By Craig Finck / Published September 2018
Short-term interest rates appear to be on the rise, as evidenced by the changes over the past year to the Federal Funds Rate (the rate at which banks lend to each other) and individual bank prime rates. There are many things associations should consider when rates are changing, and some things that associations should consider regardless of the rate environment. Smart financial management is an ongoing process, and the points listed in this article can help associations reach their long-term financial goals.
When interest rates are rising, associations need to pay close attention to the details of any project financing they are considering. Many potential loans will have floating rates that will adjust as interest rates rise. Associations that do not properly consider and plan for these possible rate changes may experience budget shortfalls as their interest payments rise. Additionally, rising interest rates can affect the owners within an association, in turn affecting the association. When individual homeowner mortgages adjust with rising rates, homeowners may start to experience personal budget shortfalls. Homeowner budget shortfalls may result in late association payments and can ultimately cause association delinquency levels to rise, affecting an association’s ability to enter into a potential new loan agreement.
As interest rates rise, associations should utilize their long-term funding plan to determine whether or not they should take advantage of locking in higher deposit rates in certificates of deposit or other FDIC-insured investments. When rates are low, associations have a tendency to suffer from complacency when their deposit options offer little interest benefit. Understanding future funding needs and ensuring the association remains as fully invested as is prudent will benefit an association in the long term. As rates rise, associations should also consider laddering their longer-term certificates of deposit, giving them options to reinvest at higher rates and liquidity options as the certificates mature.
When interest rates are falling, associations should consider working on those projects that they may have been putting off. As reserve balances earn less of a return and lending rates remain low, associations can get the most bang for their buck by completing those projects they may have delayed. Through use of their own reserved funds or project financing through a financial institution, associations may be able to make improvements ahead of schedule and at a potentially lower cost.
Even if deposit interest rates remain low for an extended period, associations should avoid the tendency to be complacent. Building up excess cash that is not earning any interest does not help an association budget. Associations should ensure that they understand their cash funding needs, that they retain the appropriate amount of liquid operating funds, and that the remaining funds are working for them regardless of the low level of interest they might receive.
Regardless of the rate environment, there are many things an association should be doing to keep their finances on the right track. To begin with, associations should have a good understanding of where their funds are being held and who has access to those funds. As association boards routinely turn over, it is common for little consideration to be given to changing signers on association bank accounts. Associations should be sure to review the list of signers on all of their bank accounts, and make the appropriate changes where necessary to remove outdated signers. This is one of the simplest—and most often missed—ways an association can protect their finances.
Every association should consider having a long-term reserve funding plan in place. This can be as detailed as a formal reserve study by a professional engineering firm, or as simple as a listing of those items the association has a responsibility to maintain and replace. Whatever the form, this information will prove invaluable to an association board as they make long-term financial plans. I am sure you have heard the adage, “You can’t get where you’re going without a roadmap.” This reserve funding plan is the roadmap an association needs to understand where they are currently and to help them plan how they will get to where they want to go. Without some form of plan, an association may ultimately get to where they are going, but the path may have unwanted detours and roadblocks.
Having a long-term funding plan is also the best way a board has to communicate the long-term needs of an association to their membership. It can be difficult for a board to articulate why they need to gather reserves to fund for a long-term need when all an owner sees is a current bank balance. Once the work has been done on a long-term plan, the information needs to be understood, implemented, and communicated beyond the board. No plan is worth the money and effort if it isn’t put into action.
Nobody can accurately predict future interest rate changes, and associations should not be overly concerned with the daily news in this regard. However, there are things that associations can do every day to put themselves in the best position to prosper regardless of the rate environment. Every association board should utilize the expertise of the professionals on their financial team, including their community management, association attorney, and association banker, to ensure they are making their best effort to reach their long-term goals.
Senior Relationship Manager, Association Banking, Centennial Bank