Create A Fortress Balance Sheet

Northwest FCU shares the strategy behind its recent repositioning.


As a part of its environmental scanning, three years ago Northwest Federal Credit Union began considering the possibilities presented by what has become an extraordinary interest rate cycle in both absolute level of rates and cycle duration. At that time, Northwest concluded that risk in the existing construct of the balance sheet was being exacerbated through the actions of the Federal Reserve, the ongoing impact of the real estate market collapse, increasing regulatory constraints, and a myriad of other variables.

As a result of this evaluation process, management and the board decided that a material restructuring of the institution’s balance sheet was prudent. Given the historical low level of rates for such a protracted period of time, it was considered probably that the upward leg of the next interest rate cycle could be both rapid and significant. Consequently, a comprehensive restructuring of the organization’s balance sheet was undertaken with the goal being to create what Northwest termed a "fortress balance sheet."

The balance sheet restructuring had three primary goals:

The Investment Portfolio

Tactical implementation of the restructuring plan began with a restructuring of the investment portfolio. At that time, the investment portfolio consisted principally of callable agency securities with duration of approximately 3¼ years. The restricting criteria settled upon included the avoidance of credit risk in the investment portfolio (i.e. U.S. government and agency guaranteed securities), duration targets of less than one year, adequate liquidity and market depth, reasonable structural complexity, and yields that would not produce a decline in portfolio earnings.

A new asset class was introduced and ultimately utilized in this phase of restructuring — SBA pools and USDA whole loans. The restructuring on the investment portfolio required nearly two years for an orderly stage in with the end result accomplishing the stated goals.

  • Purchase securities with straightforward structures and the full faith and credit of the U.S. government
  • Reduce portfolio duration from approximately 3¼ years to approximately 90 days
  • Participate in an active secondary market with adequate liquidity (although not as deep as agency callables)
  • Drive a significant pick up in portfolio yield

Loan Portfolio

A number of initiatives have been undertaken and are planned for the loan portfolio. To further assist in mitigating exposure to rising rates, management elected to securitize a sizeable portion of the institution’s long-term fixed mortgage portfolio. This process required approximately eight months to complete and reduced the yield on these assets by between fifty to sixty basis points. However in so doing, management gained the flexibility to liquidate these assets should interest rates begin to move up sharply. An additional positive benefit was a significant mark-to-market gain.

In addition to shortening duration, new sources of loan production/acquisition were developed. These included the purchase of indirect auto loans from a nationwide originator/aggregator or paper, the acquisition of variable rate mortgages from a non-financial institution originator, the development of a partnership with a boutique bank to acquire excess loan production, and the acquisition from various sources of government guaranteed whole loans. The introduction of these previously unused asset sources resulted in an increase in the organization’s outstanding loans by more than 10% (adjusted for the securitization) as compared with a decline of over 8% had these sources not been employed.

Liability Structure And Pricing

Liabilities and their pricing strategies have been restructured as well. The credit union’s liabilities were repositioned to further emphasize transaction accounts. In 2012, this added emphasis resulted in a year over year increase in non-interest bearing share draft accounts of well over 20%. Pricing strategies on interest bearing deposits have been modified from pricing off competitors to pricing based on balance sheet requirements and earnings targets. This has resulted in the ability to maintain NIM at or near Northwest’s 3% target as asset yields have declined significantly and asset composition has shifted materially with loan to asset ratios falling over the past three years.

NWFCU applied and received approval to join the NCUA’s hedging pilot program but before the credit union could begin to implement trades, NCUA pulled the program. However, all the ground work and analytics have been performed so that Northwest will be ready to launch a hedging program as soon as regulations are released.


In light of the credit union’s view of future economic conditions as well as the likelihood of capital requirements increasing, Northwest has moved our minimum net worth ratio threshold from 8.5% to 10.0%.

While this is a key component of building the credit union's fortress balance sheet, the delevering of the balance sheet compounds the earnings challenges. This level of leverage reduction represents an opportunity cost of approximately $5 million or 16% in net income. However given the institution's view of the near to mid-term economic conditions compelled this decision. Assuring future sustainability has become a focal point for management and the Board at NWFCU. As a result, the credit union has developed a fundamental model to project sustainability under various extreme stress environments based on current capital levels. As a part of the strategic planning process, this "sustainability under stressed conditions" model is being used to evaluate needed capital levels to survive extremely disrupted markets.

In summary, the views of Northwest and its responses to those views are:


  • The probability is considered very high for moderately to very rapidly rising interest rates in the next two to three year time horizon.
  • With the Federal debt load and spending out of control and at unsustainable levels, severe contraction of future Federal budgets is deemed likely. The Washington metro area would appear extremely vulnerable to such a shift in the local economy with the likely impact being significant job losses and contraction of localized real estate markets.
  • There is more than a nominal probability of a material downgrade of U.S. Treasury debt issues and/or a devaluation of the U.S. dollar, both of which would have significant adverse impacts on the national and local economies.
  • The Federal Reserve now holds more than $3 trillion in Treasury and MBS debt. Eventually as the banking system begins to more aggressively lend, the Fed will be forced to curtail its "borrowing from the banking system" and consequently, it will have to begin to liquidate its security portfolio. This will put additional pressure on the supply/demand imbalance and will likely act to exacerbate upward pressure on U.S. interest rates.
  • For every 1% increase in rates along the yield curve, U.S. taxpayers will incur an additional $160 billion in annual interest costs which will further adversely impact the domestic economy.

Responses and Actions

Based on this view, NWFCU has determined to prepare for such eventualities in the following manner:

  • Building of a fortress balance sheet by:
    • Increasing equity ratios.
    • Dramatically shortening the duration of the balance sheet without seriously impacting margins.
    • Enhancing the selectivity of credit offerings and seeking new markets to mitigate geographic, demographic, and product concentrations.
    • Developing new sources for asset and liability acquisition through mergers, partnerships, and acquisition of previously unused asset classes.
    • Preparing and using new tools and analytics, including:
      • Hedging with derivative instruments
      • Conversion to a new core system to provide new data access and analytics, new products and feature sets and to reduce costs through increased efficiencies
      • Development of new strategic management tactics such as managing for sustainability and creating the analytical tools to measure and monitor the appropriate data
      • Utilizing new analytical tools for more closely monitoring homogenous loan portfolio components, particularly real estate based loan segments.
  • Adding new focus on the income statement and profitability, including:
    • Driving a cultural change with all constituencies in the understanding of profitability and the correlation between profitability, capital, and the institution’s capacity for growth.
    • Minimizing the cost of on-balance sheet liquidity without significantly reducing the amount or quality of liquidity.

The two and one half years into this project, the results include:

  • A balance sheet that is now restructured to benefit from rising interest rates.
  • A restructuring that was accomplished without sacrificing current earnings.
  • Improved capital ratios, even with an increase in assets of nearly 30% over the past three years.
  • Three consecutive record earnings performances in the past three years with 2012 posting $30 million in net income.

Greg Gibson is the Chief Financial Officer at Northwest Federal Credit Union. He can be reached at