Awash in a Sea of Liquidity
More than $48 billion in new savings has created a flood of liquidity for CUs. To deal with this glut, CUs are promoting loans, diminishing deposit inflows, and rethinking investment strategies.
A dearth of loans and flood of savings have turned credit unions’ liquidity flows into a deluge. As a result, credit union executives may find themselves mulling over an old saw: “Be careful what you wish for; you just might get it.”
“Many credit unions were wishing for 10% asset growth,” says Steve Rick, senior economist for the Credit Union National Association (CUNA). “Well, they got it last year. They had the fastest deposit growth since the 2001 recession.”
To be precise, credit unions’ total assets grew 10.6% in 2009. Unfortunately, loan growth lagged behind at 1.2% last year due to tepid consumer demand for credit in a slow economy.
By April 2010, credit unions’ loan-to-savings ratio stood at 72.8%, down from 83.4% in 2007. The loan drought and flood of new savings dollars—$48.25 billion for the year ending April 2010—has created a torrent of liquidity (“CU liquidity flows,” p. 37). Meanwhile, credit unions’ average net worth ratio sunk from 11.4% in 2007 to 9.8% as of April 2010.
The upshot is that most credit unions face the quandary of what to do with excess liquidity. They might deploy one or more of three strategies: invest the extra funds, diminish the deposit inflow, or redouble their lending efforts.
Rick foresees loan demand recovering by the end of 2010. “In the first quarter, we started to see positive job growth,” he says. “We’re turning the corner.”
Job growth will bolster consumer confidence, he notes, and eventually release pent-up demand for credit. But that doesn’t mean credit unions must wait several months to rev up lending.
“Debt levels in this country are still at record highs,” Rick explains. “We’re telling credit unions to scan members’ loans. Contact members and ask them to refinance their bank loans at the credit union.”
Some credit unions are being aggressive in loan pricing, he adds. Such is the strategy at $8 billion asset SchoolsFirst Federal Credit Union in Santa Ana, Calif. As of April 2010, the credit union’s loan-to-share ratio stood at 60%, down from 69% a year ago, says Francisco Nebot, chief financial officer (CFO). Selling first mortgages has contributed to the dip.
“We’re pursuing loan growth, even though we know the market is difficult,” Nebot says. “We’re doing that by being very competitive with our interest rates.”
As of April 2010, SchoolsFirst Federal offered three-year vehicle loans for 2.99% and four-year loans at 3.99%. While the credit union can’t match manufacturers’ 0% pricing, “we’re on the leading edge,” Nebot says. From February through April this year, monthly vehicle loan originations grew from $20 million to $25 million.
The risk, of course, is being committed to low interest rates for the next three or four years in what might become a rising-rate environment. “We think we can manage this properly,” Nebot says, “because we believe rates will rise slowly, not drastically.”
The credit union also strives to be highly competitive on first mortgages, and it’s promoting a 3.99% rate for one year on credit card balance transfers.
Lowering deposit dividend rates and investing in one- to two-year instruments are other strategies SchoolsFirst Federal is using to deal with excess liquidity. But the primary push is to boost lending.
“We’re focusing on making our loans more attractive,” Nebot says. “That’s how we show commitment to our members.”
In recent months, most credit unions lowered dividends to help stem the inflow of money. Point West Credit Union, Portland, Ore., took a more drastic step: It invited members to move their deposits elsewhere.
“We did that to save our credit union and remain independent,” explains Robert Barzler, president/CEO of the $90 million asset credit union.
A few years ago, Point West faced heavy delinquencies, primarily stemming from a former employee’s failure to adhere to loan polices. “We had to fund our allowance for loan losses pretty heavily back then,” Barzler says. To offset that expense, the credit union closed a branch and reorganized to cut costs.
“Had the economy stayed the same,” Barzler says, “we’d be fine today.” But the economy tanked, members lost jobs, delinquencies rose even higher, and the prospect of conservatorship loomed over Point West as its capital ratio fell to 3.85% by November 2009.
The chief state examiner advised Barzler to lift the capital ratio to 4% by the end of 2009. “She asked if we were willing to shrink assets,” he recalls.
Barzler and his team devised a plan to do just that and presented it two weeks later at a meeting with state and federal regulators. “They’re willing to work with us,” he says. “We’re in it to win it.”
Point West aims to nudge the capital ratio up to 6% by 2014. Assets fell from $100 million in fall 2009 to $90 million by April 2010, with sights set on declining to $85 million.
To trim assets, Point West set its deposit rates at 0% and stopped offering certificates. It also asked about 300 members to consider moving their money elsewhere.
Many of these members had large deposits but no other product relationships with the credit union. The credit union referred them to a financial planner at a credit union service organization.
“We felt we were acting within our core values,” Barzler says. “We had members in mind. We were saving our credit union and helping members earn more on their money than they would by parking it here.”
The strategy relied on honesty and open communication. Only a few members simply took their money and ran. When staff could have one-on-one conversations with members to explain why Point West was driving away deposits, “most members said they wanted to help the credit union and to please call them when they could come back,” Barzler reports.
Even now, new members are joining. Point West saw a net membership loss in March 2010, but gained 60 new members in April—more than it had in any of the preceding 12 months.
“We’re careful now to make sure we add members who will use more of our services,” Barzler says. “And we’ve learned to cross-sell so we can do a better job [of deepening member relationships]. That’s going to be part of our success going forward.”
