2013-2014 CUNA Environmental Scan (E-Scan) Report: cuna.org/strategicplanning
CUNA CFO Council: cunacfocouncil.org
4. Surplus funds
Historically low interest rates have persisted for several years and will probably continue at least through mid-2015, according to the Federal Open Market Committee. With the unemployment rate and inflation thresholds currently guiding monetary policy decisions, however, interest rates could become volatile during the next few years.
Continued low rates are putting a strain on asset yields, requiring spot-on funding strategies to manage and improve gross spreads. More than one-third of total credit union assets are in surplus funds, with roughly 45% of those funds being held in cash, cash equivalents, or instruments with a maturity of less than one year. Total surplus funds grew from $357.4 billion at year-end 2011 to $391.4 billion at year-end 2012, CUNA reports.
CFOs must take the lead in evaluating deposit growth, pricing, and funding allocations to prevent diluting the net worth ratio and to ensure a cost-of-funds structure and funding duration that coincides with your credit union’s asset duration.
Despite historically low dividend rates since 2008, deposits keep flowing into credit unions due to consumers’ “flight to safety.” This annual deposit growth caused credit unions’ overall loan-to-share ratio to decline by 140 basis points during 2012, from 69.6% to 68.2%, according to CUNA’s economics and statistics department.
Credit unions continue to have difficulty deploying deposits profitably. That’s due to low yields on short-term investments, combined with the shortage of agency collateralized mortgage obligations available in the market as a result of the Fed’s quantitative easing policy.
CFOs will be more focused on managing cash flows and price risk in investments while attempting to boost spreads as low interest rates persist. Increased margin compression and pressure on income could result in a temptation to compromise investment principles to enhance asset yield.
CFOs must exercise caution with investing in new or unfamiliar instruments. Credit unions recognize they can find additional yield by extending investment maturities. But only extend maturity on a portion of your portfolio, and make sure doing so fits with a comprehensive investment strategy.
Loans are the preferred vehicle for surplus funds. Credit unions’ net yield on loans was 5.42% during 2012, compared to a yield on surplus funds of 1.21%, CUNA reports. But with CUNA projecting deposit growth of 6% and loan growth of 5.5% for 2013, liquidity won’t disappear soon. As a result, maximizing investment returns will remain a top priority.
5. ALM considerations
Understanding and evaluating balance sheet exposures and expectations in light of economic challenges and the changing composition of the balance sheet are at the crux of ALM.
Balance sheet management entails managing earnings and capital without adding undue levels of interest-rate, liquidity, and credit risk. CFOs are tasked with both proposing and implementing strategies that result in robust balance sheets under a wide variety of interest-rate scenarios.
This is where interest-rate risk (IRR) management comes in. Regulators require credit union managers to more holistically manage risk, realizing that risk factors aren’t isolated from one another—one risk driver could trigger another risk driver.
IRR is the potential impact of interest-rate movements on a credit union’s net interest income and capital based on the repricing speed of assets relative to liabilities. Effective IRR management not only involves the identification and measurement of IRR, it also provides for appropriate actions to control this risk.
Balancing the mix of assets and liabilities to create match funding isn’t easy. But some basic strategies can be put into place to mitigate IRR in a rising-rate environment. These include:
► Limiting long-term, fixed-rate real estate loans held in portfolio;
► Limiting investment durations to less than five years, despite limited reinvestment options and dismal yields;
► Repricing rate-sensitive share products as deposits continue to accumulate; and
► Considering strategic pricing plans for a risingrate environment.
Credit unions also must address concentration and liquidity risk. The former arises from having significant exposure to any one product or service with a potential to significantly affect net worth, assets, or risk tolerance.
Credit unions should establish a board policy that aligns concentration tolerance with the strategic plan. Recognize, however, that while concentration intensifies the impact of mistakes, stringent limits can stifle future operations.
Challenges will abound in the coming year. Your credit union must create its own solutions and constantly monitor and measure its position, factoring in members’ needs and assessing potential contingencies. Undoubtedly, the CFO’s role in monitoring risks and identifying solutions will continue to grow.
This article was written by the CUNA CFO Council's Communications Committee. The committee includes William Kennedy, chair, Interior FCU; Sonya Jaynes, vice chair, Red River Employees FCU; Brad Long, First Florida CU; and James Sessa, Coast Central CU.