/by

One Tip for Evaluating the Reasonableness of Non-Maturity Deposit Assumptions Used in Net Economic Value

Should decay assumptions change as rates are changing? Absolutely!

When we complete model validations of credit union or vendor-supplied interest rate risk results, we see all too often that decay assumptions don’t change as rates are changing. This assumption is like saying non-maturity deposit cash flows will remain constant and unchanging regardless of what rates do. History shows that this is not a valid assumption and, if used, can provide a false sense of security regarding NEV results.

It can be difficult to tell if the decay rates are changing as rates are changing by looking only at results. A good way to check this assumption is to review your model setup to see if decay rates are increasing as rates are assumed to rise. If they are not, it is a good investment of time to discuss options for representing the risk of decay rates changing as the world around us changes. Keep in mind as you do this it is not about getting the “right” assumption, because that is virtually impossible.  It is about reasonably representing changes in consumer behavior in your base-case risk analysis.

/by

Survey: Recent Examiner Findings

We always try to stay current on the most recent areas of examiner focus.  For those who have had an exam this year, we’d like to hear from you!  Please take a few moments to take our short survey and provide your thoughts.  All survey responses will remain anonymous.

Click here to complete the survey.

/by

Create a Process for Successful Execution of the Strategic Plan

,

Strategic planning can excite, galvanize and motivate teams; however, even the best strategic plans are worthless without great execution. Teams often find themselves scrambling. What sounds doable while isolated from the everyday whirlwind can seem insurmountable post-strategic planning.

A solid process surrounding strategic planning can contribute greatly to successful execution. It’s no secret that strategic planning will take place and that initiatives will result. Ideally, teams should begin meeting immediately after the planning session to start planning projects. A process that includes scheduling time well in advance of the planning session for teams to meet immediately after is key.

These post-planning session meetings should review at a high level what resources existing projects will require and when. Then, resource requirements for new projects should be sketched out along with their timing. Looking at how all the projects will interact in terms of departmental resources should provide a reasonable view of capacity and ensure that multiple projects aren’t allocating the same resources at the same time.

Also, consider the following:

  • Teams are often handed a number of big projects to be completed by end of year. Consider leaving due dates flexible on at least some of the projects until the team has been able to review resource capacity and establish reasonable due dates
  • Communicate to the entire staff what projects are being undertaken and why in order to get everyone on board to make it happen. Communication from the top will ensure that all employees understand where the organizational focus should be
  • Have a good project management process. The process should include appropriate reporting of the status of projects to staff, management and board. Regular reporting helps to maintain project momentum, organizational focus and fosters accountability

High-functioning credit union managements regularly get out of their silos, carefully evaluate resource capacity and make priorities clear in order to execute their visionary strategic plans. The resulting success inspires teams to continue to perform at a high level year after year.

/by

NEV: Do the Values Make Sense?

There is some debate regarding reasonable methodologies and approaches for loan discount rates for an NEV analysis. Discounting to the current offering rate, to a comparable asset-backed security rate and including a credit risk spread are just a few of the approaches that are debated.

Regardless of the assumptions approach, the values need to make sense. One way to check this is to compare the +300 value to the book value. A +300 value that is higher than the book value should raise a flag and could mean that the discount rate assumption may be too optimistic.

For example, consider a credit union that has an auto portfolio with a starting gain of 8%. In a +300 rate environment, the autos devalue 5% (autos usually devalue 4-6%). The economic value declined but the +300 value results in about a 3% premium over the book value.

This example indicates that the starting value is likely not reasonable. Most credit unions would not expect fixed-rate loans on their books today to be worth more if rates increase 300 basis points. As such, the discounting approach should be revisited to ensure reasonableness.

/by

Testing the Budget’s Interest Rate Risk

,

Budgeting season is around the corner. Credit unions will spend valuable time and resources over the next few months developing budgets that achieve ROA and net worth goals. As the budgeting process moves forward and nears completion, decision-makers should ask: What happens to our interest rate risk if the budget comes true?

Budgeting helps credit unions understand the new business decisions they have to make in order to achieve their ROA and net worth goals in the following year. However, it won’t show the risk trade-offs the credit union may be making as a result. Decision-makers don’t want to be surprised if the credit union achieves its budget only to find out the credit union has gone beyond its risk tolerance.

Using the budget, credit unions can create a target financial structure by using the year-end budget numbers as a starting point and running it through their risk model. With the results in hand, decision-makers can determine if they’re okay with the risk produced by the budget or if they need to make adjustments to mitigate risk.