Ditch ‘hot money’
Aventa Credit Union, Colorado Springs, Colo., has been weaning deposits slowly as it has gradually lowered share certificate rates.
“We’re letting go of the ‘hot money’ from people who go wherever they can get the best rate in town. They’re not loyal to the credit union,” says Dan Leclerc, senior vice president/CFO of the $145 million asset credit union and vice chair of the CUNA CFO Council.
At the same time, Aventa is doing all it can to meet members’ borrowing needs. “We’re not afraid of B, C, and D paper,” Leclerc says, “and we have a good pipeline for indirect lending. We look at every loan before we take it, even though it’s indirect. We’ve tightened how much we’ll lend and the underwriting.”
That was in response to overly zealous indirect lending under a former loan manager a few years ago, which led to chargeoffs.
Aventa has always taken a careful approach to mortgage lending. It experienced its first foreclosure last month and has had only a couple delinquencies, Leclerc reports. The current business plan calls for a continued push in first mortgages.
Aventa’s overall loan delinquency ratio stands at 1.4%, and its loan-to-share ratio is 84%. “We have a good lending engine going,” Leclerc says. Even though Aventa is a small player in the local lending market, “we’re able to maintain our little niche.”
He attributes that to member loyalty and to Aventa’s willingness to serve borrowers other institutions often shun: those with less-than-stellar credit, or members with excellent credit but lower income and, therefore, higher debt-to-income ratios.
“We look at the credit report and the borrower,” Leclerc says. “What’s the person’s history? If you deal only with people with upper-level credit scores, you’ll turn down a lot of good loans that would earn great yield.”
The credit union also is shifting its investment strategy. “We’ve always had a lot of liquidity because we’ve held a lot of money overnight,” Leclerc says.
Since coming to Aventa last fall, Leclerc has been migrating to one- to two-year investment instruments. “I’m slowly getting rid of overnights,” he says.
Bite the investment bullet
In today’s environment of low rates and a steep yield curve, credit unions understandably find it “hard to pull the trigger” on investment decisions, says Brian Turner, director of advisory services for Southwest Corporate Investment Services, a wholly owned subsidiary of Southwest Corporate Federal Credit Union, Plano, Texas.
“But,” he says, “with low loan demand and overnights earning 20 basis points or less, you have to do something.”
Investment actions should be guided by a basic fact, Turner says: Credit unions are in the cash-flow business.
“Even with a lot of liquidity,” he says, “you want to make sure the cash-flow structures in your portfolio are set properly to meet operating requirements, generate acceptable revenue, and offset interest-rate risk.”
As Turner sees it, having cash flow generated from a higher relative-value investment asset is the best of both worlds right now. “Because of the steepness of the current yield curve,” he explains, “the investor gets a higher total return profile by investing out longer on the curve, rather than shortening asset maturities in anticipation of rising rates. Short-term rates can’t climb high enough to break even by staying with short maturities.”
For example, a $1 million amortizing investment taken for three or three-and-a-half years brings in $20,000 to $30,000 a month in principal and interest. “You have dollars coming back to invest when rates start to go up,” Turner says. “That’s what’s important.”
He also offers two directives:
1. Tailorinvestment strategies to your credit union. “Anyone who believes in a one-size-fits-all strategy is lost,” he says.
2. Avoidchasing yield. “Even with the current steep yield curve,” he says, “there’s a fine line between going too far out on the curve or staying too short.”
Echoing that advice is Edward Meier, portfolio manager and director of fixed income at CUNA Mutual Group, Madison, Wis. “It becomes a balancing act,” he says. “You can’t go too long because you’ll be locked into low rates for a long period. But you can’t be too short because you won’t make enough to cover expenses. Then you’d have to cut costs, which could mean laying off employees.”
Balance is the key word, Meier says. Too often, investment activity mimics a rocking boat, as investors surge from the long- to short-term sides of the boat as yields rise and fall. He recommends keeping an even keel by maintaining a balance of longer or intermediate-term investments, plus having enough shorter cash surrogates in the portfolio to satisfy cash needs. “We’ve been moving some money into more intermediate-type investments—somewhere between 12 to 30 months.”
Meier suggests the mix could include instruments that go to full maturity, such as agency bullets, corporation credit bonds, and certificates. Callables and step-ups also are good to add into the mix.
Callables are likely to get called in before maturity if rates don’t change much, he explains. If rates climb, step-ups have built-in rate raises at set intervals.
“It’s easy to get lured into thinking you should go out a bit on the curve and reach for extra yield,” Meier says. “Managing an investment portfolio takes a lot of patience and discipline right now. You need to remind yourself that this, too, shall pass. We will have a higher rate environment someday. So you have to plan. You’ll take a little less yield now with the expectation of having the opportunity to lock in higher yields tomorrow.”
• In 2009, CUs had the fastest deposit growth since the 2001 recession.
• Some CUs are actively turning away deposits to maintain capital levels.
• Board focus: Tailor investment strategies and policies to your CU’s unique needs.
• CUNA CFO Council: cunacfocouncil.org.
• CUNA Mutual Group, Madison, Wis.: 800-356-2644 or cunamutual.com.
• Southwest Corporate Investment Services, Plano, Texas: 800-442-5763 or swcorp.org.