Casey Peterson Senior Advisor Mike McGinnis- Vice President, Investment Sales SSI 1 - INTRODUCTION TO CREDIT UNION FINANCIAL MANAGEMENT

Transcription

1 Casey Peterson Senior Advisor Mike McGinnis- Vice President, Investment Sales Sponsored by Catalyst Corporate FCU SSI 1 - INTRODUCTION TO CREDIT UNION FINANCIAL MANAGEMENT Reviews the basic financial components and variables that impact credit union financial performance. SSI 2 ANALYSIS OF CREDIT UNION FINANCIAL ACTIVITIES Outlines assessment ratios and analytical methodologies used in evaluating operating and financial performance. SSI3 - INTRODUCTION TO CREDIT UNION INVESTMENT PORTFOLIO MANAGEMENT Reviews the elements and variables associated with prudent investment portfolio practices. SSI 4 INTEGRATING ASSESSMENT AND ANALYSIS PRACTICE TO DEVELOP A DEFINITIVE STRATEGIC PLAN Integrating financial concepts and analytics into practical application. 1

2 Overview on the Economic and Interest Rate Environments Identify how the Financial Markets might impact Credit Union activity and to set strategic outlook Analysis of Credit Union s financial position and risk exposure Identify strength and weaknesses based on this outlook and regulatory environment Development of specific financial strategies for Liquidity, Earnings and Risk Specific investment portfolio management strategies to balance overall return Establish specific strategic guidelines for Balance Sheet and Portfolio Allocation, Capital Adequacy, Loan and Share Pricing, Cost Efficiencies, Liquidity and Risk Management 3 ECONOMIC ENVIRONMENT: National GDP is 3.5 percent with markets expecting a slight slowdown to 1.5 to 2.0 percent for the subsequent year.. Core inflation rate is 2.5 percent with expectation of 2.0 to 2.5 percent... INTEREST RATE ENVIRONMENT: Overnight rates at 5.00 percent; 3mo UST at 5.00 percent; 2yr UST at 5.26 percent; 10yr UST at 5.35 percent.. FOMC maintaining a monitored approach to monetary policy.. CREDIT UNION PROFILE: $200MM in Total Assets with substantial surplus liquidity and very limited loan demand; Equity Capital is very strong but annualized ROA is 0.56 percent.. Interest rate risk profile is adverse to declining interest rates.. GOALS: Improve earnings over next two years without diluting equity profile. Reduce overall interest rate risk exposure. 4 2

3 PRESUMED ECONOMIC ENVIRONMENT The fact that GDP is projected to decline over the subsequent year reflects an expectation that economic growth will begin to slow down.. This most likely suggests a slowdown in consumer spending (since two-thirds of GDP is associated with consumer spending). Lower spending could result in less demand for credit and also has an impact on consumer savings. Price appreciation (inflation) generally declines pending a weaker economy after an initial upward shift in core inflation. The slope of our implied yield curve is relatively flat which generally happens at the end of an interest rate cycle. Any subsequent movement depends on the direction of the interest rate cycle 5 INTEREST RATE ENVIRONMENT 8.00% 7.00% 6.00% 5.00% 3.00% 2.00% 1.00% 0.00% 6.00% 5.50% 5.00% 4.50% 2-Year US TREASURY PROJECTED Fed Funds CURRENT Rates in general have been rising over the previous few years. With slower economic growth pending, short-term spreads are narrowing, creating flatness in the yield curve. Two general rules, each of which sends the yield curve back to a normal shape...either 1) shortterm rates will fall greater than long-term rates or 2) long-term rates will increase relative to shortterm rates. We ll assume the markets are pressing for lower rate outlook as FOMC attempts to ease credit to stimulate growth. 6 3

4 APPLICABLE STRATEGY 8.00% 7.00% 6.00% 5.00% 3.00% 2.00% 1.00% 0.00% ASSET ALLOCATION, DURATION AND FIXED YIELD FUNDING ALLOCATION, DURATION AND VARIABLE COST COMMENSURATE WITH SLOWING ECONOMY IS A SUBSEQUENT DROP IN SHORT-TERM RATES. THIS SHIFTS THE SHAPE OF THE YIELD CURVE AND ULTIMATELY THE SLOPE DICTATES STRATEGY TO MANAGE THE NET INTEREST MARGIN. PRINCIPLE GOAL IS TO ENHANCE LONG-TERM ASSET YIELD THROUGH PRUDENT DURATION MANAGEMENT AND LESSEN SUBSEQUENT FUNDING COSTS THROUGH PROPER ALLOCATION AND PRICING. 7 CREDIT UNION PROFILE Balance Sheet BALANCE SHEET (in Million$) Cash $ 23.3 Investments 60.5 Loans, net Other 9.2 LOANS Amount Pct Rate WAM Unsecured $ 3, % 8.00% 3.0 Vehicle Loans 63, % Real Estate Loans 37, % Other Loans 4, % TOTAL LOANS $ 109, % Faster Prepayment Speeds? Adequate Asset Duration? Total Assets: $ Share Drafts $ 36, % 0.75% 0.3 Regular Shares 73, % Shares Other 2.7 Equity 19.3 SHARES Money Market 35, % Non-term Shares 145, % Term Certificates 32, % % of Funds Short-term Total Shares & Equity $ TOTAL SHARES $ 178, % 6.2 Adequate Funding Duration? Ratios: Equity 9.65% Loans-to-Assets: 54.5% EQUITY 9.00% = $214.4-million = +$14.4-million Asset Growth Allowance 8 4

