Following the January 25th meeting, the Fed released a forward-looking rate forecast.  This forecast shows the range of predictions made by Fed officials about the level of short-term interest rates in the fourth quarter of 2012, 2013 and 2014.  The forecast also estimates when the Fed expects to begin raising short-term rates, and describes what the Fed plans to do with their investment portfolio.

The rationale for this change in policy is to provide more clarity for businesses and consumers as to the direction and level of short-term rates.  The hope is that it will spur additional borrowing and economic growth (though it is possible this will not have any material impact on businesses or consumers, as most already expect rates to remain low for a while).

However, this shift in policy raises several questions that decision-makers should consider:

• How might other financial institutions respond? Now that the Fed announced rates are likely to remain low into 2014, do financial institutions further adjust loan pricing—dropping rates even further?
• Will financial institutions take additional risk in their loan and investment portfolios by extending maturities?
• Will there be additional market demand for short- and medium-term investments, further driving down yields?
• Does this push decisions to “hedge” balance sheet risk further down the road, at which time hedging could become too expensive?
• Why is the “risk management” function in place? To inform decision-makers about how the institution could fare in the face of unlikely events.  Institutions that put too much reliance on Fed forecasts might spend less time preparing for the unexpected
• Is the Fed always right? Consider Fed Chairmen Ben Bernanke’s quote from his July 2007 testimony to Congress when he said, “Overall, the U.S. economy appears likely to expand at a moderate pace over the second half of 2007, with growth then strengthening a bit in 2008 to a rate close to the economy’s underlying trend.”  Unfortunately, the economy worsened materially in 2008

The Fed is a group of people, each with their own opinions.  They also do not have total control over all of the factors that would impact the level of rates.  Therefore, the Fed forecasts could be wrong.  However, the forecasts might lead to overconfidence, causing institutions to make decisions they might not have made otherwise.

Sources:
Fed Expects Low Rates Through 2014, WSJ, 1/26/12
Semi-Annual Monetary Report to the Congress, Federal Reserve Board, 7/18/07

Credit unions need to analyze and understand their loan pipeline.  Many institutions currently look at their approval ratio or a “look-to-book” that tells them the percentage of applications being funded.  Both of these measures have value but don’t necessarily provide the full picture.

Ideally, credit unions should be looking at the number of applications, percent of applications approved, percent of applications funded and percent of approved applications funded.  Additionally, credit unions should be looking at how those numbers have changed over time to identify trends.  Reviewing this information by delivery channel can also be helpful.

Below are just a few questions decision-makers should consider as they analyze the more comprehensive view of their pipeline:

• How have the number of applications and the percentage of approvals and funding changed over time?  Why?  For example, the credit union may be approving and funding the same ratio of applications as during the boom times of 2005 and 2006, but the number of applications has decreased.  As such, they need to look into how to increase applications
• How have credit standards changed?  What impact is this having on approvals and denials?
• Besides credit score, why are members not being approved?
• What are the top three reasons approved applications are not funded?  These reasons can identify opportunities to increase loans and revenue without having to adjust credit standards to do it

With these answers, credit unions can determine how best to make changes that will increase loans funded and increase revenue.

Rates are low and, given news from the Fed, expected to stay low for the time being.  Some members are taking the Fed at their word and are beginning to move their funds into intermediate and longer-term CDs.  Before assuming this can help provide interest rate risk protection credit unions should answer a few questions.

CDs come with an early withdrawal penalty, but are your penalties enough to keep members from withdrawing their funds if rates move up? Consider the following example:

A credit union is offering a 5-year CD at 2% with a 6-month early withdrawal penalty.  One year after a member takes this CD, rates have increased.

Question:  How high would rates have had to increase over this year to put the member in a position to take the early withdrawal penalty and break even?

Answer:  Rates would have had to increase just 25 basis points (bps).

If the member takes the CD out early, they are charged a 1% penalty.  However, the member still has a 4-year investment horizon, which, if they can earn an extra 25 bps per year, equals the 1% penalty taken to pull their funds out early.  If rates increase more than 25 bps then it is a “no-brainer” for the member.  Some say that their members won’t early withdraw because they are fee adverse, but after years of pent up demand for more yield, it is hard to bet that the member won’t withdraw.  If there is a small fee to get a mortgage, does it stop someone from refinancing to a lower rate?

If the credit union is happy that it at least got the funds from the 6-month penalty, consider that the 2% rate minus the 6-month penalty results in a net cost to the credit union of 1% for what wound up being a 1-year CD.  1% for a 1-year CD is rather expensive for the credit union if there is not corresponding loan demand.

If rates don’t change, the member will continue to receive 2%, costing the credit union more than most investments would yield without taking substantial risk.

Credit unions do a lot of great things for members.  The key in this difficult environment is to make sure that the areas of giveback are intentional and understood.  Without such understanding, costs and risks can unintentionally increase.

