In light of the financial challenges faced by credit unions over the past few years and specifically the increasing interest rate risk that comes with many credit unions borrowing short to lend long, the NCUA has refocused its attention on asset-liability management functions. Most recently, the agency issued rules requiring complex credit unions to develop a written IRR management policy and process as part of their ALM responsibilities. The NCUA said such policies will be considered in determining the insurability of credit unions.
The bottom line is your credit union’s ALM policy needs to lessen the possibility of unforeseen future losses caused by changes in interest rates. It’s both a regulatory mandate and strategic management tool. And considering the historic low-rate environment, it requires even more serious interest by your credit union’s staff and those on the asset-liability committee.
So, where does your credit union stand with its formal ALM policy and procedures? Many management teams actively measure risk using the common and easy-to-understand GAP technique. Others rely on simulation, which calculates estimated future income based on a variety of rate scenarios. Additional measurement tools include Monte Carlo analysis, which reviews thousands of potential interest rate scenarios, and duration theory, which estimates the change in prices of investments when interest rates change. They all can provide effective techniques for managing interest rate sensitivity and forecasting future activities. But no matter which specific methods are used, a focus and commitment to maintaining strong ALM management is the key to maintaining a healthy, prosperous–and regulatory compliant–credit union.
That focus and commitment start with a fully engaged the asset-liability committee working alongside operational management, each of which has clear and distinct roles. Committee members are charged with overseeing the ALM function, monitoring it and reporting to the board of directors. However, management is responsible for execution. And, for the same reasons that you need to keep a sharp focus on ALM, given today’s volatile markets, it’s never been more important for committee members to stay up to date on the financial education and knowledge required to fulfill their roles.
As you review your ALM processes and work to manage IRR, keep the following points in mind.
Management controls very little in our business. Outside forces command much of what goes on in the financial world–members, who drive loan demand and influence liquidity; the economy and Federal Reserve, which influence interest rates; competition, which has less reliance on net interest margins; and broader markets, which sometimes can offer significantly higher returns. Be realistic in what you can do.
When measuring IRR, data integrity is critical. The data that inform your decisions must be accurate and reliable, and your analyses can only be as good as the tools used to compile the information.
ALM is not a budget. Changes are allowed and often necessary. While tracking trends is vital, no one can accurately predict where rates will be in the future. We live in a volatile environment and conditions change. Management and the committee need to be prepared to make adjustments for cyclical and market changes, as well as for issues that arise within the credit union.
Hope is not a plan. Following a gut instinct is not the path for consistent success. Understanding how to alter your credit union’s path based on statistics is a far more effective way to obtain a strong balance sheet.
While no amount of preparation can predict the future, having your credit union prepared for multiple scenarios puts your asset-liability committee and management team in a better position to succeed. We cannot know what the future holds. The benefit of running multiple scenarios is that it allows management a glimpse into “what could be” when considering future options.
At Mid-Atlantic Corporate Federal Credit Union, we’re seeing many credit unions request us to perform periodic ALM reviews, which is not surprising, as the need for outside evaluation is vital for navigating today’s market and regulatory conditions. Along with ongoing, internal vigilance by management and the committee, a third-party review provides valuable perspective that helps ensure healthy ALM practices:
• Validation of practices. An ALM expert can examine current processes to verify if they are appropriate and indicate areas where adjustments should be made.
• Balance-sheet stability. An outside viewpoint can determine how to guard against volatility while isolating risks where possible.
• Identification of trends. Management and committee members can learn how to spot movements or tendencies in the balance sheet that may serve as early warnings of the need for course corrections.
• Strategy assistance. External assistance can help credit unions develop ALM plans that are sound and steer away from issues such as concentration risk.
ALM has taken on new importance during the past few years. This is largely due to the record-low interest rates, as well as consumers’ increased mortgage refinancings and the related risk due to mismatches. Credit unions have seen their share of these issues. And we all share the need to focus on developing, maintaining and reviewing an effective ALM program.
Bruce A. Six is senior vice president/chief investment officer at Mid-Atlantic Corporate Federal Credit Union.
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