/by

Selling Investments for Liquidity

A few weeks ago, we discussed increasing loan-to-share ratios resulting from loan growth outpacing share growth.  The blog went on to discuss the potential liquidity pressures some could experience, today or in the future, if this trend continues.

To keep the lending machine going, many decision-makers maintain that to fund future loan growth they will sell investments in the future.  While this may be an option worth considering, market rates in the future are uncertain and it can take a considerable amount of time to offset losses you may take on the sale of investments.  Let’s walk through an example:

Assume a credit union is experiencing continued loan growth and it also holds a $100M agency bullet, with three years remaining until maturity, earning 0.75%.  Their liquidity analysis is projecting they may need to sell this investment in 12 months to help fund loan opportunities.

Rates could go in any direction but what if rates increase 1% in the next 12 months?  The credit union sells the $100M investment, now with two years remaining until maturity, at a $1.6M loss.  If rates increase 3% in the next 12 months, the loss is $5.4M.

Sell Asset in 12 Months

Beyond asking if the credit union is willing to take the loss, the next question should be, How long it will take new lending opportunities to offset the loss? Assuming loans will yield more as rates go up, it could take up to six months to recoup the loss on the sale in a +100 basis point (bp) increase in rates and 17 months in a +300 bp increase in rates.

Months to Breakeven

The objective here is not to advocate a particular strategy, rather to encourage thorough analysis and provide a different perspective for credit union boards and managements to understand the trade-offs of difficult decisions.

/by

Will Recent Real Estate History Repeat Itself?

,

The director of the Federal Housing Finance Agency recently announced that Fannie Mae and Freddie Mac were planning to bring back some of the same types of lending criteria credited with contributing to the last crisis in housing (such as lower down payments, etc.). The intended objective is to further stimulate the housing market, which has recovered some, but is still well below highs seen in 2006 (see graph below).

Historical Performance graph

The question for decision-makers is not whether the FHA is making the right decision, but, how could changes like this impact credit unions? Consider the impact not just today, but 4 or 5 years into the future:

  • Will this create “artificial” demand for housing, potentially leading to another real estate bubble?
  • How could this impact second mortgages? Both current loans and future demand for second mortgages?
  • How did your credit union fare through the last mortgage cycle? What changes would you make if a similar scenario played out again?
  • If the more lax lending standards became prevalent again, how could this impact the balance sheet choices your credit union is making? Would current asset allocation (concentrations) need to be re-evaluated?
  • How many other market participants will also choose to follow the lead of the agencies and lower their standards?
  • How does this impact the mortgage volumes for those credit unions that continue to adhere to stricter lending standards?
Given the impact underwriting changes could have, it may be a good time for credit unions to evaluate their mortgage programs and their appetite for risk, making sure that decision-makers are on the same page before any major issues materialize.
Sources:  Low Down Payments Are Coming Back
Is Congress setting the stage for another mortgage crisis?
/by

What is the Objective?

Before any project within a credit union is launched, the project manager and project team should construct an appropriate objective statement for the finished project. The objective statement should clearly give anyone who reads it a precise idea of what the project will achieve once implemented.

An objective statement should be SMART:

  • Specific
  • Measurable
  • Attainable
  • Realistic
  • Time-bound

The statement should be written so that it can easily be understood by all stakeholders and easily evaluated at the end of the project. If appropriate, it is helpful to include how the project fits into organizational strategy in order to keep everyone focused on the strategic purpose of the project.

An example objective statement for a project to implement an online account opening system could be:

  • By August 15, 2015, 75% of all applicants applying for membership online will become a member in less than 15 minutes. This supports our strategic initiative to make it easy for our members to do business with us electronically

An example objective statement for a project to implement a new loan origination system could be:

  • By August 15, 2015, at least 75% of all auto loan applicants with a credit score of X or higher will receive a decision within 15 minutes. This supports our strategic initiative to be a highly lending-focused organization

The beauty of a well-written objective statement is that, no matter the size and scope of the project, the objective statement serves as a rallying cry for all involved to complete the mission successfully. When the team knows what it is fighting for, other decisions related to the project can suddenly become easier to manage – paving the way for a well-executed project.

/by

30-Year Fixed-Rate Mortgages vs. 5/5 ARMs

Recently, we’ve seen more credit unions offering a 5/5 ARM product. While there are some differences institution-to-institution, usually the 5/5 ARM repricing characteristics have a 2% initial cap, a 2% annual cap and a lifetime maximum rate adjustment of 5% above the initial interest rate. The intent is to offer a product that is beneficial for the member by having a lower initial rate and smaller rate adjustments throughout the life of the loan due to the initial cap. As a side benefit, 5/5 ARMs are assumed to have less risk than a 30-year mortgage in a rising rate environment.

Let’s evaluate the 30-year mortgages and 5/5 ARMs from a business perspective over a 10-year period. The example below compares the earnings of a 30-year mortgage with a 4% rate to a 5/5 ARM with a 3% rate and the repricing characteristics described above in a +300 rate environment.

Fixed vs ARM Example

Over the course of 10 years, the 5/5 ARMs will not earn as much as the 30-year fixed mortgage. The 5/5 ARMs will certainly earn more in years 6 through 10 due to the higher rate, but that is not enough to offset the first 5 years of lower income compared to the 30-year mortgage. Eventually, the 5/5 ARMs will earn more than the 30-year mortgages; however, the breakeven point is not until about 12.5 years.

The 5/5 ARMs can be an additional product to offer members as a giveback. The key is to understand the trade-offs of such a product and how it fits with the credit union’s strategy.

/by

Liquidity Risk: Loan-to-Share Ratios Are Moving Up

Throughout the sustained, low interest rate environment, many credit unions have become flush with non-maturity deposit funds, while also experiencing lackluster loan growth.  In other words, liquidity risk hasn’t necessarily been at top of mind.

However, as the economic landscape shifts and murmurings of an increase in government interest rates grow, the issue of liquidity may become an increasing concern once again.  According to June 2014 NCUA Aggregate data, loan growth (on average) continues to outpace share growth.  What if this trend continues and/or accelerates?

NCUA Aggregate Data Table

One thing to consider is analyzing how your members’ average balances have evolved since the last economic rate cycle back in the summer of 2007 when short-term rates were at 5%.  Key areas to address include:

  • What would my liquidity position look like if members reverted back to historical average balances?
  • What options do I have available, and what are the financial implications of those options, if the above scenario caused a stressed liquidity position?
  • As discussed in earlier blogs, the mix and cost of your deposits will also change as rates rise.  See our post on Isolating Interest Rate Risk with a Static Balance Sheet for more detail on this

While it may not feel like a problem today, highly successful credit unions are continuously looking forward and staying ahead of the curve.  Take the time to understand your liquidity position today and the threats and opportunities of tomorrow so that when the future is realized, you’ll be better prepared.