Effective Risk Management Tools

Profitability Doesn’t Have to Fall When Deposit Expenses Rise

Article for March 21 Webinar

There are signs that deposit expenses will rise for credit unions over the next several years.  Many managers will repeat mistakes of the past and pay interest rates on their deposits based on emotion, best guess or their competitors.  History tells us these are dangerous strategies.  TCT Risk Solutions, LLC (TCT) provides stochastically derived tools for making sure credit unions price their deposits in a way that assures profitability.  When contemplating deposit rates, credit union boards and managers should consider the following realities.

Cost of Funds Will Increase

  • The Fed is making it clear that it is shifting to a tightening strategy with the intention of driving up interest rates.  As competitors increase their deposit rates, credit union managers will feel pressure to increase their rates as well.
  • Loan growth exceeded deposit growth for many credit unions in 2017.  If this trend continues, credit unions will need to increase deposit rates to assure they maintain deposits sufficient to meet loan demand. 

Maintaining Interest Margin is Critical

  • The greatest determiner of profitability in a credit union is interest margin (subtracting the cost of funds from the interest earnings on loans and investments).  This means one of the most important duties a credit union’s board and CEO performs is making sure interest rates on loans and deposits are set to assure a healthy margin.

There are Dangers in Pricing Deposits Using Traditional Methods

  • Too many credit unions set deposit rates according to emotion, best guess or according to what their competitor’s rates are.  Pricing any service primarily based on the competition’s prices will get any business into trouble. 
  • Setting rates according to the competition is not effectively managing interest margin since no two institutions share the same expenses, goals, reserves or interest rate risk.
  • Credit unions have a tendency to raise rates on deposits faster and at a higher level than necessary to maintain deposits necessary to meet loan demand. 

Stochastic Methodology is Best for Setting Deposit Rates

  • Instead of looking to the outside to set rates, credit unions should be looking within their own balance sheets and using empirical, statistically derived methods. 
  • Using empirical methods to set rates takes the emotion and subjectivity out of the process thus assuring the maximum interest margin is maintained and profitability meets long term goals. 
  • Not all classes of deposits have the same price elasticity (risk of members withdrawing based on rates).  This affects how deposit classes should be priced.  Only stochastic methods can determine price elasticity of each class and how rates should be administered for each class.

TCT Provides Stochastically Derived Tools for Setting Deposit Rates

  • Dr. Randy Thompson, CEO of TCT, after research and statistical analysis, has developed a Margin Management tool which has been adding as much as 30 basis points to credit unions’ Return on Assets.  Dr. Thompson’s Margin Management tool utilizes a unique “dividend payout ratio” which considers a credit union’s loan-to-deposit ratio goals, growth and profitability plans and Interest Rate Risk parameters.  TCT’s Margin Management tool assures a credit union’s deposits are priced effectively to meet goals and it maximizes its interest margin. 
  • Besides its Margin Management tool, TCT also has developed additional empirical processes to help credit union boards and managers maximize interest margins.  


When the Economy Slumps, Will Your Charge-offs Bump?

You Need to be Prepared with Effective Risk Management Tools

Article for March 28 Webinar

In 2008, the economy went into a freefall and so did credit union earnings because of loan write-offs.  There are signs that a recession is imminent in the near future.  A recession always leads to increasing loan delinquencies and loan write-offs.   The big question for credit union CEOs is: are we better prepared for the upcoming recession in respect to loan deteriorations than we were in 2008?    Those credit unions using TCT Risk Solutions, LLC (TCT) Credit Migration tool are far better prepared to control the default risk in loan portfolios.

Credit unions could soon see deterioration in their loan portfolios because:

  1. A recession is predicted in the near future

The bond and equity markets are roiling.  Consumers have seen investment losses.  As consumers perceive their net worth is deteriorating they will cut back on their consumer spending.  This affects the economy and employment numbers negatively. 

  1. Inflation and interest rates are rising

Existing open-end, variable-rate loans will become more expensive for consumers as monthly payments rise.  This will make it more difficult for consumers to service their existing debt.  

  1. Consumer credit is at concerning levels

Many consumers are now borrowing for every day expenses.  Financial institutions report faster growth in loans than in savings.  Furthermore, consumer debt levels are at the same levels now as just before the 2008 “Great Recession”.  Many consumers are “maxed out” as far as their ability to service debt is concerned.  Any reduction in personal revenues as is common in a recession will send many consumers into a budget crunch.  Like 2008, many loans will default if not managed effectively by lenders. 

  1. Financial institutions are getting nervous with some types of consumer loans

Financial institutions report they are cutting back on many indirect loans and less-than-prime loans partially as a result of seeing delinquencies rising since 2013.  Many consumers will not be able to obtain financing for new debt or will not be able to “roll over” existing debt.  This leads to slumps in consumer sales (a slower economy).  It also means many consumers will be limited in their ability to juggle their existing loans – leading to defaults.


Credit unions can minimize losses in their loan portfolios during economic downturns

Stochastically-derived risk-management tools are critical when it comes to minimizing risk and losses in loan portfolios in good times or bad.  TCT provides tested and effective risk management tools including Credit Migration (CM).

TCT’s Credit Migration tool is one of the most accurate in the market place and provides a CEO the ability to: (1) track and monitor loans individually and collectively (by class and loan type) that are digressing or improving using changes in credit scores for each and every loan; (2) forecast excesses or shortfalls in the Allowance for Loan Loss; (3) assure their boards and regulators that they are using a tool that is: (a) using methods according to latest regulations and GAAP; (b) using a credit union’s unique data and market area data for purpose of establishing environmental factors; (c) validated by one of the leading CPA firms in the nation who specialize in credit union audits.  TCT’s CM tool is also effective for determining changes necessary in loan policies and practices sooner than other methods.