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Key Business Questions

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When credit unions evaluate changes in strategy or financial structure, the focus from an A/LM perspective is often on valuation and net interest margin.  However, these traditional approaches to measuring risk will not answer several critical business questions.  Consider, does NEV or net interest income analysis allow a credit union to see:

  • Under what rate environments could the decisions we have made and implemented cause us to have materially reduced or negative earnings?
  • Under what rate environments could our existing business cause us to no longer be Well Capitalized from interest rate risk?  How does the answer change as other risks are aggregated?
  • What does our new business need to earn going forward in order to achieve our net worth and asset size goals and offset existing risks?
Key components of risk will be missed in the analysis process if there is not a consistent focus on understanding long-term, bottom-line profitability, as well as incorporating the aggregation of other unexpected events.  Remember your credit union only puts net worth dollars at risk through bottom-line negative earnings.  Do your A/LM tools allow you to see when negative earnings could occur, and when they do, what the magnitude could be?  If not, consider what risks might be missing.
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Project Closure: The Handoff to Process Improvement

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It is true that projects, by definition, have a definitive end. Planning for development and implementation is painstaking. Test cases are created and tried, there are usually at least a few bumps in the road but finally a project manager reaches the “go-live” date for the product, service or other initiative and, boom—the project is completed.

However, effective businesses don’t leave completed project outcomes “on the shelf” to collect dust. An important component of process excellence is reevaluation of completed initiatives by way of process improvement. In the initial stages of project management, key objectives for the project are defined and project managers get agreement from stakeholders that the project will meet the stated objectives. However, evolving consumer behavior and other changes in the economic and competitive landscape will always change the definition of success and will inevitably alter how effective old initiatives are for meeting current objectives. As such, it can be helpful to go back to the basic concepts of process improvement:

  • Define (or redefine) the objectives
  • Measure speed, quality, and cost
  • Analyze effectiveness based on the measures (in light of objectives)
  • Improve? Based on the outcome of the analysis, is improvement necessary to satisfy stakeholder objectives?

The moral of the story is a simple one: If a project is initiated and completed—but the process outcome no longer meets its intended objectives—it’s time to reevaluate the process.

A successfully implemented and completed project does not guarantee ongoing success. Continuing to monitor the performance against objectives will be critical. Too often businesses will leave established products, services, and processes on autopilot—which could be wasting valuable resources and potentially causing lost opportunities and/or revenue.

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Project Management Tip #25: Beware the Yes Men

If you hear “yes” a good deal—beware! You might be surrounded by the notorious “yes men.” It is hard for some project managers to ask resources for help, and then when they do they are relieved to hear those resources say “yes” they can complete tasks for a project. The problem arises if these resources are saying yes to all the other unrelated tasks that are also being offered to them throughout the day. When resources say yes too often, they become a risk for putting the project in jeopardy. “Yes men” often agree to things, in hopes of being people pleasers. They are not doing it to cause headaches, and they might not realize they are doing it at the time. When these “yes men” resources take on too much, there are a limited number of outcomes that could occur, and none of them are good:

  • The resource could drop the ball for the tasks they agreed to on the project
  • The resource could drop the ball for the tasks they agreed to on other projects
  • The resource could fail to complete the tasks in a timely manner
  • The resource could fail to complete the tasks with quality
  • The resource could run out of time and choose to complete some tasks after hours, straining themselves and throwing off their work/life balance

Each of these outcomes has the very real potential of causing a domino effect.

For big projects that require many tasks make sure that, as the project manager, you are vetting the “yes” you receive with proof that your resources can truly handle their workload. This might require courageous conversations and, sometimes, a shift in the credit union’s culture.

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Betas – An Unintended Consequence of Simplifying Pricing Assumptions

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Non-maturity deposits (NMDs) and their treatment in A/LM modeling is often a hot-button topic with examiners and management teams.  While there are key risk characteristics of NMDs not addressed with many methodologies (see previous blog entries below), the topic of this blog concerns NMD pricing assumptions.

Pricing assumptions for NMDs can be called by many names – derived rates, betas, rate sensitivity factors (RSFs), etc.  However, regardless of the name, the objective is to generate a model assumption for NMD pricing in a given interest rate environment.

Pricing betas assume that the credit union will adjust non-maturity share pricing based upon some percentage of the overall movement in prevailing market rates (often indexing to short-term rates).  While the methodology and approach may seem sophisticated, the implementation of such an approach reduces the flexibility of A/LM models to address changes in pricing strategy for the current rate environment and automatically results in assumption changes for rising rate environments. For example, consider running a what-if through an A/LM model adjusting today’s share pricing strategy:

The unintended consequence of pricing betas results in a lower share rate in changing rate environments, as outlined below:

In the above example with a 45%beta on money markets, the +300 basis point (bp) rate is 0.15% less than the base case assumption for the same rate environment.  Was the intention of running the what-if to test a 0.15% reduction in money market rates today, or was the intention to carry that same reduction in rates through all rate environments simulated?

Utilizing a prescribed pricing strategy, such as derived rates, allows management teams to develop a pricing assumption based upon the level of prevailing market rates – and does not result in unintended assumptions changes in key rising rate environments.  If your model does not have derived rates capabilities, then the model should be re-calibrated frequently – minimally with each change in current pricing levels.  Having derived rates capabilities adds control over model assumptions in risk limit rate environments and also can give management teams confidence that they are testing the impact of changing share rates today without automatically adjusting share rates in simulated rising or shocked interest rate environments.

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Prepare for Your Upcoming Exam

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A successful exam is often tied to the preparation done in advance. Simply having the most recent A/LM results ready, without understanding the overall risk profile and rationale for key assumptions, is not a recipe for success.

One best practice in preparation for an upcoming exam is to anticipate some questions that could arise and how management would respond. For example:

  • How is the credit union positioned with respect to interest rate risk and liquidity risk?
  • How did management determine their A/LM policy risk limits? Is the credit union within established limits?
  • What are the loan prepayment assumptions used in the A/LM modeling and how were they determined?
  • What are the non-maturity deposit assumptions used in the A/LM modeling and how were they determined?
  • Has management run stress tests in the A/LM model with other maturities, rate sensitivity factors, decay rates, prepayment assumptions and/or performed other what-if analysis? If yes, does it materially change the risk profile?
  • Does management document the model assumptions and any changes made to the model assumptions?
  • Have there been any major changes to the credit union’s strategic plan or business plan, or are there any future events that will change the credit union’s interest rate or liquidity risk position?

A/LM providers can be a resource for exam preparation. Quarterly results calls are a great opportunity for decision-makers to gain a better understanding of the credit union’s risk position. Also consider an exam prep call with your A/LM provider a week in advance of the exam. There is always an element of unpredictability when it comes to examinations but following this practice can better position the credit union for success.