CFO Corner: A Glass of Liquidity – Hold the Rocks: Your Liquidity Strategy

Everyone Is Drunk on The Spiked Kool Aid

It was a nightmare…flashing lights…loud music…empty dance floor. No, I wasn’t in some 70’s throwback bar it was actually the client party for a financial services convention. Everywhere I looked people were laughing and drinking to music that most of them had never heard before. These same industry leaders last year were wringing their hands unsure of NCUA assessments, watching their capital reserves drop before their eyes as commercial loans in sand states literally bit the dust.

Last year the only liquidity anyone was thinking about was what they could pour into their glass as they were hoping it was all a bad dream. Fast forward to today and the world is upside down as Big Banks have emerged stronger with higher assets, broader consumer bases and TARP has becoming a bad memory as quarterly profits erase past mistakes.

Credit Unions have begun to breathe again as evidenced by the record attendance at this convention. Credit union leaders are feeling better about their financial positioning and are starting to get some swagger back in their step. Watching everyone else talk about recovery even I was starting to get a smile on my own face. Then I read this great article written by Edward Lis, our CEO guest blogger, and suddenly I had to wonder why were all of us drinking the spiked Kool Aid when 12 months ago we thought the sky was falling. 

So here is the million dollar question, “Why be concerned now about liquidity when most credit unions are awash with funds resulting from a flight-to-safety fund inflows and loan portfolio outflows due to lack of loan demand?” Edward lays out some thoughts every senior management team should be considering as they prepare a liquidity strategy for the next rising-rate environment that some economists are predicting could kick off by late-2011.

The Fly in the Kool Aid

Before you waive off the article as the fly in your spiked Kool Aid consider that rising rates typically are used to manage economic recoveries. So it is likely rising rates will be accompanied by a return of flight-to-safety funds to the market and a spike in loan demand, putting many credit unions back in the tight liquidity environment of a few years back. Many credit unions have rate floors under their variable rate loans.  As rates move up, rates on these loans won’t move for a while. But your cost of funds will. The result is a compressed net interest margins or NIM.

The objective of a viable liquidity policy and strategy is to provide a framework to minimize the adverse effects of a significant and sustained liquidity crisis.  This can result from changing economic or interest rate conditions, deposit outflows, unusually strong loan demand, intense competition, an international crisis, or any other factors that can deplete the liquidity of the credit union.

In the event of a serious and sustained liquidity crisis, you might find you need to adopt various strategies. Some of these strategies are preventative and must be implemented prior to the onset of a crisis.  Other strategies are reactive and may be implemented immediately.   The strategies will differ in terms of the implementation time, costs, risks, financial implications and regulatory consequences.

  

Looking for a Glass of Liquidity – Hold the Rocks

The first place to look for sources of liquidity is within your own balance sheet. Some areas to consider are listed below.

• Loan Payments and Prepayments-a credit union may write loans with long repayment schedules, however, with that said; loan portfolios continue to be relatively short term-the turnover rate. Track and test loan payments and prepayments in all economic environments to estimate the level of cash inflow to the credit union under a variety of scenarios. As a reminder, when interest rates are falling-prepayments will increase, and when rates are rising-prepayments will slow down.

• Increasing Member Deposits-to bring about an inflow of deposit funds without cannibalizing previously deposited funds are often referred to as “disparity” or “segmentation” strategies. They are designed to identify depositors based on rate sensitivity and encourage an inflow of deposits when needed.  You should be forecasting your liquidity needs and anticipating those needs in the marketing of your deposit products.

• Selling of your Assets-mortgage loans written to conforming loan standards can normally be sold in a short period of time with one major issue to remember: Loans will be sold at their “market price”, which may be more or less than their “book value”, depending on the current level of interest rates. Other types of loans have the potential for sale as well, i.e. consumer loans

• Non-Member Deposits-non-member deposits, also referred to as brokered funds, can provide near-immediate and short-term funding.  Note these come at a high price and the funds are very rate sensitive.

• Loans from the Corporates-the corporate credit union is still the lender of first choice for a majority of credit unions. Loans fall into two major categories: A line of credit and a term loan. A Line of Credit-these come in two varieties: committed and uncommitted. A committed line, most common, the credit union pays a fee based on the size of the line and its duration. There is a contractual assurance that the funds will be available to the credit union when those funds are needed.  An uncommitted line of credit, funds may be available based on the lender’s-the corporate-ability and willingness to fund. Generally, there is no charge for an uncommitted line of credit, but the certainty of obtaining the funds when you need them could be in doubt.

• Term Loans-these involve a specific amount borrowed for a specific period of time. It may be a bullet loan with the principal due in full at maturity, or an amortizing loan similar to an installment loan. Rates can be fixed or variable.

• Federal Home Loan Bank (FHLB)-the FHLB is a quasi-government organization with the objective of supporting and providing loans to financial institutions that make first mortgage real estate loans or that purchase and hold mortgage-backed securities. These organizations offer a diverse line of lending services to qualifying credit unions. Much like the corporate system, liquidity from the FHLB involves lines of credit and/or term loans at fixed or adjustable rates often at more favorable rates than the corporates.

To borrow directly from the FHLB, a credit union must be a member. To be eligible for memberships at the New York Federal Home Loan Bank refer to

 http://www.fhlbny.com/aboutus/membership.htm.

Note: For a credit union not belonging to the FHLB, check to see if your corporate credit union has an agency relationship allowing the natural-person credit union access to FHLB resources without becoming an FHLB member.

The Central Liquidity Facility-the Central Liquidity Facility is administered by the NCUA Board.  CLF advances to natural-personal credit unions are normally limited to short-term, temporary needs. Borrowing directly from the CLF requires that the credit union apply for membership in the CLF and purchase stock. However, many corporate credit unions are appointed as CLF agents and may be able to facilitate an advance to natural-person credit unions that are not members of the CLF. For more on the CLF refer to the following link :  Http://www.ncua.gov/Resources/CreditUnionDevelopment/ResourceConnection/Files/Partners/NCUA-CLF.pdf

The blog entry you have just read was written by Edward Lis who was a former CEO and CFO of two different credit unions. If you enjoyed this article I encourage you to learn more about Edward by visiting www.edwardlis.com

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