MADISON, Wis.-The U.S. financial services industry has been in a declining interest-rate environment for 30 years, meaning many credit union executives have never worked or managed in a rising-rate environment.
That is the message from Theran Colwell, director of strategy and business development for CUNA Mutual Group, who described interest rates and related scenarios as "fascinating."
"Over the last month rates spiked up a little bit, but they still are at or near historic lows," he observed. "The Bank of England has been tracking rates longer than anyone, and as of a couple months ago they were at the lowest levels in 311 years."
When rates do go up they tend to spike up faster than they go down, Colwell noted, pointing to the increase in mortgage rates from 3.5% to 4.5% in just weeks, before rates retreated a bit. A difference of one percentage point dramatically changes a member's monthly payment, making rates one of the most important issues for the 2014 planning season.
"It is really important to talk about interest rate scenarios," he advised. "During strategic planning be sure to map out a variety of scenarios. Know how each potential scenario could impact the credit union's income statement, balance sheet and net worth ratio-the latter being something examiners watch closely."
Interest rate scenarios must include rate shocks-which Colwell said could be from 100 basis points to 400 BP up, and must also test a rate decline of up to 100 BPs.
"In strategic planning, go beyond ALM and interest rates and discuss what would happen if the economy goes back into a recession," he said. "Also plan for a strong recovery. Go through these scenarios, learn from them, determine which is the most probable, then bring that into the design phase."
Other factors to consider: there will be political changes, technology changes and economic changes ahead. Colwell said there also will be socio-cultural changes, meaning changes in consumers' attitudes.
"ALM is under the economic component," he said. "Credit unions have their ALM models, and they can learn what would happen to their assets and liabilities under various scenarios. Depending on the results, maybe things look good, maybe not. The ALM models make it pretty clear."
What Next?
After running rate shock scenarios through ALM models, what takes place next depends on the individual credit union. Colwell said some CUs have more interest rate risk than others.
One example is a CU that holds a large percentage of long-term, fixed-rate assets and some short-term liabilities. In a rising rate environment, he warned, liabilities will reprice faster than assets.
"For 70% to 80% of credit unions, the bulk of their income comes from interest rate spread. If there is a high interest rate risk, the credit union can choose to sell long-term mortgages to Fannie and Freddie, or take long-term borrowing from the FHLB to lock in low cost of funds. Another option is to change the duration of assets by doing more auto lending and less mortgage lending.
"The changes that can be made are almost unlimited, but the key is to understand the balance sheet and income statement," he added.
