Effects of the Economy on Credit Unions

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An operating environment resulting from slow growth in the economy, low interest rates, and nagging unemployment has from a macro-perspective produced an outcome of rapid savings growth, slow loan growth, and a steep yield curve.

We have seen:

  • Declining yield on assets due to lower interest rates plus the asset distribution shifting to lower-rate investments and maturing loans being replaced with low rate loans;
  • Declining cost of funds due to lower dividend rates plus the distribution of savings shifting to low-cost savings products;
  • Indeterminate net interest margin due to cost of funds falling faster than yield on assets if dividend rates are aggressively lowered.  However, if loan growth is very weak and savings growth very strong, yield on assets may fall faster than cost of funds;
  • Rising provisions for loan loss due to higher bankruptcies and charge-offs reflecting employment trends;
  • Lower operating expense to average asset ratio due to rapid savings growth increasing assets faster than the growth in operating expenses;
  • Higher fee income due to non-sufficient funds and late payments.
  • Return on assets will be flat to marginally lower; and
  • Capital-to-assets will be flat to marginally higher.

Things to consider in maintaining net income when interest rates are very low are listed below:

  • Avoid extending investment maturities significantly;
  • Limit additions to the fixed rate mortgage portfolio;
  • Don’t overreact by slashing operating expenses; and
  • Adjust rate paid on member savings downward.

Some factors to consider with respect to falling net worth ratios are as follows:

  • Members are seeking a safe place to store their financial assets (asset growth has been strong);
  • If rates paid on savings are not hyper-competitive, this savings growth can be healthy.

This blog entry you have just read was written by Edward Lis who is a former senior executive of three different credit unions. If you enjoyed this article I encourage you to learn more about Edward by visiting www.edwardlis.com or by calling 518-420-2108.

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3rd Party Due Diligence

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To expand their services and product offerings, credit unions are increasingly outsourcing functions and programs through collaboration with third parties.  Third party relationships are essential and can enable credit unions to become their members’ primary financial institution.  That said, not managing and controlling these relationships can result in unanticipated costs, legal disputes, and financial loss.
The regulators goal is to ensure credit unions clearly understand the risk they are assuming and balance and control these risks considering the credit union’s safety and members’ best interests.

The vendor due diligence objectives for credit unions are to:

  • Ensure that outsourced relationships are initiated based on a sound business case and comprehensive due diligence in the selection process.
  • Ensure that outsourced relationships are effectively managed by providing for consistent, risk focused controls and processes.
  • Ensure that the credit union is in compliance with regulatory guidance and requirements pertaining to outsourced relationships.

Credit Unions can achieve these objectives by maintaining an active vendor management oversight function.  Specific practices should be supported by guidelines and checklists that ensure that vendor performance is monitored, contractual requirements are in place and regulatory requirements are met.

Herein is an overview of the key areas when developing a vendor due diligence program in your credit union:

  • Identifying key vendors and their risk levels;
  • Gathering information for due diligence reviews;
  • Conducting initial and ongoing reviews;
  • Tracking and documenting; and
  • An in-house  compared to an outsourced programs.

This blog entry you have just read was written by Edward Lis who is a former senior executive of three different credit unions. If you enjoyed this article I encourage you to learn more about Edward by visiting www.edwardlis.com or by calling 518-420-2108.

Finalized-FDIC Overdraft Guidance

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The FDIC guidance “reaffirms” a best practices document that was issued in 2005, and it creates specific risk-mitigation techniques that it expects regulated banks to implement.   The FDIC guidance does not apply to credit unions, however, with that said this guidance opens the door for others.
Herein are some specific risk-mitigation techniques:

  • Your board must be involved with its ODP program.  Expected; is regular oversight including an annual board review of an ODP program’s key features.
  • Reviewing ODP advertising to minimize confusion and to promote responsible use.
  • Monitor programs for excessive or chronic customeruse.  What is abuse? When a customer overdraws the account on more than six occasions where a fee is charged in a rolling twelve-month period.  If and when that occurs, the bank must undertake “meaningful and effective” follow-up action, which may include, for example:
    • Contacting the customer to discuss less costly alternatives; and
    • Giving the customer a reasonable opportunity to decide whether to continue fee-based ODP coverage or choose another available alternative.
  • Instituting appropriate daily limits on customer costs by, as an example, limiting the number of transactions that will be subject to a fee or providing a dollar limit on the total fees that will be imposed per day.
  • Considering the elimination of overdraft fees for transactions that overdraw an account by a small amount.
  • Considering the use of cost effective, existing technology, as appropriate (e.g., text message, e-mail, telephone or cell phone) to alert customers when their account balance is at risk of generating a fee for non-sufficient funds.
  • Reviewing check-clearing procedures and any third-party vendor to ensure they operate in a manner that avoids maximizing customer overdrafts and related fees through the clearing order.

The FDIC expects affected institutions to have their new risk-mitigation techniques in place by July 1, 2011.

The guidance will create downward pressure on bank ODP revenue streams.

If your credit union earns income from an ODP program, that income is now at risk.  How much is at risk is yet to be determined, but one may want to consider the following.

  • How much ODP income do you receive from smaller transactions. If the small dollar amount transaction cutoff for fees take effect, ODP fees from those transactions could go away.   What is the impact?
  • How much ODP income do you earn from consumers who are charged more than 6 ODP fees in any 12-month rolling period? If this applied to you, you’d have to reach out to them and show them alternatives. Let’s say only 10% of those consumers opted out of your ODP program. How much money would that be?
  • Do you clear items from largest to smallest in terms of dollar amount?  If you had to clear items based on the order received or by check number, how might that affect your income?
  • Imagine you implemented a daily limit of $25 or $50 for ODP programs.  How would that have affected your income in 2011?

Credit unions are member-centric organizations.  It is recommended those credit unions with an ODP program begin to  develop and deploy several of the risk-mitigation techniques above if they already have not.  That said, it is widely anticipated many executives will be revisiting this area once again.

A Lost Revenue Stream

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Changes to Reg. E, the financial reform legislation, and the uncertainties of the future, compel credit unions take decisive steps to protect their account relationships and their associated revenue stream.

Because of recent changes to Regulation E, all financial institutions, including credit unions, cannot charge a fee for overdrafts from everyday debit card or ATM transactions unless the account-holder has affirmatively consented.

If your credit union was unable to execute a well thought out opt-in program you may see a 50% or more reduction in overdraft fee income.

On Aug. 16, your account-holders’ debit cards started to be rejected     where they would have worked in the past. Account-holders view this as your credit union treating them badly and providing poor service. Let’s understand, they do not blame the federal government or the merchant who simply passes along the message that the card has been declined. They will blame the credit union for the embarrassment and any problems that arise from the card’s denial, like not being able to purchase groceries for the family.

This previously profitable account-holder is now embarrassed, upset and looks for another institution that will treat them better.

Consumers change institutions because they get mad at their current one.  Expect an increase in angry account-holders.

Significant revenue is “at risk” because of this one change to the regulation. Finding a solution to adequately address this problem should be at the top of a “to do” list. I know the “to do” is getting longer and longer.  There remains time to mitigate the effects, however, with that said, indecisiveness increases the likelihood of account-holder attrition and lost revenue.

Being ready to act when a cardholder has a point of sale denial, places the credit union in a better position to keep the account and its associated revenue stream.

Your debit processor can provide you with a denial report. The report should show those transactions that were rejected for a variety of reasons.

Your core processor should be able to provide you with a list of accounts showing which were opted-out automatically and which were opted-out because of an account-holder decision.

The key to here maintaining the revenue stream and member service is being able to combine the two lists and then develop a well thought-out message to your account-holders.  Education at all levels of the organization, especially platform staff, is critical for success.

If an account-holder failed to respond to the opt-in communication and then has a debit transaction declined, someone needs to reach out and contact then letting them know why the denial occurred. Your efforts achieve the following.

Contact me today to assist in developing and deploying a viable solution.

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