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What If The Fed Rate Projection Is Right?

This is a question credit unions should try to answer as part of their ongoing long-term forecasting process.  The FOMC reaffirmed on Wednesday (December 12) that they do not anticipate raising rates until 2015.

Source:  Federal Reserve

So what happens to earnings and net worth if rates stay at historic lows for two more years, and then start to rise? Instinctively, the net interest margin should be squeezed over the next two years as assets continue to reprice down without a corresponding reduction in the cost of funds. The big unknown is: how much and how fast will rates rise?

Credit unions may need to run a series of “what-ifs” to understand the impact. “What-ifs” should include rates rising over different time periods (i.e., 12 months, 24 months, etc.) and increase to different levels (i.e., 100bps, 200bps, 300bps).  It would also be prudent to test changes in balance sheet mix, as rates may rise for different reasons.  If the economy is booming, then the credit union may be able to originate more loans.  This would help the bottom line and possibly mitigate the impact of the lower-yielding assets brought on in 2013 and 2014.  However, if the economy is stagnant, loan growth could be an issue—which would hurt earnings and net worth.

Decision-makers should review the series of “what-ifs” and discuss any areas of concern.  Credit unions should run additional “what-ifs” that address their concerns—particularly in cases where success measures would not be met or the credit union’s ability to deliver on its strategic objectives is threatened.

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NCUA Beefs Up Insurance Requirements with New Emergency Liquidity Rule

Approved at NCUA’s July 24th board meeting, the proposed rule on maintaining access to emergency liquidity will require credit unions to create/maintain various levels of liquidity planning based on asset sizes.

Under $10 million in assets:  Maintain a written policy approved by the board with a list of contingent liquidity sources.

$10 million or more in assets: Establish a formal contingency funding plan (CFP) that clearly defines strategies for addressing liquidity shortfalls under adverse circumstances.  The CFP must address, at a minimum, the following:

  1. The sufficiency of the institution’s liquidity sources to meet normal operating requirements as well as contingent events
  2. The identification of contingent liquidity sources
  3. Policies to manage a range of stress environments, identification of some possible stress events and identification of likely liquidity responses to such events
  4. Lines of responsibility within the institution to respond to liquidity events
  5. Management processes that include clear implementation and escalation procedures for liquidity events
  6. The frequency that the institution will test and update the plan

$100 million in assets: In addition to maintaining a CFP as described above, demonstrate access to at least one of the following three sources:  becoming a member of the CLF, becoming a CLF member through a CLF agent, or establishing borrowing access at the Federal Reserve Discount Window.

Required For Federal Insurance
Perhaps more interesting to note is the placement of this proposed rule under Part 741 of the NCUA rules and regulations, which outlines requirements for Federal insurance.  This is the same Part that was revised to require formal IRR programs/policies earlier this year.

Liquidity Contingency Planning
When approaching liquidity planning, c. myers provides its clients with no less than 2 “what-if” scenarios based on an actual liquidity forecast:

  • What-if #1:  What’s our bad-case liquidity environment? Consider heightened loan demand, increased competition for low-cost deposits and potential cuts in lines of credit in order to stress the credit union’s liquidity position
  • What-if #2:  How will we respond to our bad-case liquidity environment? When addressing the bad-case environment, consider triggers the credit union can pull to protect its liquidity position, including slowing down/stopping lending, selling investments, raising rates to attract “hot” money, etc.

Exploring these scenarios on a regular basis can help credit unions be prepared for potential liquidity risks—and in light of the new proposed rule—will also help satisfy regulatory requirements for federal insurance if the rule is realized.

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Corporate Shuffle: Questions To Ask When Searching For Alternative Providers

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Many credit unions rely on the corporate credit union system for mission-critical functions; however, changes in the corporate system are imminent.

Alternative providers could possibly include other corporates, newly formed CUSOs, the Federal Reserve, large banks and publicly held companies.  It is important to objectively evaluate each on their real merits.

Following are just a few questions you may want to consider:

  • What are the three top decision drivers for evaluating various service providers?
  • What are potential threats to your credit union’s business model?  (e.g., if your credit union has high loan demand and your corporate provided a line of credit, what are alternatives?
  • What strategic initiatives are you willing to forego during this service conversion?
  • What will be the hard-dollar cost of the conversion?  Have you budgeted for it?
  • Will the shift be transparent or nearly transparent to members?

Invest the appropriate time to create an RFP that details your requirements and rank them in importance with a weighting system, such as a scale of 1 to 10.  A few examples of requirements you may consider weighting include:

  • Necessity of investing upfront capital to receive services
  • Cost to process ACH transactions
  • At least __ years of previous demonstrated financial strength