McQueen Financial Advisors

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1 Fall Leadership Development Conference Interest Rate Risk and Industry Trends Jim Craven McQueen Financial Advisors SEC Registered Investment Advisor $4 Billion + under management Municipal & Corporate Credit Reviews Comprehensive Reporting Valuations Credit Union Mergers Credit Union + Bank Mergers Mortgage Servicing Rights Complex Investments Consulting Strategic Planning Branch Analysis Board Training Policy Development Exam Preparation Risk Analysis Asset Liability Management Liquidity Stress Testing Core Deposit Studies Assumption Sensitivity Analysis Prepay Speed Analysis ALM Validations Back Testing Analysis McQueen Financial Advisors, Inc. 1

2 Today s Agenda Interest Rate Risk and Industry Trends Examiner Focus Industry Update Interest Rate Environment Economic Indicators Interest Rates Pop Quiz Pop Quiz Historical Impact of Rising Interest Rates Challenges Opportunities McQueen Financial Advisors McQueen Field Experience McQueen Financial Advisors, Inc. 2

3 Examiner Focus McQueen Field Experience 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 Liquidity Policy Multiple Lines of Credit Testing of Available Lines Ability to Borrow Ability to Sell Loans Level of Unfunded Commitments McQueen Financial Advisors Industry Update McQueen Financial Advisors, Inc. 3

4 Industry Update Trends Industry Update Trends Now Exceeds $1 Trillion McQueen Financial Advisors, Inc. 4

5 Industry Update Earnings Industry Update Net Worth & Asset Quality McQueen Financial Advisors, Inc. 5

6 Industry Update Asset / Liability Management & Productivity Industry Update Pop Quiz We just looked at 24 industry trends. How many of them are favorable? 20 of 24 McQueen Financial Advisors, Inc. 6

7 Industry Update Unfavorable Trends 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. Industry Update Credit Unions The credit union industry is over 100 years old. Total assets of all credit unions topped $1 trillion for the first time in 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 2.7% of U.S. banks have assets of less than $25 million compared to 49% of credit unions McQueen Financial Advisors, Inc. 7

8 Industry Update Credit Unions Combined, assets at credit unions and banks exceeds $17 trillion. McQueen Financial Advisors Economic Indicators McQueen Financial Advisors, Inc. 8

9 Economic Indicators Unemployment Underemployment Rate still too high Has not been this low since the late 1970s Economic Indicators Labor Force Participation Has not been this high since the early 1960s McQueen Financial Advisors, Inc. 9

10 Economic Indicators Consumer Price Index (ex Food & Energy) 1.70% Economic Indicators Home Prices Downward trend for many years McQueen Financial Advisors, Inc. 10

11 Economic Indicators New & Existing Home Sales New home sales doubled but are still far below normal level Economic Indicators Household Debt Service Ratio: 9.9% Percentage of take home pay allocated to debt service McQueen Financial Advisors, Inc. 11

12 Economic Indicators U.S. Auto Sales Annualized: 13.2 Million Back to normal levels and expected to grow Economic Indicators Federal Reserve Meetings McQueen Financial Advisors, Inc. 12

13 McQueen Financial Advisors Interest Rates Interest Rates Historical Fed Funds Rate: 1955 to 2015 Fed Funds Rate Unchanged for Nearly 7 Years McQueen Financial Advisors, Inc. 13

14 Interest Rates Pop Quiz 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? ( ) Interest Rates Historical Fed Funds Rate Changes Number of times the Fed Funds Rate Changed in Each 7 Year Period McQueen Financial Advisors, Inc. 14

15 Interest Rates Historical Fed Funds Rate Changes 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 Interest Rates What s Next? When will interest rates change and by how much? Economic indicators will continued to be released. Markets and the Federal Reserve Bank will react. McQueen Financial Advisors, Inc. 15

16 McQueen Financial Advisors Historical Impact of Higher Rates Historical Impact of Higher Rates Yield Difference: Short vs Long Wider spread Narrow or negative spread. Difficult environment. McQueen Financial Advisors, Inc. 16

17 Historical Impact of Higher Rates Higher Short Term Rates and Narrow Spread Late 2003 to Late 2006 Narrow or negative spread. Difficult environment. Historical Impact of Higher Rates Rates Rose 400 Basis Points Looking at yield curves and market changes alone, it appears impossible to make money McQueen Financial Advisors, Inc. 17

18 Historical Impact of Higher Rates Result of a 400 basis point rate increase McQueen Financial Advisors Challenges McQueen Financial Advisors, Inc. 18

19 Challenges Review Risk to Income Important to review income sensitivity and trend over time. Challenges Review Risk to Value Important to review value sensitivity and trend over time. McQueen Financial Advisors, Inc. 19

20 Challenges Review Non-Parallel Scenarios Non-parallel scenarios are more diverse and more likely than parallel scenarios. Challenges Review Pricing Sensitivity Analysis compares changes in the Fed Funds rate to the client s deposit rates during a period of rapidly rising interest rates ( ). Client A: Increased rates very little Client B: Increased some rates and cut some rates McQueen Financial Advisors, Inc. 20

21 Challenges Review Pricing Sensitivity 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 little Client B: Increased some rates and cut some rates Challenges Review Performance & Condition Ratios If loan to deposit ratio is high Measure liquidity stress, potential impact of loosing deposits. Review deposit pricing and contingency liquidity sources McQueen Financial Advisors, Inc. 21

22 Challenges Impact of Low Rate Environment Very low rates initially boosted credit union earnings as deposit costs fell to historic low levels. But it didn t last long Deposit costs can not fall further, while loan and investment yields continue to fall. Common to see anemic loan growth and swelling deposits. Excess cash has been deployed in portfolios that consistently roll-over at lower yields. McQueen Financial Advisors Opportunities McQueen Financial Advisors, Inc. 22

23 Opportunities Slope of the Yield Curve A steeper yield curve would likely result in: Considerably higher loan and investment rates (generally intermediate to long term) Moderately higher deposit rates (generally short term) Opportunities Economic Conditions Matter 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 Loan delinquencies rose Charge-off rates increased Borrower credit scores declined Earnings suffered Reversal of these trends will likely have a greater impact on margin and net income than will rising interest rates. McQueen Financial Advisors, Inc. 23

24 Opportunities Economic Conditions Matter 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 Opportunities Potential Impact of an Improving Economy Improved loan-to-deposit ratio Higher loan volume & yields Modestly higher deposit rates Normal investment returns: 2007 Example: Loan Yield 7.14% Investment Yield 4.66% Higher risk tolerance Investment portfolio losses Lower profit on mortgage lending: Spread and fee income McQueen Financial Advisors, Inc. 24

25 Opportunities Strategies Plan to raise deposit rates slowly in response to need for funds Offer deposit specials to encourage member CDs in response to need for funds Prepare for consumer loan growth with properly trained staff Consider member business lending where floating rate loans are more common Retain only the most favorable real estate loans Understand your interest rate risk Shorten investment portfolio as bonds mature Opportunities Strategies 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 Enhance marketing efforts and use of technology to reach potential members McQueen Financial Advisors, Inc. 25

26 Questions? McQueen Financial Advisors, Inc. Jim Craven Woodward Avenue Royal Oak, MI f a.com f a.com McQueen Financial Advisors, Inc. 26

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