Shaping Your Financial Destiny

 Author: Martin Webster, mwebster@profitstars.com

I’m reading a book entitled, “The Compound Effect” by Darren Hardy, publisher of Success Magazine.  In it he demonstrates how the decisions we make today, both conscious and unconscious, shape our destiny.  Of course, the leaders of financial institutions make choices every day that direct the financial future of their organization.  Over the last few years, those that made the wrong choices have paid a severe, if not fatal, price.  Others have prospered from their choices.  Once again, we have forces looming that will test our decision making and expose our financial management habits.  Some looming forces include:

Margin Compression – The community banks and credit unions that survived the credit losses of the last few years have come back strong.  However, margins continue to compress; cost of funds can’t seemingly go any lower, existing loan portfolios continue to reprice at lower rates and loan demand is sporadic at best.  The Fed has made it clear that they intend to maintain this low rate environment for the foreseeable future.

Basel III – While Basel III has been put on hold, it certainly isn’t dead.  The latest version of the plan would have “hindered credit availability, dampened economic growth and harmed the competitiveness of the U.S. banking system,” according to a letter sent by financial industry groups to the Federal Reserve, Office of the Comptroller of the Currency and the Federal Deposit Insurance Corp.  Although the final ruling on Basel is uncertain, it’s clear that regulators are intent on putting mechanisms in place to ensure the safety and soundness of U.S. financial intuitions.  Whether it comes in the form of additional capital requirements, additional regulation or both, it will force financial managers to respond.

The Fiscal Cliff – The Congressional Budget Office estimates that governmental spending and taxation policies set to go into effect on January 1, 2013 would cut gross domestic product (GDP) by four percentage points in 2013, sending the economy into a recession. At the same time, it predicts unemployment would rise by almost a full percentage point, with a loss of about two million jobs.  While the President and Congress wrestle over the final form these policies take, the uncertainty is already impacting business and consumer investments and could further damping loan demand.

Regardless of the outcome of these economic forces, it’s critical that financial managers take them seriously and develop strategies for mitigating their effects and taking advantage of opportunities that may arise.  Here are some steps you can take now.

1. Review and Update your ALM Policy – This is critical to your decision making process.  It provides financial risk guidance that has been approved by your board of directors.  Ensure that it:
• Clearly defines responsibilities of the board, the ALCO and senior management as to overall management of interest rate risk and liquidity risk.
• Addresses capital adequacy, policy exceptions, and asset allocation strategies.
• Directs the liquidity management process and the Contingency Funding Plan.
2. Run multiple what-if scenarios to quantify the impact of your decisions.  Include
• Decreased loan demand and cost of funds (yes, it can get lower)
• Increased loan demand but higher credit risk
• Increased capital requirements
• Merger/Acquisition
3. Stress test each scenario to understand the risk associated with each financial decision
• Be sure to include immediate and ramped shocks
• Include up and down scenarios and rate twists
4. Establish a process for creating rolling forecasts to constantly improve the quality of the information available
• Forecast at least quarterly
• Extend forecasted time horizons beyond twelve months, to at least 18-24 months

Are you positioned to make the best decisions for your bank or credit union, regardless of the forces on the horizon?