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Interest Rates Have Risen – Now What?

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The 3-month Treasury rate has moved more in the last 8 months than it has in the preceding 8 years.  For many who think of A/LM in a time of rising rates, it can be time to calibrate pricing strategies, non-maturity deposit withdrawal assumptions, or loan prepayment speed assumptions.  Others may begin to consider strategic liquidity options, such as borrowings or locking in brokered CD funds to hedge against an assumption that rates may continue to rise.  However, as a CFO, have you considered the following:

  • How many of your senior managers have not had a role of responsibility when short-term rates have increased?
  • How many of your key front-line staff have never seen a rate increase in their professional careers?
  • Are you facing an uphill battle when trying to discuss risk management with others in the organization when earnings are up, loan demand is strong, and current economic indicators point to expansion?

A/LM is much more than inputting data into a model and generating report output.  Strategic thinking CFOs understand it is more about the conversation surrounding running a business than it is about looking at reports – and they have structured their risk modeling around addressing business questions first.  While there are many areas to consider, let’s touch on one – funding risks and how consumer behaviors driving deposit activities may be different going forward.

Consider that CD rates are up for many institutions – nationwide.  Let’s now look at recent retail experience – consider that a recent Pew Research Center study, released in late 2016, found that 79% of adults in the U.S. have purchased online.  Beyond just online, over half of those surveyed have purchased with a smartphone.  Further, consumer purchases initiated through a social media link are increasing as well.  In 2007, during a survey with comparable questions, only 49% of adults responded that they had made a purchase online (Source: Digital Commerce 360).

What does shopping online have to do with A/LM?  Quite frankly, a lot.  Consider how consumer borrowing behavior and credit union lending strategies have been impacted by online lenders and increased FinTech competition.  Don’t just focus on the “A,” and lose sight of the “L,” in asset/liability management.  The liabilities are critical to understand in the A/L equation – and how might member deposits react to rising rates now that nearly everyone has some established comfort level with making purchases online?  In the mid-2000s, how many of your deposits were lost to (or how many of your deposit strategies were impacted by) the orange bouncing ball of ING Direct?  Since that time, there has been a 60% increase in the number of adults making purchases online.

Beyond members, how might front-line staff react to members wanting to transfer funds or close CD accounts?  Front-line staff are more than just those in-branch or at the teller window – how might staff members in the call center or ITM department respond to similar requests?  For those staff members that are traditionally viewed as “back office” (such as the wire department or ACH/Electronic Funds department), are they now the new first line of interaction if members were to transfer funds to seek yield elsewhere?

A/LM goes well beyond just producing end of month or end of quarter reports from a model – it should be forward-looking, and it should help address risk-related business questions that decision makers are facing today.  Ask yourself if you are proactively answering these business questions.

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Focus on Frictionless

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Your competition is not standing still. They are making it faster and easier for a consumer to open an account and get a loan by removing friction in their processes. More and more consumers are getting spoiled by how fast they can now do their banking, and they are telling their friends.

You can easily start removing friction from your processes today. Fortunately, you have data at your fingertips that can be quickly turned into actionable business intelligence. You can use this business intelligence to make the right decisions to streamline processes so they are not only easier for your members, but also for your staff. Wouldn’t it be great if making loans faster and easier – without taking additional credit risk – led to even more loans!

Learn more by watching this interview of our President, John Myers, after he spoke at the CUES CEO/Executive Team Network Conference last month: Watch Now.

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AICPA: Buzz About CECL

We had the benefit of speaking at the AICPA conference on one of our favorite topics, how to use ALM for actionable business intelligence. In this case, the focus was on how a credit union can support changes to remain relevant.

Another topic that also had a lot of buzz at the conference was CECL, which can also impact relevancy. Based on the discussions, we thought it would be a good idea to repost the blog from May 19, 2016.

CECL’s Threats To Your Business Model:  Six Questions To Consider</font size>

CECL is a new set of rules that every credit union eventually will have to play by. While it may not be in effect until 2021, many credit unions could find that they need all that time to reposition their business models to prepare for its impact. Keep in mind that the impact being discussed currently is in a good credit environment. How does the exposure to CECL change in a bad credit environment?

At the end of 2015, the nearly 500 credit unions with assets over $500 million had an average net worth ratio of 10.9% and an ALLL of 0.9%. If the impact of CECL causes ALLL to increase 50%, or even what some refer to as a worst case of 100%, the net worth will be reduced but not dramatically for most.

