By Terry Treadwell, CPA
In "ALM: A Working Framework" we reviewed how effective asset/liability management policies provide the working framework for your credit union's balance sheet management strategies. These policies define a credit union's risk tolerance levels as well as outline monitoring parameters. Today, we'll review how to structure a best-practice asset/liability committee (ALCO), the group tasked with driving the credit union's big-picture balance sheet decisions.
The ALM Hierarchy
Effective credit union boards and senior management teams understand the nature and level of risk exposures and ensure appropriate management processes are in place. Orchestration of ALM processes varies from credit union to credit union depending on size and balance sheet complexity, But, typically, the ongoing responsibilities for measuring, monitoring and managing interest-rate risk are assigned to an ALCO.
Common characteristics of a top performing ALCO is a focus on managing future net interest income and making prudent interest rate-risk-management, capital and liquidity decisions. Oversight for growth and profitability goals and establishing a results-producing mix of assets and funding sources (while conforming to policy guidelines) are key ALCO objectives.
Regardless of size, all the key functional departments of your credit union should be represented at your ALCO meetings. This reinforces consistency of departmental goals with overall credit union goals. In a smaller credit union, ALCO may consist of the CEO, CFO and the branch manager. In a larger credit union, ALCO may be all the "C" level executives and key departmental middle managers. In either case, board members should be encouraged to attend as well.
Implementing ALCO strategies on a daily basis is the responsibility of credit union management with specific task assignments and clear accountabilities. The day-to-day management of investments, loan products and pricing, deposit products and pricing, wholesale funding, hedging, and capital management reflect the ALCO decisions made.
The ALCO Agenda
ALCO meetings should be held at least quarterly—and more often for underperforming credit unions or those with more complex balance sheets. The agenda should be focused and the objectives clear. Focus on the future while considering past results.
ALCO reports should contain clear and concise information—not simply data. And it is critical that all committee members understand the reports.
The following types of credit union information should be presented:
- Overall financial performance—Look at balance sheet, income statement, yields, costs of funds and other key management ratios. Consider period over period as well as comparisons to budget and benchmarks. Comparing these performance metrics with peer groups is helpful as well.
- Loan and deposit pricing matrix—Include retail and wholesale sources and uses of funds.
- Net interest margin rate/volume change analysis—This highlights changes in net interest margin due to interest rates, volumes and mix. It can focus on both historical changes and forecasted changes.
- Competitive market pricing review—Compare credit union pricing of loans and deposits to area competition.
- Market interest rate and economic outlook—Consider local, regional and national levels.
- Investment performance review and alternative funding sources—Outline current portfolio performance and current opportunities for investment. Alternative funding sources and excess collateral should be considered.
- IRR measurement and forecasts—Include IRR, balance sheet and earnings simulation, economic valuations, gap (see my next post, "ALM: A Practical Approach," for more thoughts on gap), capital and liquidity ratio calculations compared with ALM policy limitations. Include an overview of key forecast assumptions that were used and review these for reasonableness.
Collectively, this information should help your ALCO anticipate future earnings impacts and develop appropriate alternative strategies—with the majority of your meeting spent on formulating balance sheet strategies and decision making.
Effective ALCO processes will improve the risk/reward profile of your credit union by improving your decision-making and strategy development processes. Remember, your goal is no balance sheet surprises, amid the rise and fall of interest rates.
Watch this space for my next installment: "ALM: A Practical Approach."
Terry Treadwell is an associate of Stogniew and Associates, providing internal audit and consulting services to credit unions and community banks. She has over 15 years experience in ALM and can be reached via e-mail or at 727.787.7400.
Read the first post in this series, "ALM: A Working Framework."
Read more on ALM in this Credit Union Management magazine archive.
