For most credit unions, asset/liability management (ALM) has been a “get in line” topic: Get in line behind security, marketing, loan origination and tracking, member relationships, and a host of other pressing matters.
Until now. Credit unions are looking more intently at ALM for a simple reason: Regulators are coming down hard on financial institutions that don’t do thorough ALM.
“We’re seeing increased interest in ALM among financial institutions,” says Kevin Haffner, group president of performance solutions at ProfitStars®. “ALM has taken a back seat over the past 10 years. But regulators increasingly are scrutinizing financial institutions in the wake of the economic downturn and recent banking crises. They want to make sure nothing else happens on their watch. Credit unions now must stress test their balance sheets more often and more strenuously than before.”
“ALM often amounted to just checking a box,” notes Deby Smith, area vice president of sales/financial solutions at Open Solutions Inc. “But in the past six to eight months I’ve seen a more active approach to ALM, including more hiring of ALM experts in mid- to large-size credit unions. Also, credit unions are growing their deposit base, and rapid growth brings more factors to consider. Add to that the realization that credit unions are now being scrutinized more intensely.”
“Historically, financial institutions of all sizes have taken a minimalist approach to ALM,” says Tom Parsons, director of consulting services at Plansmith Corp. “But examiners no longer tolerate this. That means credit unions may have to run more than one or two scenarios. They could be forced to run several scenarios based on both expectable events and catastrophic events.”
Parsons believes the current monetary policy of low interest rates seems to be working and will probably last through the end of 2011. “At that time there could be a risk of sustained rising interest rates,” he says. “Financial institutions have to be prepared for rising rates, but the related topics of liquidity and contingency funding are little known or understood. Lack of attention to liquidity has created a sense of complacency, which in a rising interest rate situation becomes very important.”
Previously, says Parsons, it was easy to predict which core deposit accounts would stick around. But consumers are becoming more rate-sensitive, which could affect credit unions’ liquidity in a rising-rate environment.
“Credit unions will now need to forecast and test different scenarios’ effects on liquidity,” he says, “and then plan for how they might retain existing accounts and acquire new accounts. Those steps are what examiners are looking at closely.”
Haffner agrees that when interest rates eventually rise, consumers will seek higher returns. This will beg the question, how will financial institutions retain consumers’ deposits?
“Regulators are scrutinizing credit union liquidity and contingency plans,” he says. “Fortunately, they have been more proactive recently about what they’re looking for, which will aid deposit retention.”
Next: In-house vs. outsourcing
In-house vs. outsourcing
Vendors disagree about whether credit unions should outsource ALM or bring it in-house.
“We’re seeing a trend among credit unions to hire us as an outsourced ALM provider while still using our in-house software solution,” says Haffner. “We, in turn, become a quasi-employee that delivers monthly or quarterly ALM reports. Interestingly, regulators a few years ago were the prime movers behind a push to bring ALM in-house. They wanted credit unions to thoroughly understand how to handle assets and liabilities, but they didn’t factor in the limitations, such as small asset bases or small staffs, that could keep credit unions from acquiring the deep knowledge the regulators were looking for.”
Haffner says outsourcing counters a lack of personnel or expertise, and prevents problems that arise when a knowledgeable employee leaves. “There’s flexibility, too,” he adds. “Clients may purchase different levels of consulting from us, and we can assist clients on what to expect from regulators.”
But Jon Heath, senior financial consultant for Fiserv’s Wisdom suite of financial management and accounting solutions, sees a drawback to outsourcing.
“In most cases with outsourcing you’re getting only quarterly reports, which means you’re looking at old news by the time you get your analysis back,” he says. “If you ask for more complex analysis, you have to pay extra. Keep in mind, too, that many outsourced analyses use generic data to forecast various scenarios.”
If credit unions decide to outsource, Haffner cautions them to be wary of brokers or investment advisors who offer to do ALM. “Do you want your risk manager to also trade and make investments on your behalf? Although they may offer ALM as a ‘free’ or ‘value-added’ service, you’re paying for it via commissions on their bond trades.”
Haffner suggests credit unions look at four things when seeking an ALM provider, whether in-house or outsourced: track record, client base, references, and what the vendor provides beyond software—expertise, consultation, and the ability to deal with regulators.
Every credit union is unique, so the key to accurate ALM modeling is taking into account how members behave during various market conditions, Heath says. “Be willing to get into details and look at historical trends and other information, including off-balance sheet data such as plant closings, etc.
“Also, be consistent and perform ALM on a regular basis. Be methodical and put thought into your assumptions and how your members will react to market changes. Run multiple scenarios to see how your balance sheet might perform and where you might have to address key issues. Make ALM training and ongoing education a priority not only for the staff who perform ALM, but for boards and ALM committee members.”
Parsons says earnings and capital trump everything—even less-than-stellar ALM. “If you’re challenged on income, or you’ve been warned in the past about insufficient ALM practices,” Parson says, “examiners will say, ‘No excuses.’ So you could see your ratings change for the worse.”
Heath agrees: “What are possible consequences of insufficient ALM? Failure. And that pertains to every credit union, from the smallest to the largest.”
Next: Focus on these seven risks
Focus on these seven risks
Jon Heath, senior financial consultant for Fiserv’s Wisdom suite of financial management and accounting solutions, cites seven risks credit unions should focus on:
1. Interest-rate risk: Changes in market interest rates that could adversely affect a credit union’s capital and earnings.
2. Liquidity risk: Risks arising from a credit union’s ability to meet its obligations when they come due.
3. Credit risk: Risks arising from an obligor’s failure to meet terms of any contract with the credit union, or otherwise perform as agreed.
4. Transaction risk: Risks arising from fraud or error that result in an inability to deliver products or services, maintain a competitive position, and manage information.
5. Compliance risk: Risks arising from violations of or nonconformance with laws, rules, regulations, prescribed practices, internal policies and procedures, or ethical standards.
6. Strategic risk: Risks arising from adverse business decisions, improper implementation of decisions, or lack of responsiveness to industry changes.
7. Reputation risk: Risks arising from negative public opinion or perception.