For those same credit unions, if you were to go back to the Great Recession, what potential impact could CECL have created?

CECL Graph

While many experienced a reduction to ALLL in the years following, what would have happened to the credit unions that would have had materially lower net worth? How could this impact business models and strategic decisions going forward?

Every credit union should be asking:

  • Because CECL will be extremely volatile in changing economic conditions, how much net worth do we need to have to prepare for that potential additional volatility?
  • How should our business model be repositioned so that we have enough net worth in volatile, bad case scenarios?
  • If our current target markets are susceptible to credit risk and could wipe out significant amounts of net worth under the new CECL rules, do we need to adjust who we target in the future?
  • After CECL is in place, loan growth, especially strong loan growth, will come at much lower initial profitability. How does this impact our business model?
  • What changes should we be making, if any, to our concentration risk policy?
  • If the battle for prime paper increases materially, will we choose to increase our presence in that battlefield, and how will we differentiate ourselves in order to remain relevant?

If you don’t think these questions are relevant, consider that in today’s good credit environment, 22% of all existing auto loans are to subprime borrowers (Wall Street Journal). How much could this increase in a recession due to credit migration?

As you wrestle with the mechanics of implementing CECL, it is even more important to think about the business model implications. In addition to the current economic environment, think through what could happen in a recessionary environment when loan losses can mount rapidly and the impact of CECL can be magnified.

The point is not to dissuade you from taking credit risk, but rather to stress that the rules have changed; everyone will need to be much more deliberate with their business models, strategic plans, and the execution of those plans to be well-positioned for CECL.

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c. notes – Evaluating Risk/Return Trade-offs When Margins Are Razor Thin

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It is no secret that decisions today are more complex and far-reaching than ever before, and margins are razor thin. Traditional and non-traditional competitors on the battlefield keep multiplying and plotting to get more of consumers’ business, all while credit unions have to throw resources toward protecting their flank from attacks such as the CFPB, CECL, NCUA’s NEV test, and RBC.

This c. notes outlines advanced approaches to evaluating risk/return trade-offs so that decision-makers can have actionable business intelligence at their fingertips.

To continue reading, please click here.

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Who’s Afraid of the Big Bad FinTechs? A Powerful Value Proposition Can Calm the Fear

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A lot of financial institutions are concerned about the competition brought by FinTechs that seem to be rewriting the script for how financial business gets done. How can a credit union without a tremendous development budget hope to compete with their slick technology? The concern is well-placed, but perhaps, not for the right reasons.

Yes, FinTechs have advanced technology and they are capturing significant market share, but the financial services industry isn’t really competing with their technology; it’s competing with new customer expectations. Remember when mail order meant filling out a paper form, mailing it, and waiting 6 to 8 weeks? People were content with it because that’s what they expected and they did not know anything different was possible. Fast forward to today; thanks to players like Amazon, customers now expect delivery in a few days, even as quick as one hour in some cases.

What the FinTechs have done is change how people expect to do business. Now that they know it is possible to have a much faster and simpler banking experience, there is no going back. We can never go back to 6 to 8 week mail order deliveries, even if Amazon goes away tomorrow. And if today’s FinTechs don’t survive, customer expectations are still forever changed.

So are faster and simpler processes a requirement for most people? Yes. Does that mean you need to look like a FinTech? That depends on your value proposition. If a FinTech’s value proposition is the ability to get a loan in pajamas, quickly, without talking to anyone, what is your value proposition? There’s room in the marketplace for more than one. If your value proposition is very low loan rates, helping people with credit issues, or building strong relationships, focus on delivering that flawlessly. If it is clear and powerful enough to truly resonate with your target market (and that target market is big enough to sustain the organization), you shouldn’t feel the need to copy the FinTechs; own your value proposition.

At the same time, you will still have to respond to those changes in member expectations; the questions are how and when. Most of that leading-edge technology is available today – for a price. Going back to the shipping example, there are plenty of successful online retailers that do not offer 2-day deliveries as a standard, but very few are in the 6 to 8 week range. Using your value proposition as a filter will result in a more strategic allocation of resources by choosing the right offerings to meet your unique membership’s expectations and support your value proposition.

Remaining relevant to your membership requires thoughtful adjustment as the world around us changes, but the key is to have a clear, powerful value proposition – and deliver on it.