What can be done if you decide that it isn’t in the credit union’s best interest to add an additional giveback?

Consider not trying to be top of the market on intermediate and longer-term CDs.  Some credit unions have increased the penalties on intermediate and longer-term CDs.  Eighteen months or half of the term are examples.  You could have the stiffer penalties for your current CD rates and offer lower rates for members that want the flexibility of a lower penalty.

This may seem like an odd question but it’s probably not asked enough.  Planning for the future usually revolves around all the things you ARE going to do.  However, c. myers has observed that one key to credit union success is deliberately making “no” or “stop doing” decisions.

Every product, service and delivery channel the credit union offers uses resources.  Because resources are not unlimited, it is critical to direct them only toward those items that are aligned with strategy.  This not only applies to new initiatives but also to decisions that were made in the past that no longer serve the credit union’s strategy.

Try holding a brainstorming session specifically dedicated to “no” decisions.  Spend an hour making a list of past “no” decisions and possible future “no” decisions.  Using your strategic plan as a decision filter, consider how each idea on the list aligns with strategy.  This should make your strategy stronger as a result.

We’re interested to hear from you on this subject.  What “no” decisions have you made in the past?  Do you think those were good decisions now?  What “no” decisions are you planning to make going forward and why? Feel free to comment below, or email us at:  smay@cmyers.com.

During a recent education course, we fielded the following question:  “How do you develop a proxy for a worst-case loan loss assumption when aggregating risks to net worth?”

This is a great question and it stimulated lively discussion.  While there is not one right way, the following method has been valuable in developing concentration risk limits designed to address credit risk.  This method looks back over a specified timeframe (a common, initial look-back is 5 years) and identifies the 6- or 12-month period that experienced the highest annualized loss rate for each loan category.  Each rate is then applied to the current balance of each respective loan category and totaled to come up with the dollars for the total worst-case loan loss assumption.  Frequently, a factor is added to answer, “what if we had to absorb losses beyond our worst historical experience?”  Common factors include increases of 33%, 50%, or even 100% above the worst historical experience.

With many credit unions having just come out of their worst credit loss experiences in memory, this method captures and utilizes the information gained during that environment.  This method is easily reproducible on a periodic basis and can be re-evaluated annually to ensure that the risks are sufficiently captured.  As time progresses, and as loss histories for various loan categories continue, the loss rates may need to be adjusted to account for new loss experiences in order to keep the spirit of capturing a “worst-case” environment.  This process will help to ensure that a credit union’s management and board do not lose sight of the credit union’s worst credit loss experiences.

Whether or not the above methodology is utilized, one thing is abundantly clear—documenting the rationale behind a worst-case loan loss assumption is an absolute must!

Looking over the last 12 months, what has happened to your credit union’s net interest margin? If yours is like most credit unions, the answer is it has declined. Competition for loans and low interest rates continue to erode yield on assets.  Cost of funds has declined but (for most places) not enough to completely offset the reduction in asset yields.

If interest rates remain low throughout 2012, the yield on assets will continue to decline.  Can the cost of funds be reduced further?  For some, the answer is yes; however, others are at, or near, the floor.

Below the margin, many credit unions have made cuts to operating expenses over the last couple of years.  Most of the “low hanging fruit” has been picked.  Some credit union managers are feeling they have done everything they can do with operating expenses, yet earnings still aren’t where they would like them to be.  What can you cut after you’ve cut everything?

Sustainable expense reductions often come not from cuts, but from improving processes.  Have you examined and mapped out all the processes at your credit union? If so, were you surprised (shocked?) by what you learned?  We’re doing what!?!

Improving processes to remove unnecessary steps, to move members through the process faster and free up employee time, can both reduce expenses and increase revenue.  Remember that every minute a frontline employee spends completing a non-value-add step in a process is a minute less they spend interacting with members.

For many credit unions, the margin continues to be squeezed and loans as a percent of assets continue to decline.  For these and several other reasons, strategic allocation of financial and human resources becomes more important every day.  Focusing on things that are in the credit union’s control can be very beneficial.  We feel that this is such a critical issue that we are re-posting the following blog on Project Management:

Who doesn’t want to have the right things done, at the right time, within budget?  Nobody.  Yet, across all industries, up to 72% of projects fail (Source:  The Chaos Report, Project Management Institute, April 2009).  A poor project management process is the single largest reason for this high rate of failure, which costs money, wastes time and increases frustration.

In today’s chaotic environment, it is advantageous for management teams to focus on the key items in their control so they are better prepared to handle the blows from external forces that are likely to persist.  One of the key areas over which managements have most control is strategic allocation of human and financial resources (efficiencies and operating expenses).  This strategic allocation is critical to the success of daily operations as well as new projects.

