Preparing for Higher Interest Rates
Posted by Mike Sims, Senior Advisor with Catalyst Strategic Solutions, Catalyst Corporate FCU on 1/26/2017

Last year ended with one of the more volatile interest rate periods since 2013. For now, the lengthy period of extremely low, relatively stable interest rates appears to be over.

The largely unexpected outcome of the 2016 presidential election contributed to a bond market sell-off. The 10-year Treasury note yield increased by almost 75 basis points between November 8 and December 14. The FOMC fueled the “rising rate risk is back” fire at its December 14 meeting, combining a 25 bp rate hike with more hawkish economic projections. And, the FOMC’s median fed funds projections increased for the first time in several years:

It appears some interest rate volatility has returned. And interest rates are more likely to rise than they were, say, in June when markets were reeling from Brexit. (Remember Brexit? Seems so long ago…)

So, as you begin navigating your balance sheet through the next interest rate cycle, remember these tips:

  1. Nothing substitutes for cold, hard figures. Quantify and create a boundary around your potential interest rate risk (IRR) exposure. Assessing the sensitivity of your credit union’s projected short and long term earnings to multiple interest rate scenarios and assumptions can go a long way in answering IRR concerns.For example, Catalyst Strategic Solutions routinely models short and long term earnings sensitivity of 300 credit unions nationwide most measure balance sheet risk quarterly in a wide range of interest rate and balance sheet scenarios.

  2. Measure, dissect and monitor IRR metrics, but incorporate them into your ALM decisions with a grain of salt. IRR modeling uses numerous assumptions to gauge how assets and liabilities will react to changes in interest rates. Knowing these assumptions and their limitations will solidify understanding of your credit union’s IRR profile and increase your confidence when making ALM decisions.

  3. Add more arrows to your ALM quiver. Perform pro-forma simulations that show how changes in model and balance sheet assumptions will impact your projected interest rate risk profile. For example, if you are currently assuming that your shares will increase 25 bps in cost for every 100 bps the fed funds rate increases, change the assumption to 50 bps to see how much your interest rate risk sensitivity changes.

A potential move to a different interest rate environment should elevate interest rate risk dialogue at your credit union. Stay in front of the discussion with a thorough understanding of your credit union’s IRR metrics and modeling assumptions.

Categories: Business Partners, Financial & Auditing, Research, Strategic Planning & Consulting
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