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Considering New Systems? How to Improve Chances for Success

Many credit union management teams are considering changes to their mobile platform, home banking, loan origination system (LOS) and/or account opening system (AOS).  The following are just a few (of many) tips to consider:

  • Get clarity before submitting RFPs.  As a leadership team, agree on your decision drivers and the specific business objectives you are trying to achieve
  • Sort out the “must haves” versus the “nice to haves” and reach consensus as a leadership team
  • Document your agreements and rationale—people are overloaded and memories can be fuzzy and short
  • Map the ideal process.  It is invaluable to map the ideal process as part of your discovery.  It helps teams clarify objectives and sort out priorities before submitting RFPs
  • Remember, the IT department is only a fraction of the resources that will be needed on these types of endeavors.  Many departments will be involved so be sure to identify the resources needed for each (think of testing, training, marketing, compliance, etc.)
  • There is no perfect system.  Choices and sacrifices will have to be made.  When faced with these decisions, always go back to your decision drivers and business objectives
  • As the saying goes, don’t pave the cow’s path!  It’s surprising how many businesses spend tons of time and money implementing slick new technology, only to follow the same processes used with the previous system
  • Before pulling the trigger, agree on other projects that will be put on hold.  Again, document your agreements and rationale (memories are fuzzy and short!)
  • Have a rigorous process to sort through the many times you will hear or think, “wouldn’t it be cool if…?”  Technology is often filled with good intentions of using all the cool bells and whistles.  Yet for many, the only people that know about the cool features are the people in IT who installed the technology.  If you get bells and whistles, don’t forget to develop plans to tout them to your employees and members
  • Have a Senior Executive Sponsor who clearly understands the credit union’s strategy, business objectives and priorities who is involved in both discovery and implementation

Installing a new home banking, LOS or AOS is a venture that should not be taken lightly.  There is more on the line than just a successful implementation—the credit union’s reputation could ultimately be at stake.  It will be critical to weigh and measure every decision with the gravitas these projects deserve.

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Making “No” Decisions

One of the key characteristics of a high-functioning credit union is the ability to make “no” decisions in order to stay focused on the credit union’s strategic direction. As this year starts and the project list grows, it will be important to keep a laser-like focus on the projects that the management team has determined are the most important for achieving the credit union’s strategic objectives.

With 100% certainty, there will be many “shiny new objects” throughout the year that will be highly tempting or considered “must haves.” Before committing to those “shiny new objects,” it will be critical to take the time to filter them through the credit union’s strategic direction and objectives to see if or how they fit.

If they truly fit, then deliberately consider the timing of taking on more. Are these “shiny new objects” really top priorities or would the credit union be better served by delaying the start date so as not to distract from current strategic objectives?

Mastering the skill of strategically allocating resources is exceedingly important because technology innovations are happening at lightning speed. In the meantime, distractions will need to be put in the “no” or “not right now” column.

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Evaluating Derivatives―Part III: Economic Value as Rates Change Instantly

This blog will begin to review the economic value of a swap when testing an instantaneous rate change. This builds on the blog Evaluating Derivatives—Part II:  Economic Value.  As before, the example swap has the following terms:

  • 7-year term
  • Notional amount: $100 million
  • Credit union pays fixed rate of 2.00%
  • Credit union receives 3-month LIBOR (~0.25%)

The base value of zero is assumed to increase to $6.1 million for a +100 shock. In the example below, the dash line shows the implied path to arrive at the $6.1 million value.

+100 Implied Path Graph
Derivatives analytics provided by The Yield Book® Software.
Note that the rate shocks identified below are layered on top of the “implied rate path” used to establish the pricing of the swap on day 1.

If rates were to instantly increase 100 bps, the credit union’s initial cash flows are still negative. In other words, even if the market value increases it does not necessarily mean the credit union will experience positive cash flows. The reason the value increases is due to the implied path. The rate shock shifts the entire implied rate path up 100 bps. Note, if rates don’t follow the implied path, rather they stay flat after the 100 bps increase, then the cash flows would remain negative for the entire time frame.

The example above Is only for 100 bps increase, if larger shocks are tested, the same methodology is applied, creating larger values.

Economic Value Table

So what is the take away? When evaluating rate shocks, it is important to understand how the implied path affects values.

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Evaluating Derivatives―Part II: Economic Value

In a previous blog, impact to earnings was discussed as it relates to derivatives and the insurance they can provide against a rising rate environment. While derivatives can be a good option for hedging interest rate risk, especially in today’s low rate environment, it is also important to consider how economic values are determined.

Because of the complexity of this topic, there will be a series of blogs so that we can keep them relatively short.

On day 1 of a swap transaction, the swap’s economic value will be zero, meaning the economic value will not reflect a gain or loss in the current rate environment. This value will change over time even if rates don’t change.

Why is the beginning base economic value zero? The present value of expected cash flows for both the fixed-rate party and the floating-rate party are assumed to be equal.

Using the swap example in Part I:  Earnings, the party paying fixed starts with a large negative cash flow. In order for the present value of cash flows to be equal, the pay-fixed side would need to have positive cash flows at some point in the future.

For the example swap (pay fixed 2%), the math indicates that short-term rates would need to go up about 300 bps before the swap matures in order to offset the present value of the initial negative cash flow.

Implied Cash Flow GraphDerivatives analytics provided by The Yield Book® Software.

The expectation that rates go up needs to be understood since the results would be quite different if the implied rate path does not come true. This critical consideration will be addressed in more detail in future blogs.

We will also address questions such as:

  • How do the value results differ from actual earnings?
  • What could cause the values shown to not come true?
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What Changes Will Low Oil Prices Bring?

The low price of oil is affecting communities across the nation in a variety of ways, depending on their relationships to energy-related industries.  We’d like to hear from you – how is it affecting your credit union?  What changes do you anticipate in lending?  What other areas could be affected?