5 CREDIT UNION PROFILE Investment Portfolio Structure Par Market Eff (in 000s) Value Value Yield Avg Life Dur Yield Investment Cash $ 23,300 $ 23, % % Cash & O/N Investments $ 23,300 $ 23, % % Certificates of Deposit 13,645 13, % % US Agencies - Bullets 9,100 9, % % US Agencies - Callables 12,000 11, % % MBS - Agency PACs 25,577 25, % % Investment Securities $ 60,322 $ 59, % % Adequate Profile? Yield to Duration? Cash Flow Diversity? Cash Flow Exposure? Total Portfolio $ 83,622 $ 83, % % Yield to Duration? Market Value Exposure? 9 CREDIT UNION PROFILE Liquidity +8% -5% (in $000s) +100bps -100bps Loans Growth Share Growth Cash & Investments >6mos $ 44.7 $ 38.4 $ 38.4 $ 38.4 Loans Other Assets Total Uses Shares and Deposits Equity Total Sources Liquidity Ratio 81.3% 78.1% 82.4% 81.8% 10 5

6 CREDIT UNION PROFILE Earnings EARNINGS (to Average Assets) Net Asset Yield 5.00% Cost of Funds 1.71 Net Interest Margin 3.29% Net Spreads 3.80% 3.60% 3.40% 3.20% 3.00% 2.80% 2.60% 2.40% 2.20% 2.00% 3.66% Net Interest Margin 3.46% Net Operating Expense 2.19% 2.40% 3.29% 2.73% '94 '95 '96 '97 '98 '99 '00 '01 '02 '03 '04 '05 Non-Interest Income 0.75% Non-Interest Expense 3.48 Net Operating Expense 2.73% Net Income 0.56% Net Income (ROA) 1.40% 1.20% 1.00% 0.80% 0.60% 0.40% 1.27% Net Income 1.26% 0.56% 0.20% '94 '95 '96 '97 '98 '99 '00 '01 '02 '03 '04 '05 11 CREDIT UNION PROFILE Earnings EARNINGS (to Average Assets) Net Asset Yield 5.00% Cost of Funds 1.71 Net Interest Margin 3.29% Non-Interest Income 0.75% Non-Interest Expense 3.48 Net Operating Expense 2.73% Net Income 0.56% Net Interest Margin Net Operating Expense 8.00% 7.00% 6.00% 5.00% 3.00% 2.00% 1.00% 0.00% 3.50% 3.00% 2.50% 2.00% 1.50% 1.00% 0.50% 0.00% 6.46% 6.92% Net Asset Yield 5.00% 346 bps 366 bps 329 bps 3.00% Cost of Funds 3.26% 1.71% '94 '95 '96 '97 '98 '99 '00 '01 '02 '03 '04 ' % Op Expense 3.00% 2.54% 273 bps 240 bps 219 bps Op Income 0.60% 0.75% 0.35% '94 '95 '96 '97 '98 '99 '00 '01 '02 '03 '04 '

7 Strategic Solutions Institute CREDIT UNION PROFILE Earnings EARNINGS (to Average Assets) Net Asset Yield 5.00% Cost of Funds 1.71 Net Interest Margin 3.29% Net Asset Yield 10.00% 8.00% Avg Asset Yield 6.00% 2yr US Treasury 2.00% 0.00% Non-Interest Income 0.75% Non-Interest Expense 3.48 Net Operating Expense 2.73% Net Income 0.56% Cost of Funds 10.00% 8.00% 6.00% 2.00% 3M US Treasury Cost of Funds 0.00% 13 CREDIT UNION PROFILE Earnings EARNINGS (to Average Assets) Net Asset Yield 5.00% Cost of Funds 1.71 Net Interest Margin 3.29% Non-Interest Income 0.75% Non-Interest Expense 3.48 Net Operating Expense 2.73% Net Income 0.56% NON-INTEREST OPERATING EXPENSE (000s) Amount Ratio Peer Compensation & Benefits $ 3, % 1.77% Office Occupancy & Operations 2, % 0.95% Travel & Conference % 0.06% Education & Promotion % 0.16% Loan Servicing % 0.22% Professional Services % 0.25% Member Insurance % 0.01% Operating Fees % 0.02% Miscellaneous % 0.08% TOTAL EXPENSES $ 6, % 3.51% 14 7

