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HELOCS May Be Set To Take OFF – Is Your Credit Union Ready?

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For the last 10 years it seems like the home equity line of credit (HELOC) has been a forgotten product for many credit unions and their members. As rates on fixed mortgages hovered at record low levels, and with home equity under pressure, the demand for variable rate HELOCs decreased for many institutions. However, that tide could be shifting. J.D. Power recently released a report that predicted home equity lines of credit would double over the next 5 years as equity has exploded in many markets, and rates on fixed mortgages have become a little less attractive.

Smartphone showing HELOC on screen

The J.D. Power 2018 U.S. Home Equity Line of Credit Satisfaction Study went on to note that the way in which HELOCs are delivered to members will change. So is your credit union ready? Consider the following:

  • Over half of the Millennial survey respondents researched HELOCs through a digital channel. Does your credit union have a compelling story to tell about your HELOC products and services through the digital channel? How much can the member accomplish before they have to pick up the phone or walk into a branch?
  • How does your team and marketing message clearly articulate why the consumer should choose your HELOC versus the numerous other options they are likely to have? The survey noted that 80% of Millennials shopped around at more than one lender.
  • The study noted that nearly 64% of people looking for a HELOC have some sort of concern about the product, with the Millennials having the highest concern (at 87%). Some of the concerns include the variable nature of the loan or overextending themselves. How can you address those member concerns and help them feel confident about the structure of the product, and how they can use it effectively and efficiently? Are there training gaps with your lenders and front line staff?
  • Have you discussed and agreed upon your credit union’s risk appetite given what is happening in your markets? Consider the S&P/Case-Shiller CO-Denver Home Price Index graph below showing how home prices in Denver, Colorado have changed over the last 8 years. Financial institutions in the Denver area might look at underwriting a bit differently – perhaps taking less risk – than credit unions in markets who have not seen the same kinds of increases in home values.

Graph showing Denver CO home price index as of April 2018 for HELOC blog

  • What are some of the credit risks? There is potential risk from a collateral perspective but also from a rising payment perspective. Will you underwrite variable-rate loans like a HELOC to help ensure that the member can cover the payment even if market rates continue to change? And if so, through what changes in the rate environment?
  • How would growth in variable-rate HELOCs impact your financial structure and A/LM position? What stress tests should your modeling include? Common scenarios could include increasing provision for loan loss, or modeling with a periodic or lifetime cap that is lower than what is contractual.
  • How would growth in HELOCs impact the credit union’s liquidity position from an unfunded member commitments perspective?
  • CECL can be impacted by the unfunded portion of a HELOC, depending on how the loan is structured. Understanding the impact this could have in advance of any growth initiative would be important.
  • Finally, don’t forget rates can now go down too! A couple of years ago, the common thought was that rates can only go up, but that is not the case anymore.

What other questions should your credit union be asking? The possibility of growing HELOCs again is an exciting prospect for many institutions, but there are many variables beyond rate to consider. Credit unions with a well-defined strategy and plan will be better positioned to take advantage of this potential opportunity.

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Strategic People Planning

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The following blog post was written by c. myers and originally published by CUES on July 9, 2018.

It is common for businesses to have strategic planning sessions at least annually. What is not common, yet necessary, is to purposefully and strategically plan talent requirements for the intermediate and longer term.

The world continues to become more complex and evolving business models often require a different type of talent. How do you begin to build that “right team” or even define it?

At the executive level, one key component of strategic people planning is to get the right talent infrastructure in place, so that the people who need to think and act strategically every single day can do so.

It starts with strategic clarity. The credit union must have a clearly defined understanding of its desired business model and strategic vision. This is necessary because the talent infrastructure should be designed to support the building and maintenance of the desired long-term strategy.

Four Steps to Building an Effective Talent Infrastructure:

1. Design the ideal team for the job. Think through and define the optimal leadership team, both in terms of the team’s functionality and the characteristics of the executives needed to bring the strategy to fruition. There is not one right answer for all credit unions.

From a functionality perspective, consider how delivery and marketing of products and services is changing—as well as how to truly engage the consumer and sell in a digital world. Think of how consumers are bombarded, hourly, by marketing messages. How is your organizational structure evolving to cut through this noise and deliver on your value proposition at every connection with your members?

The desired executive characteristics are also changing. Many are considering how many people on the team need to have the ability to navigate quickly in the gray, and regularly demonstrate sound decision-making in the face of ambiguity.

Also, which team members need to be masters of multidimensional thinking, meaning they can move fluidly between creative problem-solving, critical thinking, and strategic thinking?

2. Determine what you have and what you need. Assess which characteristics and skills the credit union has within the current executive team, and identify the gaps. How well are the existing characteristics and skills of the current executives aligned with what is needed? Recognize that this is easier said than done.

3. Create a plan to get there. Determine the strategic and tactical steps that are needed over the next few years, to move in the direction of having the right executive team functionality and desired characteristics.

4. Build a supporting structure. Executive team members must have appropriate time to think and act strategically. The key to this is having the right executive-supporting talent, so each executive must, in turn, define the functions and skills needed from that talent, assess, and make appropriate changes to build that support.

