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Cost of Funds: Pulling Together Deposit Assumptions

There is a lot of debate on the mathematics and methodology for deposit withdrawal speed and deposit pricing assumptions in different rate environments. Let’s step back for a moment and first ask the question: What is the objective of developing the deposit assumptions? Ultimately, the end objective of these assumptions is to arrive at a projected cost of funds (COF).

From a risk perspective, the projected COF should be in line with, or more conservative than, what the credit union has experienced historically. Some credit unions may choose to model a projected COF that is lower than their historical experience and, in those cases, it is especially important that decision-makers document their rationale.

There are a couple of ways to compare the projected and experienced COF. One approach is to compare the projected and experienced COF at the high point in the previous rate cycle; in this case, short- and long-term rates at 5%. For example, the credit union’s COF on the June 2007 call report was 2.00%, while the projected COF increases to 2.10% by the end of the second or beginning of the third year of the simulation. This provides support that the assumptions are reasonable.

For models that are unable to simulate a +500 basis point (bp) rate environment, another way credit unions can compare the projected and experienced COF is to look at the percent movement of the COF in comparison to the market rate. For example, if the COF moved 30% of the market when short-term rates went from 5% to 0%, then the projected COF should move minimally 30% of the market in a simulated +300 bp rate environment.

It is important to evaluate the individual withdrawal speed and deposit pricing assumptions and determine an approach that matches the credit union’s strategy. However, comparing the projected COF to history can help decision-makers pull together the assumptions to understand the impact of each on the end results and ensure their reasonability.

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Process Improvement: Are You Getting Your Desired Results Out of New Systems?

Many credit unions have implemented new loan origination and/or new account opening systems.

While these new systems can absolutely enhance consumer experience, save time and drive better performance, we sometimes find that old processes remain in place when new systems are launched. If your credit union has implemented new systems and has not achieved desired results, it may be time to really dig in and review exactly how the new systems are being used.

Once you agree on, or recommit to a new process, it is necessary to control the new process and measure success. Click here for more detail on process improvement.

Following is just one example of a “control chart” analysis related to the average time it takes to decision a loan. Weekly and monthly iterations calculating average time and control limits can help decision makers understand if a process is “out of control.” A “control limit” (CL) is calculated based on the average of the sample set; standard deviations are then calculated to develop an “upper control limit” (UCL) and a “lower control limit” (LCL).

Keep in mind, it is absolutely true that what gets measured gets focus!

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Is a Fight for Deposits Heating Up?

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We are seeing some financial institutions in pockets of the country raise money market and CD rates.  If you have not done so already, now may be a good time to proactively test the financial, liquidity and strategic impact of a fight for deposits, assuming rates don’t change.

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RESPONSE TO NCUA PROPOSED PCA RISK-BASED CAPITAL RULE

Since last week’s blog post, we have received many requests for our response to NCUA’s Risk-Based Capital Proposed Rule. As a result, we have made our final response readily available on our website.

One of our objectives in writing this response is to point out that prudent risk management is too complex to be reduced to arbitrary risk-weightings applied to the masses. We welcome any questions you may have on why we took such a strong stand in regard to this proposed rule.