Key ALM Assumptions for Rising Rates. Current Landscape Interest Rates CU Balance Sheet & Financial Performance Trends

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1 CONNECT WITH US Key ALM Assumptions for Rising Rates Lisa Boylen Senior ALM Analyst February 21, 2018 Objectives Current Landscape Interest Rates CU Balance Sheet & Financial Performance Trends Planning Considerations Fine Tuning Model Assumptions and Current Position Data Integrity Modeling Scenarios 1

2 Rates on the Rise 2

3 Bloomberg Rate Forecast Historical & Projected Rates Implications Pressure on NIM Higher increase in deposit costs than yield on earning assets Flat yield curve mitigates the benefit of rising rates 3

4 CU Industry Earnings Source: NCUA Financial Performance Report Increase in ROA The Drivers Source: NCUA Financial Performance Report 4

5 NIM Yield or Cost? Source: NCUA Financial Performance Report Source: NCUA Financial Performance Report 5

6 Continued Growth in Lower Cost Funding Source: NCUA Financial Performance Report Potential Liquidity Crunch? Source: NCUA Financial Performance Report 6

7 Potential Liquidity Crunch? Source: NCUA Financial Performance Report 7

8 Market Rates Up CU Offering Rates? Source: NCUA from SNL database Market Rates Up CU Offering Rates? Source: NCUA from SNL database 8

9 What Do Market & Trends Tell Us Increase in Overnight Fed Funds Target Rate Flat Yield Curve Expansion in Net Interest Margin Can it Continue? No Change in Funding Cost starting to see higher CD offering rates Loan Yields are down Earning asset yields are up with reallocation of investments into loans Average loan offering rates show little change over last 3 years Loan Growth Faster than Share Growth How much liquidity left on balance sheet to fund growth? Pressure for higher deposit rates to fund growth Investment Portfolios increased rates, lower values Confidence in Model Projections Review Model Assumptions Review Current Position Data Market Scenarios Stress Test Assumptions Liquidity Forecasting & Impact to Earnings 9

10 Repricing Assumptions - Loans Offering Rate Current Rate on New Volume How is the offering rate determined Use average rate on recent originations as a guide Make sure sample size is adequate Review data are there large outliers skewing the WAC? Recent rate increases not reflected in prior 1 month to 3 month originations? Review model setup how are offering rates determined? Rate Tied to a Key Rate Verify Key Rate (Market or User Defined) Update margins Loan Offering Rate Assumptions Example 10

11 Loan Repricing Assumptions Offering Rate Change in Response to Changes in Market Interest Rates Example: Current Offering Rate of 5.0% Beta of 1.0% 100 bp Rate Shock Offering Rate of 6.0% With the recent rise in rates, have you increased your loan rates? Loan Repricing (Beta) Example 11

12 Repricing Assumptions - Shares Current beta assumptions based upon historical behavior What does most recent rise in rates tell us? Beta increases across scenarios may not be linear Stress testing is critical Prepayment Assumptions The payment of all or part of a loan prior to its due date Income Simulation - Impacts level of loan runoff and repricing at new offering rate NEV value = discounted cash flow. Change in cash flow impacts valuation Liquidity projections higher prepays results in more cash flow, lower prepays results in less cash flow 12

13 Prepayment Assumption Example Certificate Share Assumptions Bump Up CDs entitles the member to request a bump up in rate to take advantage of rising rates Do you have a large portfolio of this type of account? Determine if your model has the ability to model this assumption most likely will use the functionality of a prepayment/decay table Stress various % of balance that would exercise this option Not modeling will understate interest expense projections Early Withdrawal do you have early withdrawal penalties and will they be enforced? 13

14 Growth Assumptions Regulatory Compliance static balance sheet with no change in balance composition Earnings & Liquidity Projections Dynamic Balance Sheet expected loan and share growth Balance Composition Surge Balances NMS leaving the credit union for equity/bond investments Share Migration lower cost NMS shares moving into certificates Segregate Potential Surge from Core NMS different repricing betas Current Position Data Review Data Files and Model Setup Are critical fields included in the data file? Are they captured in the model? Variable Rate Loans Index Margin Reset Dates/Frequency Lifetime Cap Lifetime Floor Periodic Cap Introductory Rates 14

15 Current Position Data ARM Loan Current Position Data ARM Loan 15

16 Current Position Data Callable Bonds Is the bond set up as callable? How is the call determined? Rising Rates If bond is incorrectly called, interest income overstated because cash flow is reinvested at a higher rate Market Scenarios - Parallel Rates move parallel with the current yield curve shape of the curve does not change Instantaneous rates move up instantaneously. Standard scenarios used for regulatory compliance modeling Ramps rates move up gradually over time 16

17 Market Scenarios Non-Parallel Short or long end of the curve move at differing rates shape of the curve changes Bear Flattener short term rates rise faster than long term rates Bear Steepener long term rates rise faster than short term rates Bull Flattener long term rates fall faster than short term rates Bull Steepener short term rates fall faster than long term rates Non-Parallel Yield Curve Shifts 17

18 Know Your Risk in Different Scenarios Know Your Risk in Different Scenarios 18

19 Liquidity Forecasting Build a model forecast with best expectation of loan and share growth Maintain or let investments runoff Most models self balance do you have excess funds to invest or do you need funding? Run various investment or funding strategies choose best risk/reward option Impact to Earnings Risk to NII Risk to NEV Summary Further Fed Increases with Flat Yield Curve NIM pressure Liquidity Tightening develop and model funding strategies Uncertainty of Member Share Behavior model various scenarios Assumptions Determine reasonableness and stress 19

20 Contact Lisa B. Boylen, CPA Senior ALM Analyst (336) (direct) (800) ext Triad Center Drive, Suite 410 Greensboro, NC