Fall Leadership Development Conference
Interest Rate Risk and Industry Trends
Jim Craven
SEC Registered
Investment Advisor
•
$4 Billion + under
management
•
Municipal &
Corporate Credit
Reviews
•
Comprehensive
Reporting
Today’s Agenda
Pop
Quiz
Pop
Quiz
Industry Update
Interest Rate Environment
•
Economic Indicators
•
Interest Rates
Historical Impact of Rising Interest Rates
Challenges
Opportunities
Examiner Focus
Interest Rate Risk and Industry Trends
McQueen Financial Advisors
McQueen Field Experience
Examiner Focus
At small credit unions:
• Interest Rate Risk/ALM ALM Policy
Use of Reports
Effective ALM Meeting Minutes • Liquidity
Policy
Testing of Available Lines • Cyber Security
At large credit unions:
• Interest Rate Risk/ALM ALM Policies
Appropriate policy limits Board oversight Separation of duties Effective ALM Meeting Minutes ALM Validation
Support for ALM Assumptions Core Deposit Study Prepay Speed Analysis ALM Back Testing
Effective ALM
Meeting Minutes
• LiquidityPolicy
Multiple Lines of Credit Testing of Available Lines Ability to Borrow
Ability to Sell Loans
Level of Unfunded Commitments
McQueen Financial Advisors
Trends
Industry Update
Trends
Earnings
Industry Update
Asset / Liability Management & Productivity
Industry Update
Pop Quiz
Industry Update
We just looked at 24 industry trends.
How many of them are favorable?
Unfavorable Trends
Industry Update
Consolidation related to aging member base & succession planning Growth at smaller credit unions is difficult. Aging neighborhoods. Difficult to maintain high margin without loan growth. At many credit unions, deposits are growing faster than loans.Credit Unions
Industry Update
The credit union industry is over 100 years old. Total assets of all credit unions topped $1 trillion for the first time in 2012.
U.S. banks grew by a similar amount in the past two years
Each of the four largest U.S. banks is larger than the entire credit union industry:
• JP Morgan Chase • Bank of America • Wells Fargo Bank • Citibank
Credit Unions
Industry Update
Combined, assets at credit unions and banks exceeds $17 trillion.
McQueen Financial Advisors
Unemployment
Economic Indicators
Underemployment Rate still too high
Labor Force Participation
Economic Indicators
Has not been this high since the early 1960s Has not been this low
Consumer Price Index (ex Food & Energy)
Economic Indicators
1.70%
Home Prices
Economic Indicators
New & Existing Home Sales
Economic Indicators
New home sales doubled but are still far below normal level
Household Debt Service Ratio: 9.9%
Economic Indicators
U.S. Auto Sales Annualized: 13.2 Million
Economic Indicators
Back to normal levels and expected to grow
McQueen Financial Advisors
Interest Rates
Historical Fed Funds Rate: 1955 to 2015
Interest Rates
Pop Quiz
Interest Rates
Last Fed Funds rate change was
December 2008 (nearly 7 years)
Pop Quiz Question #1:
In the 7 years prior to this, how
many times did the Fed Funds rate
change?
(2002-2008)
Historical Fed Funds Rate Changes
Interest Rates
Historical Fed Funds Rate Changes
Interest Rates
Pop Quiz Question #2:
On average, over the past 50 years how often
has the Fed Funds target rate changed?
A. Every 3 – 4 months
B. About once per year
C. Every 18 months
D. Every 2 - 3 years
What’s Next?
Interest Rates
When will interest rates change and by how much?
McQueen Financial Advisors
Historical Impact of
Higher Rates
Yield Difference: Short vs Long
Historical Impact of Higher Rates
Wider spread
Narrow or negative spread. Difficult
Higher Short Term Rates and Narrow Spread
Historical Impact of Higher Rates
Late 2003 to Late 2006
Narrow or negative spread. Difficult
environment.
Rates Rose 400 Basis Points 2004-2006
Historical Impact of Higher Rates
Result of a 400 basis point rate increase
Historical Impact of Higher Rates
McQueen Financial Advisors
Review Risk to Income
Challenges
Important to review income sensitivity and trend over time.
Review Non-Parallel Scenarios
Challenges
Non-parallel scenarios are more diverse and more likely than parallel scenarios.
Review Pricing Sensitivity
Challenges
Analysis compares changes in the Fed Funds rate to
the client’s deposit rates during a period of rapidly rising
interest rates (2004 – 2007).
Review Pricing Sensitivity
Challenges
Often, these studies show that deposit rates changed very little or were
cut in response to a large increase in the Fed Funds rate. It would not
be appropriate to assume the same deposit pricing going forward.
Client A: Increased rates very littleClient B: Increased some rates and cut some rates
Review Performance & Condition Ratios
Challenges
If loan to deposit ratio is high…
Impact of Low Rate Environment
Challenges
Very low rates initially boosted credit union earnings as deposit costs fell to historic low levels. But it didn’t last long…
Common to see anemic loan growth and swelling deposits.
Excess cash has been deployed in portfolios that consistently roll-over at lower yields.
Deposit costs can not fall further, while loan and investment yields continue to fall.
McQueen Financial Advisors
Slope of the Yield Curve
Opportunities
A steeper yield curve would likely result in:
Moderately higher deposit rates (generally short term) Considerably higher loan and investment rates (generally intermediate to long‐term)
Economic Conditions Matter
Opportunities
ALM reports measure the impact of higher rates on income and value:
Interest Rate Risk
It is also important to consider broader economic conditions and the potential
impact. During the recent tough economic environment:
•
House prices fell
•
Unemployment increased
•
Charge-off rates increased
•
Loan delinquencies rose
•
Borrower credit scores declined
Economic Conditions Matter
Opportunities
The impact of higher rates may not be immediate on margin or income.
Brighter economic conditions matter much more:
Lower unemployment rate Higher home values
Faster economic growth Higher earnings
Greater consumer spending & borrowing
Potential Impact of an Improving Economy
Opportunities
Higher loan volume & yields
‘Normal’ investment returns: 2007 Example: Loan Yield 7.14% Investment Yield 4.66% Higher risk tolerance
Strategies
Opportunities
Plan to raise deposit rates slowlyin response to need for funds
Prepare for consumer loan growth with properly trained staff
Shorten investment portfolio as bonds mature
Consider member business lending where floating rate loans are more common
Retain only the most favorable real estate loans
Offer deposit specials to encourage member CDs in response to need for funds
Understand your interest rate risk
Strategies
Opportunities
Attract and retain low-cost core deposits
History suggests that members may withdraw funds as the economy improves: Stock Market
Competitors Spending
Large purchase down payments
Tie members to the credit union with direct deposit, smart-phone apps,
electronic deposit and payment services, low cost non-maturity deposit products Train staff regarding importance of low-cost core deposits