Creating a solid infrastructure for building and maintaining the right executive talent can help position the credit union to drive toward its desired business model and, ultimately, the strategic vision for the credit union. Directly linking the desired talent capabilities and characteristics to your institution’s unique strategy translates to a keener ability to find, grow, and maintain the right talent.

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Policy Risk Limits are Often a Moving Target

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With market interest rates on the rise for the first time in nearly 15 years, comes a host of new considerations for the credit union industry. Among them is an understanding that many Interest Rate Risk (IRR) policy limits are in fact a moving target. Whether rates stay put, continue to increase, or possibly head back down, the same rate shocks performed in years past look much different in today’s higher environment.

First, it is important to acknowledge that not all A/LM policies are created equal. Some credit unions choose to focus on 300 basis point (bp) movement in rates while others may focus on rate changes beyond a traditional 300 bp movement. While every credit union needs to reach agreement on their own appetite for risk, we will use a 300 bp movement here to illustrate how policy IRR tests are changing.

For example, the table below reflects the changing rate environment. From 2009 to 2016, short-term market interest rates were essentially 0%. This means simulating a 300 bp increase in rates resulted in a 3% simulated short-term rate environment. With short-term market interest rates now at roughly 2%, that same 300 bp increase takes rates to a 5% simulated environment.

Policy risk limits are often a moving target blog - short-term rates table

Why is this important to understand? Think about your credit union’s balance sheet. What is the auto portfolio yielding? How about the investments purchased over the past few years? Then consider how long before these lower yielding assets run off the books.

The difficult reality for many credit unions is that the lower yielding fixed-rate assets on the books just don’t perform as well in a 5% post-shock environment, versus a 3% or 4% post-shock environment. Naturally, the results of the IRR analysis may not look as favorable and could cause the credit union to run up against their IRR risk limits. The policy environment being tested is moving higher because the base rate environment is higher, therefore the IRR tests are getting more difficult.

The policy environment being tested is moving higher because the base rate environment is higher, therefore the IRR tests are getting more difficult.

The best thing credit unions can do in this challenging environment is to talk about it and not panic. If the IRR risk limits are becoming more of a concern, view it as a positive. The policy must be doing its job, making sure the institution is not on cruise control in a changing rate environment. As IRR requires more active management, ALCOs can consider a variety of options and perform what-if analysis to address policy concerns.

While every forecast has the ability to be wrong, the Federal Reserve Bank projects that the Federal Funds target rate could be 3% in 2019. You might already be doing the math and yes, that would take a 300 bp increase to a 6% short-term rate environment.

If you are concerned that interest rates will continue to increase, then it can be helpful to see an early warning of risks in the higher rate environments, before current rates move again. This advanced view is a big plus as it provides decision-makers more time to think and plan should rates continue to increase.

This early warning can help decision-makers understand, in advance, if there is significant risk in the higher environments and balance that with the reality that rates could stay the same or go down.

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Putting Member Rate Advantages Into Perspective

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The environment is quickly changing and so are members’ savings alternatives. Technology has made it such that competition is no longer limited to the institution down the street. A simple online search reveals there are financial institutions all over the country with money market rates close to 2.00%:

Source: Savings Accounts & Rates. Retrieved from https://www.bankrate.com/banking/savings/rates/, June 8, 2018.

And it’s not just other financial institutions with these rates; uninsured money market mutual funds also have non-maturity deposit yields close to 2.00%:

Source: Top Retail Money Fund Yields. Retrieved from http://www.barrons.com/public/page/9_0204-trmfy.html, June 8, 2018.

With members gaining material advantages to moving their savings dollars between financial institutions or uninsured money market mutual funds, why aren’t many currently doing so? There are various reasons why a member may not be taking advantage of the higher yield opportunity, but one could be that they simply haven’t crunched the numbers.

Consider a member that has $250K in a money market account. There are different credit union money market rates out there but in the following example, let’s compare a potential rate of 0.40% to the 2.00% alternatives pictured above.

This simple calculation shows that the member is leaving $4,000 of interest on the table. Seeing the missed opportunity from a dollars perspective may be part of the reason why many members are not currently taking advantage of the changing environment. The actual dollars are more meaningful than just seeing that there is a 1.60% advantage to move.

While the average member deposit balance has typically increased over the years, not everyone has $250K in savings. What about a member with potentially $50K in a regular share account?

The takeaway from these examples should not be that credit unions need to increase their deposit rates or match the highest rates in the marketplace. However, the examples are a healthy reminder that the current environment is quickly changing and members will periodically do things that are in their best interest.

As a result, it is important credit unions start thinking creatively about sustainable deposit retention and acquisition strategies. Rate is important to the membership but the traditional strategy of attracting deposits strictly through rate may not be feasible from an affordability standpoint. If you are considering certificate promos to attract deposits, don’t forget to consider their marginal cost as discussed in our blog post Hidden Cost of Addressing Liquidity Needs.

 

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Latest Entry in Our Napkin Math Video Series

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The latest entry in our Napkin Math Video Series demonstrates how to calculate the risk for return of different types of assets.  Like the other videos in this series, this video shows simple math that people can do on a napkin to understand ballpark financial performance.

When you have a few minutes, please watch the new video and let us know what you think. To watch, visit our videos page.