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Developing Dynamic IRR Strategies at Your CU

July 23, 2021

By Loren Blake, Catalyst Strategic Solutions Senior ALM Consultant

Implementing IRR tools for a changing economy

The recent shifts in the economy and interest rates during the pandemic have impacted credit unions in several distinct ways. As more changes are likely to follow, how can institutions prepare for the potential impacts to their interest rate risk profile?

The scope of ALM modeling includes stress testing to assess the risk to earnings and the risk to capital, based on the current balance sheet structure, projected interest rates and key modeling assumptions. Aside from these assessments, additional benefit can be derived from scenario-based risk analysis.

By performing what is commonly referred to as a “what-if analysis,” credit unions can assess the potential impact changes to strategy, membership, or product offerings would have on its interest rate risk exposure.

Assessing the current economic climate

Over the past 18 months, many credit unions have experienced growth in deposits, while simultaneously experiencing decreased loan balances. In many instances, the combined impact of these balance sheet shifts and the dramatic decline in interest rates has put pressure on net interest margin and return on assets. 

What If ModelingAs institutions prepare for the future, analysis of likely scenarios – in combination with stress scenarios – can aid strategic planning. Some comprehensive what-if tools, like Catalyst Strategic Solutions’ online model in TranZact, enable credit unions to run unlimited scenarios, applying varied assumptions. Additionally, results for Net Economic Value (NEV) and Net Interest Income Simulation (NII) are provided for the basecase, +/- 300 basis points in 100 bps increments.

Making the right what-if analysis assumptions

Interpreting the analysis and underlying assumptions is key to developing strategies and operational changes necessary for implementing a credit union’s desired strategic direction. Catalyst Strategic Solutions’ What If Model is preloaded with the assumptions from the latest CSS-performed ALM analysis. This includes the projected yield curve, prepayment assumptions and other assumptions applied in the standard analysis. 

The what-if analysis enables the user to add and subtract balances from various asset and liability categories. The basecase results provide insights to a likely scenario. Assessing the shocked scenarios enables the credit union to understand the impact to IRR limits under different rate environments.

Interpreting what-if analysis results

The ALM What If Model Report includes comparison tables and graphs for NEV and NII. This allows the user to clearly see the impact proposed changes on the balance sheet have to the risk and return profile. The summary within the report shows additional comparison data for asset yield, cost of funds, net worth and equity ratios.

Ultimately, including what-if scenarios in the strategic planning process provides a more comprehensive view of the dynamics already in play within the balance sheet and earnings structure of the institution. Catalyst’s What If online modeling tool can be run independently by the credit union anytime through the TranZact portal.

What If Modeling is one of many key services provided by Catalyst Strategic Solutions’ ALM Consultants. Our team of highly-experienced professionals can assist you throughout the process and help interpret your credit union’s results. For more information, contact us today.