8 CREDIT UNION PROFILE Short-term Interest Rate Risk INCOME SIMULATION 000s Base Cash and Investments $ 693 $ 724 $ 809 $ 884 $ 1,048 $ 1,125 $ 1,412 Loans, net 4,800 5,209 5,446 5,620 5,904 6,240 6,598 INTEREST INCOME 5,493 5,933 6,255 6,504 6,952 7,365 8,010 Interest Expense Dividend Expense ,253 1,433 1,680 2,405 INTEREST EXPENSE ,253 1,433 1,680 2,405 NET INTEREST INCOME $ 4,820 $ 5,171 $ 5,360 $ 5,251 $ 5,519 $ 5,685 $ 5,605 $ Change in NII (431) (80) Pct Change in NII -8.2% -1.5% 2.1% - 5.1% 8.3% 6.7% 15 CREDIT UNION PROFILE Long-term Interest Rate Risk NET ECONOMIC VALUE 000s Base MV of Earning Assets $ 185,035 $ 184,061 $ 183,246 $ 181,913 $ 178,620 $ 174,363 $ 169,986 MV of Funding 165, , , , , , ,089 IMPLIED NEV 19,303 18,311 17,478 17,286 17,420 15,718 13,897 Chg in MV Earnings Assets 3,122 2,148 1,333 - (3,293) (7,550) (11,927) Chg in MV Funding 1,105 1,123 1,141 - (3,427) (5,982) (8,538) Implied Chg in NEV 2,017 1, (1,568) (3,389) Chg in MV Earnings Assets 1.7% 1.2% 0.7% % -4.2% -6.6% Chg in MV Funding 0.7% 0.7% 0.7% % -3.6% -5.2% Implied Chg in NEV 11.7% 5.9% 1.1% - 0.8% -9.1% -19.6% 16 8

9 CREDIT UNION PROFILE Investment Portfolio Interest Rate Risk (dollars in thousands) Cash and Overnight Market Value $ 23,356 $ 23,337 $ 23,319 $ 23,300 $ 23,281 $ 23,265 $ 23,246 Change in Value (19) (35) (54) Percentage Change 0.24% 0.16% 0.08% % -0.15% -0.23% Average Life Effective Duration Term Investments Market Value $ 62,218 $ 61,538 $ 60,824 $ 59,818 $ 59,719 $ 58,749 $ 57,232 Change in Value 2,400 1,720 1,006 - (99) (1,069) (2,586) Percentage Change 4.01% 2.87% 1.68% % -1.79% -4.32% Average Life Effective Duration Market Value Exposure? Extension/Contraction Risk? Total Portfolio Mkt Value of Portfolio $ 85,574 $ 84,875 $ 84,143 $ 83,118 $ 83,000 $ 82,014 $ 80,478 Change in Value 2,456 1,757 1,025 - (118) (1,104) (2,640) Percentage Change 2.95% 2.11% 1.23% % -1.33% -3.18% Average Life (Yrs) Effective Duration Interest Rate Risk on Cash Flows and Market Values? 17 ECONOMIC ENVIRONMENT: National GDP is 3.5 percent with markets expecting a slight slowdown to 1.5 to 2.0 percent for the subsequent year.. Core inflation rate is 2.5 percent with expectation of 2.0 to 2.5 percent... INTEREST RATE ENVIRONMENT: Overnight rates at 5.00 percent; 3mo UST at 5.00 percent; 2yr UST at 5.26 percent; 10yr UST at 5.35 percent.. FOMC maintaining a monitored approach to monetary policy.. CREDIT UNION PROFILE: $200MM in Total Assets with substantial surplus liquidity and very limited loan demand; Equity Capital is very strong but annualized ROA is 0.56 percent.. Interest rate risk profile is adverse to declining interest rates.. GOALS: Improve earnings over next two years without diluting equity profile. Reduce overall interest rate risk exposure. 18 9

