumption driving net economic value results, the effective discount rate applied to each loan category.
Tip: Compare the effective discount rate in the current interest rate environment to the applicable loan portfolio yield. Understand the reasons for material differences.
You might be thinking – “Why do I need to see the effective discount rate in the current environment if I can see the values?” Well, how do you know if the starting value is reasonable?
Seeing the assumed effective discount rate and comparing it to the loan portfolio yield would help you think in terms you deal with every day. For example, if you could see the weighted-average yield of your auto loan portfolio has been holding steady at about 5.50% yet the assumed effective discount rate in the current environment is 2.75%, you would probably want to understand why there is such a disparity. You begin asking questions.
Are we charging our members above market rates? If not, what might be the reason that our yields are so much higher than market? Do we accept a higher than typical credit risk? Perhaps insufficient credit spreads are being applied to the assumed discount rate.
Are there other unique lending practices that we perform that might account for higher than market yield in our portfolios? For instance, if your mortgage rates are materially higher than the effective discount rate, dig deeper. Maybe your mortgage loans are non-conforming and the discount rate has not been adjusted appropriately. Ask yourself why a purchaser of non-conforming loans would not want to be appropriately compensated for a potentially higher risk and less liquid asset.
Even if your ALM model touts that a unique spread is being applied for every single loan, you should still step back to determine the reasonableness of these assumptions and understand the overall portfolio effective discount rate for the current interest rate environment relative to your portfolio yield.
Performing this quick reasonableness test helps bring a common sense approach to values and ultimately NEV results.
Interest Rate Risk Policy Limits: One Big Misconception
ALM, Interest Rate Risk Blog PostsWe often see interest rate risk policy limits that rely too much on net interest income (NII) volatility and miss the absolute bottom-line exposure. Such reliance can cause boards and managements to unintentionally take on more risk than they intended. Why? Because these types of policy limits ignore strategy levers below the margin.
Establishing risk limits on only part of the financial structure is a common reason for why risks are not appropriately seen. Setting a risk limit focused on NII volatility does not consider the entire financial structure and can lead to unintended consequences.
For example, assume a credit union has a 12-month NII volatility risk limit of -30% in a +300 environment. The table below outlines their current situation and the margin and ROA they would be approving, as defined by policy, in a +300 bp rate shock.
By definition, the credit union is still within policy from an NII perspective but because of the drop in NII, ROA has now decreased from a positive 0.50% to a negative 0.43%. This example helps demonstrate that stopping at the margin when defining risk limits can result in a false sense of security.
Not All 30% Declines are Created Equal
To punctuate the point, let’s apply the 30% volatility limit to credit unions over $1 billion in assets using NCUA data as of 3Q/2015.
On average, if this group of credit unions experienced a 30% decline in NII in a +300 bp shock, the resulting ROA would be 6 bps.
But each credit union’s business model and strategy are unique. So instead of looking at the average for this group, let’s look at the potential range of outcomes.
This enormous range of ROA, and with so many credit unions at risk of negative earnings, helps demonstrate that an interest rate risk limit along these lines could result in material risk with the unintended consequence of institutions being potentially blinded to the exposure of losses.
Strategy and Risk Management – Is Leadership in Sync?
ALM, Strategic Planning Blog PostsUnderstanding and prioritizing strategy has never been more complex, especially as new disruption continues within the industry. Beyond delivering valued products and services profitably to members while remaining safe and sound, decision-makers face new threats to remaining relevant as non-traditional competitors create inroads into financial services. With limited resources, success can depend on choosing the right path.
Creating an optimal strategic focus requires decision-makers to share a common understanding of threats to the business, and a clear assessment as to which of those threats warrant attention and resources. This is where linking risk management practices to strategic planning can provide effective guidance.
Consider the following simple, yet powerful, exercise with your team:
Note: We are using relevancy as a broad category to describe the myriad of new competitive pressures and changing member expectations. This should be customized for your credit union’s uniqueness.
THE VALUE
Here’s where this exercise can create significant value, as decision-makers begin to link results with their gut feeling and appetite for risk. What is your level of risk? Where does it exist? Where would you most want to see improvement? For some, these discussions may identify:
Each of these outcomes can create opportunities for the credit union such as:
In addition to aligning strategic planning with risk assessments and management, consider the benefit of knowing that the leadership team shares a deeper, common understanding of the risks facing the credit union and the reasons driving strategic priorities.
As the credit union industry changes and faces new competitive pressures, linking strategic planning and risk management could be key to ensuring ongoing success.
Process Improvement Takes Strength
Process Improvement Blog PostsExcerpt from CUES Magazine – Published January 2016.
The challenge with process improvement is that it is not for the faint of heart; it requires rebels who are willing to step up and tear processes to shreds, and rebuild them from the ground up.
It is not human nature to constantly challenge the status quo. It takes a rebellious nature to question everything and accept nothing at face value. The death stroke of a good process improvement plan is the belief that everything is fine because “that’s how we’ve always done it, and it’s never been a problem.” A huge advantage non-traditional competitors have is that they are not bogged down with legacy thinking and processes.
Rebels are required to shake things up.
Process improvement is a habit credit unions can create to find better, faster, and easier ways of bringing value to members and employees. In some credit union circles, process improvement is slowly gaining traction as one of the most important tools in a credit union’s hip pocket.
Click here to read the full article on the CUES website.
Strategic Planning for Mobile Users
Strategic Planning Blog PostsIt is a safe bet to assume that many credit union strategic plans include a focus on engaging mobile users. One of the first steps in engaging a consumer is to better understand them.
The Federal Reserve’s report, Consumers and Mobile Financial Services 2015, is nothing short of a treasure trove of data that has been reformulated into potential decision information. We’ll explore data about the various ages in which consumers use mobile banking.
Excerpt from Consumers and Mobile Financial Services 2015 Report
Table provided by Board of Governors of the Federal Reserve System
At first blush it may seem to confirm what we hear far too often – that Millennials should get the biggest allocation of marketing dollars – but it is important to not just view usage in absolute numbers. Understanding trends, including the rate of growth, can be eye opening. Viewing data from various perspectives can open doors for new opportunities.
If you take the data from the table above and dig deeper, you will see that, while one year does not make a trend, it should not be ignored that the youngest group had a decline in usage (see below). Meanwhile, the age groups that tend to have deeper relationships with their credit union show a healthy rate of growth.
Take Advantage of the Treasure Trove of Data
If you haven’t started already, dig into the data your credit union has for your members. As we’ve seen with so many strategic planning clients, once you have reliable data about what your members are doing with your credit union, you can easily start asking more of the right questions. Answering these types of questions, based on relevant data, will likely result in actionable decision information.
Keep in mind the more questions you answer, the more questions you will have!
Just a few questions to ask when strategically planning for mobile banking:
Many credit unions have access to this type of invaluable data, without significant hard costs to access it. The biggest investment is the time to ask and answer the thought-provoking questions. However, investing time to tap into member data and turn it into relevant decision information to drive strategic discussions, decisions, and planning is no longer optional.