What If The Fed Rate Projection Is Right?
December 13, 2012
This is a question credit unions should try to answer as part of their ongoing long-term forecasting process. The FOMC reaffirmed on Wednesday (December 12) that they do not anticipate raising rates until 2015.
Source: Federal Reserve
So what happens to earnings and net worth if rates stay at historic lows for two more years, and then start to rise? Instinctively, the net interest margin should be squeezed over the next two years as assets continue to reprice down without a corresponding reduction in the cost of funds. The big unknown is: how much and how fast will rates rise?
Credit unions may need to run a series of “what-ifs” to understand the impact. “What-ifs” should include rates rising over different time periods (i.e., 12 months, 24 months, etc.) and increase to different levels (i.e., 100bps, 200bps, 300bps). It would also be prudent to test changes in balance sheet mix, as rates may rise for different reasons. If the economy is booming, then the credit union may be able to originate more loans. This would help the bottom line and possibly mitigate the impact of the lower-yielding assets brought on in 2013 and 2014. However, if the economy is stagnant, loan growth could be an issue—which would hurt earnings and net worth.
Decision-makers should review the series of “what-ifs” and discuss any areas of concern. Credit unions should run additional “what-ifs” that address their concerns—particularly in cases where success measures would not be met or the credit union’s ability to deliver on its strategic objectives is threatened.