Many credit unions are undertaking projects with the intent of bottom line improvement that are failing or adding to expenses due to lack of prioritization, proper scope and execution.  The following three actions can improve strategic allocation of human and financial resources, efficiencies, and employee, management and/or member satisfaction:

1. Developing an effective, repeatable project management process
2. Dissecting key processes and implementing appropriate changes to create sustainable efficiencies
3. Creating a reliable process for CEOs and senior managements to use to successfully manage a portfolio of projects

For a more detailed framework on how to achieve these actions and possibly an improved ROA, please refer to our recent c. notes articles:

• Project Management:  Essential Project Planning, November 2009
• Project Management:  Execution, Control And Closure, December 2009

According to recent news articles, outstanding student loan debt is expected to hit $1 trillion this year for the first time.  Researchers say that Americans now owe more on student loans than on credit cards.

As students are borrowing more than ever, the amount of delinquencies is growing too.  Student loan delinquencies (loans more than 90 days past due) are now at 11.2%, up from 10.6% in Q1 2011.

Student loans are difficult to shake because borrowers can’t get rid of them with methods like personal bankruptcy.  At the same time, increasing amounts of student borrowing could have a major impact on the future economy.  Experts say that students who borrow too much will delay things like buying a car/home, getting married and having children.

If your credit union offers, or is thinking of offering student loans, there are 3 important questions to consider:

1. Is it the credit union’s responsibility to ensure students do not over-borrow?
2. What is the best way to manage borrower expectations to not lose trust if the credit union is forced to take collective action?
3. If the laws change regarding student loan collections, what must the credit union do to prepare?

Sources:

• Scariest Student Loan Debt Numbers Ever:  $100 Billion, $1 Trillion, TIME Magazine, 10/19/11
• Student Loans Outstanding Will Exceed $1 Trillion This Year, USA Today, 10/18/11

Over the past 20 years, c. myers has worked with many credit unions of varying sizes, and during that time, we have watched credit unions thrive based on a few key factors.  Below is a quick list of observations we call the 6 Keys to Credit Union Success:

1. Strategic Clarity: Successful credit unions know:

• Why are we in business? (Purpose)
• Who is the strategic focus of our business/marketing plan? (Target Market)
• What do we do/offer that our target market will find valuable and motivate them to do business with us? (Value Proposition)
• How will we uniquely deliver on our strategy and value proposition better than our competitors? (Competitive Advantage)

2. Making “no” decisions: Have you ever been asked whether you would jump off a bridge if someone else was doing it too?  Successful credit unions would rather strategically say “no” to opportunities or initiatives rather than jeopardize future success.

3. Data Information equity: It’s not enough to have simple facts or data; a credit union must dig deeper to truly understand how its business/members are behaving, and why.  Successful credit unions are able to deliberately analyze their data for information that can lead to strategic decision making.

4. Mass customization: There’s an adage that says “You can’t be all things to all people.”  This is true; however, in some ways, you can be all things to your target members.  Imagine serving members with an “Amazon-ish” business model, where you customize your credit union’s offerings to a member based on that member’s needs and desires.

5. Make it easy: There’s a reason why fast-food joints have proliferated over the past 30 years—people want things to be EASY.  Successful credit unions know that efficiency allows them to better serve members.  This, partnered with customization, can translate to more volume of quality business.

6. Talent, talent, talent! No matter how many right things your credit union might do, if you have the wrong people doing them, you might as well not do them at all.  Successful credit unions take seriously their approach to hiring problem solvers who will be passionate and think strategically for their organization.  These credit unions also make sure that everyone is in the most appropriate role for their skill set.

Bank of America announced Tuesday that it would not proceed with its plan to charge its customers a $5 per-month debit card usage fee.  The announcement has been claimed as a victory by many groups, such as the “Occupy Wall Street” movement, but for businesses everywhere, including credit unions, the announcement reinforces some lessons.

The power of the internet/social media: A 22-year-old BofA customer launched an online petition shortly after the bank announced the proposed debit card fee.  Reports indicate the petition drew as many as 100,000 signatures within a week.

The internet is a double-edged sword for businesses.  It can be used to generate buzz about exceptional service/products.  It can just as easily inform potential members/customers of policies or services deemed “bad.”  Think through social media strategies carefully and “what if” them with the bad things that could happen, and what the response might look like.  Also ask the question, do we need a social media strategy?

The importance of thinking through actions before implementing them: How does BofA’s decision to scrap these plans make them look to the public—like a corporation that listens to its customers, as they claim, or as a desperate one, grasping at straws and not thinking through their actions?  How will this affect their reputation?  Arguments can be made on either side, but many are left wondering what else the bank has up its sleeve.

A question more specific to credit unions is, what affect, if any, will this news have on November 5th’s Bank Transfer Day, the day designated for Americans to close their accounts at big banks and move their funds to smaller banks or credit unions?  Will consumers who were going to participate still move their banking, or was the debit card fee a big decision driver for them and now they will stay put?  Only time will tell.

What do you think?  Click here to let us know what you think will happen on Bank Transfer Day.

Source:  Under Pressure, Bank of America Drops $5 Debit Card Fee