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c. notes Excerpt: Thriving In A World of Shrinking Margins

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As interest rates have been at historic lows for a prolonged period of time, credit unions have had the benefit of lowering their cost of funds (COF) as loan and investment yields decline.  Many seem to have worked through their credit issues and, at least for now, have been able to reduce their provision for loan losses (PLL)—another counter-balance to declining asset yields.

Unfortunately, for many, the COF and PLL have—or will soon—hit a floor while asset yields continue to decline.  Some have turned to longer-term assets, such as mortgages, mortgage investments and callable bonds to help current earnings. However, these options add interest rate risk in a rising rate environment.

To read the full article, please see our c. notes page, available here.

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Budgeting During Times Of “Unusual Uncertainty”

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Creating a budget is always a challenging and uncertain process.  Developing the annual budget for 2011 may be unusually difficult as there is heightened uncertainty about loan demand, interest rates, investment yields and deposit trends.  Net operating expense concerns include share insurance assessments, threats to non-interest income and provision for loan loss trends—stable, declining, or, for some institutions, still increasing.

Due to this uncertain economic environment, credit unions should consider developing a base budget and then creating multiple scenarios identifying key vulnerabilities that could stress financial performance, such as:

  • What if loan demand continues to be anemic?
  • What if provision for loan loss increases unexpectedly?
  • What if mortgage originations decline materially?
  • What if cost of funds cannot be lowered enough to help offset other adverse scenarios?

Evaluating combinations of negative factors, while depressing, can provide valuable early warning information to management and the credit union’s board.  This process can also help manage key players’ expectations appropriately.

If the base budget is acceptable but there are several plausible scenarios that could create unsatisfactory financial performance, it is good to know this in advance so that decision-makers can begin to think about contingency plans.  This is particularly relevant if the credit union has a level of net worth with very little breathing room.

Identifying the potential problems early on will give your credit union a better chance at making 2011 a financially successful year.  Good luck!