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Borrowing Rates Are Up – Other Impacts to NEV

Continuing with our message from last week, if you are running NEV, there are some other changes you will notice as a result of borrowing rates increasing. As pointed out last week, NEV calculations for the current rate environment will result in shares showing increased value as “market rates” (generally represented by borrowing rates) have risen relative to dividend rates. However, in a +300 bp rate change, the percentage decline in value of shares will actually decrease when compared to your last NEV calculation. This is because a 300 bp change represents a smaller proportional change when you are starting out with a higher discount rate. The overall impact to your NEV results will depend on changes in your balance sheet, but there will be less decline in share values to offset declines in asset values when compared to using lower borrowing rates in your last NEV. Understanding this may help you interpret some of the nuances of your NEV results; however, it will not tell you if your credit union is positioned to make money or not.

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Borrowing Rates Are Up– Now My Credit Union Has Less Risk?

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Net economic value (NEV) is often cited as one way to quantify the interest rate risk exposure of a financial institution. While there are many concerns with relying upon NEV to provide good decision information, this discussion focuses on recent changes in interest rates and the resulting impact to the NEV of credit union shares.

As borrowing rates have increased for nearly all borrowings with final maturities of two years and beyond (increasing roughly 15-90bps from March 2013 to June 2013), the resulting discounted cash flow calculations for non-maturity shares produce increased share valuations all else being equal, and may show significantly stronger NEV ratio positions in today’s interest rate environment.

If credit union management uses NEV analysis to aid in decision making, an important question must be asked: Does my credit union really have less risk today than we did last quarter because borrowing rates have increased?

Or, more importantly, has the continuation of relatively low interest rates and tough competition for loan dollars placed more pressure on your financial structure, potentially increasing risk to earnings and net worth?