NCUA’s Letter to Credit Unions 12-CU-10—“Changes to Central Liquidity Facility Access and Emergency Liquidity Proposed Rule”—has brought liquidity issues to the forefront. While this proposed rule raises several issues for credit unions to consider, let’s focus on liquidity as part of managing a credit union’s balance sheet.
Liquidity is a measure of how quickly you can convert (or liquidate) an asset into cash. Like most businesses, cash is also king in our industry. Liquidity serves as our inventory: We buy it from our depositors and sell it to our borrowers.
How we put that liquidity to work has a major impact on our bottom line. Let’s look at why considering liquidity risks should be an important part of managing your credit union even in a time when liquidity risks seem unlikely.
Liquidity at many credit unions remains at historic highs. We’ve seen deposits grow at very strong rates for the past several years.
Loan-to-share ratios have been dropping, significantly. Since 2008, the ratio has dropped from 83% to 67% as of June 2012.
Many economic factors are influencing this. Consumers’ flight to safety has had an impact on our deposit balances. With the economic turmoil of the past few years, many members are choosing to place more of their funds into our savings, checking, and money market accounts.
They see credit unions as a better alternative to the big banks. Members also brought us more deposits rather than invest them in a volatile stock market.
We’ve also seen much lower loan demand, so this increase in liquidity has inflated our cash, our near cash, and our investment balances.
And it’s not surprising to learn that many credit unions haven’t really been concerned about liquidity in today’s environment. So, why should they worry now?
While I certainly don’t have a crystal ball, let’s consider several possible outcomes. And even if they never come to pass, at least we’re prepared to address likely scenarios.
As the economy improves, most economists agree that a number of situations are likely to happen simultaneously. Rates will begin to rise, lending will pick up, and deposits might leave the credit union for higher earning options, such as the stock market.
Overnight rates near 5% might not be soon, but they’re certainly possible before the first mortgage your credit union just made will pay off.
In a perfect storm, your credit union could be left without sufficient liquidity to fund operations, allow members to transfer funds to investments, or fund an increase in loan demand.
It also could be entirely possible you’d have to sell some assets to fund operations, and in a higher rate environment you might have to do so at a loss.
What should we do? This is where “what-if” scenarios and contingency planning come into play. By performing an analysis of future events, you can establish a contingency plan.
This plan should likely include prioritizing which assets you could sell to fund liquidity, determining the funding sources that would be available based on the severity of the crisis, itemizing your preferences for turning to certain sources over others, etc.
Going through this process can even lead to current strategies such as including a layer in your investment portfolio that contains variable-rate products, which won’t be sensitive to increases in rates (and can be sold without a major loss).
If your credit union runs various scenarios and considers the possible outcomes, you’ll have the resources available to weather that storm.
DAVID D’ANNUNZIO is senior vice president/chief financial officer at Heritage Trust Federal Credit Union, Summerville, S.C., and chair of the CUNA CFO Council. Contact him at 843-832-2680. For more information about CUNA Councils, visit cunacouncils.org.