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Fed Indication on Bond Buying

On June 19, Chairman Ben Bernanke indicated that the Fed may slow its bond purchases later this year. Since that statement, the 10-year Treasury yield has increased 35bps from 2.20% on Tuesday, 6/18, to 2.55% on Wednesday, 6/26 (Treasury.gov), while the Dow Jones Industrial Average (DJIA) has dropped 408 points over the same period (Bloomberg.com). Keep in mind, the Fed only made a statement.

This raises some interesting questions for decision makers to consider, including:

If the rate increase is sustained…

  • How might this impact loan volumes in the short and intermediate term? Could volumes increase in the short-term for fear of loan rates increasing? What impact would it have on longer-term loan demand?
  • How might non-interest income be impacted?
  • If you were counting on your callable bonds to be called, and now they may not be called, should you hold them or fold them?
  • Could you experience another flight to safety if the stock market continues to be volatile?

Treasury rates could come back down and the stock market will hopefully “right” itself at some point. Nonetheless, decision makers should consider the impact to financial performance if current trends continue. Running through different “what-if” scenarios of how the institution would react and testing them in forecasting and risk models can help decision makers be better prepared.

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Liquidity: Another Thing to Worry About?

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Imagine a scenario where it is difficult to find deposits. Suppose the stock market is booming and members are taking funds out of your credit union. Even if you don’t have liquidity issues, what if your competitors do and deposit rates are higher as a result?

Is this hard to imagine given all the liquidity you have now? Consider the relationship between the change in the Dow Jones Industrial Average and credit union deposit growth. In the past, strong stock markets have typically been accompanied by reduced deposit growth. This pattern has yet to repeat in 2010, but what if it does? What would your liquidity position be if you lost the funds you have gained in the last year?

cu deposit growth and dow jones percent change

Also consider that this time your external sources of liquidity may not be available. What if a new corporate credit union structure included a reduced ability for corporates to lend funds? How about the FHLB? What if they are not able to lend funds at the level they have in the past?

The recently finalized Interagency Policy Statement on Funding and Liquidity Risk Management underscores this importance of liquidity planning. This policy statement specifically requires financial institutions have contingency funding plans (CFPs). We recommend you prepare for potential future periods of reduced liquidity now rather than wait for your regulator to request a CFP, or worse yet, to face a period of tight liquidity without a plan.