10 NET MARGIN Significant cash holdings in declining rate scenario not welcomed. Loan growth outlook very weak so alternative moves to investment portfolio.. Sizeable funding from non-term shares with relatively high COF. NET OPERATING EXPENSE: Much higher than peer group and appears to be impacted more by lack of fee generation.. Few opportunities to reduce future expense structure to benefit this year. CAPITAL: Well-capitalized; Credit union has the ability to grow assets to garner additional income, if necessary. ROA under-performing. INTEREST RATE RISK: Already adversely exposed to declining rates due to higher liquidity and high cost of funds; Best remedy is to address pricing guidelines on non-term shares. 19 INTEREST RATE ENVIRONMENT Relative Value of Asset Activities Portfolio Investment 1Yr 2Yrs 2.5Yrs 3Yrs 4Yrs 5Yrs U.S. Treasury % 5.26% 5.25% 5.23% 5.26% 5.21% FRM 30-yr Vehicle Loans Fixed Invmts- Fixed Maturity Agy Bullet Retail CD Invmts- Fixed Callable Agy Calls Invmts- Fixed Amortizing MBS PT/CMOs

11 INTEREST RATE ENVIRONMENT Relative Value of Asset Activities Portfolio Investment 2Y 2.5Yr 5Yrs PINPOINTS STRATEGIC DURATION U.S. Treasury % 5.25% 5.21% Fixed-Rate Mortgages 30-yr Vehicle Loans Fixed IDENTIFIES BUILT-IN CREDIT VALUE Invmts- Fixed Maturity Agy Bullet Retail CD IDENTIFIES VALUE OF OPTIONALITY Invmts- Fixed Callable Agy Calls Invmts- Fixed Amortizing MBS PT/CMOs IDENTIFIES VALUE OF MONTHLY CASH FLOW OPTION 21 REINVESTMENT STRATEGY Relative Value of Asset and Funding Activities Reallocating From Cash to Per $1MM Per$5MM Decrease Non-term Share Rates: Per: $5M $10M $25M $50M 2-year Average Lives: Agency Bullets $ 3,000 $ 15,000 Retail CDs 4,500 22,500 Agency Calls 4,600 23,000 Agency PACs 5,200 26,000 3-year Average Lives: Agency Bullets $ 3,000 $ 15,000 Retail CDs 10,000 50,000 Agency Calls 6,700 33,500 Agency PACs 6,600 33,000 Vehicle Loans 10,000 50, bps: Amount $12,500 $25,000 $62,500 $125,000 COF -0.01% -0.01% -0.03% -0.06% 50 bps: Amount $ $50,000 $125,000 $250,000 COF -0.01% -0.03% -0.06% -0.13% 75 bps Amount $37,500 $75,000 $187,500 $375,000 COF -0.02% -0.04% -0.09% -0.19% 22 11

12 IMPACT ON LIQUIDITY PROFILE STRATEGY OF REALLOCATING $15.0-million.HAS NO ADVERSE IMPACT +8% -5% (in $000s) +100bps -100bps Loans Growth Share Growth Cash & Investments >6mos $ 59.7 $ 53.4 $ 38.4 $ 38.4 Loans Other Assets Total Uses Shares and Deposits Equity Total Sources Liquidity Ratio 88.9% 85.7% 82.4% 81.8% 23 IMPACT ON NET SPREAD AND RETURN ON ASSETS STRATEGY Amount Investment Rate WAL RESULTS Before After $5-million 5-yr Retail CD 5.72% 5.0 $5-million 2.5-yr MBS $5-million 3-yr Retail CD $15-million TOTAL 5.92% 3.4 Portfolio: Yield: 5.00% 5.18% WAL: Impact on Portfolio: Yield: % WAL: Impact on ROA: % Impact on Equity: 9.65% 9.65% 24 12

13 IMPACT ON NET SPREAD AND RETURN ON ASSETS POST-STRATEGY RESULTS Before After ROA: +0.56% Reprice/Reinvest: Pricing of NTS Net Impact Of Strategy +0.56% +0.95% POST-STRATEGY ASSESSMENT Improved ROA but not to desire goal. Repricing/Reinvestment opportunities over the next year add a little more. Increasing rate sensitivity of NTS and to align average rates more to market levels. Liquidity profile not volatile. Level of fixed assets protect against declining rate scenario but amortizing creates opportunity in rising rate scenario. Equity position strengthened. 25 IMPACT ON SHORT- AND LONG-TERM INTEREST RATE RISK EXPOSURE POST-STRATEGY RESULTS Before After Short-term Exposure (Income Sim) -100 bps + 2.1% +2.7% +100 bps Long-term Exposure (NEV) -100 bps -9.8% -6.8% +100 bps bps +11.7% +10.1% +300 bps POST-STRATEGY ASSESSMENT Less exposure to declining rates in both shortand long-term assessment.. Only slightly higher risk exposure given a rising rate scenario but still considered low profile. Less volatility of existing narrow spreads relative to high cost of funds. Liquidity and cash flow profiles well structured for both rising and declining rate environment

14 Casey Peterson Senior Advisor Mike McGinnis VP Investment Sales