Five Issues Facing CFOs
CFOs will play a more prominent role in monitoring risks and identifying solutions.
During its search to identify the most pressing issues facing credit union chief financial officers (CFO), the CUNA CFO Council’s Communications Committee identified five key trends facing finance in 2013:
Let’s take a closer look at these five trends.
1. Purchase and assumption
Getting a call from your regulator usually means an upcoming exam or a complaint. But sometimes regulators simply need your help—such as when NCUA plans to liquidate a nearby credit union.
Purchasing a failing credit union’s assets could be one of the most important transactions your credit union makes. But typically there’s a short window to perform due diligence, develop a bid, and make it happen— all while keeping it secret. Aft After all, this isn’t a merger of equals.
Reasons to consider a purchase-and-assumption deal are unique to each acquiring credit union. But remember: You don’t have to acquire everything. Consider taking on only what makes sense for your credit union’s situation.
If the credit union being liquidated serves different geographical areas, there might be an opportunity to carve out deposits and other assets from your geographic area. This allows other credit unions to take on assets best suited to them.
There’s nothing wrong with cherry-picking the best assets, such as bidding only on high-performing loans. Some loans aren’t worth the headache at any price.
Bid only on the buildings or other fixed assets you want. The same holds true with deposits and services such as an ATM network or credit union service organization. The bid must make sense for your credit union.
Once you submit your bid, it’s time to prepare your team. You could have less than 60 days from bid acceptance to assumption, which means your staff will have to be innovative and come up with creative solutions.
At this point in the process, you should have determined your conversion game plan. Do you have the necessary expertise in-house or will you outsource? Don’t underestimate the expertise and time needed to coordinate all of the activities related to the project.
Are your vendors nimble enough to perform quickly? Be creative and explore your options.
Staff must be able to improvise—processing outstanding items can be challenging and automated clearinghouse routing sequences could be useless.
News of the acquisition will surprise your new members. Be prepared for plenty of misinformation, and train your branch and call center staff accordingly.
Remember, not all members read the communications they receive. They might blame any service disruptions on you. Be patient and flexible, and have processing contingencies in place in case your plan doesn’t work.
NEXT: Data analytics
2. Data analytics
If it hasn’t already, your credit union should take a serious look at soft ware that analyzes the huge amount of data that exists across numerous soft ware applications. This data—properly analyzed—can be a tremendous tool to help you make decisions and develop strategies. And the need for more aggressive risk management solutions requires greater analytical tools to help manage and mitigate risk.
Credit unions have extensive data on, for example, loan performance and members. Unfortunately, this data oft en is housed across multiple soft ware applications that rarely communicate with each other.
Forward-looking credit unions realize the strategic competitive advantage that’s obtained by using a single platform to aggregate this data and apply reporting and analytical tools at the loan and member levels. Users from all departments benefit as they gain new perspectives of their portfolios and other relationships.
This is generally called “data mining” or “data analytics.” Now, with accessible loan-level and member-level data, managers of all departments can identify risk in greater detail. They can also discover untapped markets, product and pricing opportunities, and revealing statistical trends. This level of reporting detail also helps satisfy compliance requirements.
Many credit unions use historic performance methodologies to estimate reserves and manage loan loss allowances. But using a predictive model with all available data can give you a more complete picture of a loan and its expected performance.
Credit unions can use data characteristics from borrowers, loans, collateral, regional geography, and the economy to develop a probability of default and loss severity for each loan. You can apply these measures to future cash flows (performance) at the loan level based on potential economic scenarios to estimate loss and your loan loss allowance.
The success of predictive analytics depends on the vast array of centralized data you have. If you have robust data and advanced analytical tools, the accuracy of your predictions will be high.
For the borrower category, some of the more common data points available for a predictive model are income, debt, direct deposit, delinquencies, credit score, and employment. For the loan category, you can include balance, rate, term, pay-date trend, auto pay, superior/subordinate loans, and length of time delinquent.
Examples of collateral data points include value, liquidity, value trend, and marketing time. A predictive model also includes institutional or credit union attributes to profile members, such as borrower stability, charge-offs, borrower bankruptcy rate, and delinquency rates.
Predictive methods also can be applied to lending. Today, the fastest loan decision made with appropriate risk-based pricing oft en determines who originates the loan. Predictive modeling can provide operational advantages to enhance not only speed but the confidence level at which a suitable risk-based price is offered.
Using the appropriate system to aggregate data into a single relational database provides a competitive advantage to credit unions that successfully use data mining and analytics to turn knowledge into strategic decision-making.
3. Loan participations
The challenges of lending in today’s economy combined with weak investment returns are prompting CFOs to get more involved in loan participations. These instruments can add both diversity and income to your loan portfolio.
Government-guaranteed loan participations oft en call for a CFO’s involvement. These instruments don’t count against your regulatory business loan cap, and they have significantly less credit risk because they’re guaranteed.
Although the returns are lower compared to most participation loans, these instruments provide much better returns than comparable investments. There are three types of government-guaranteed loan participations:
The investor purchases the guaranteed portion of the SBA/USDA loan from the originating lender and receives an unconditional guarantee: no credit risk so long as the investor isn’t knowingly participating in a fraudulent situation. And the unconditional guarantee from the government transforms the loan into a permissible investment under NCUA rules.
Unlike traditional participation loans that require full underwriting, government-guaranteed participations require no credit underwriting review. Evaluating these loans is much like appraising a security based on a yield table rather than examining a borrower’s credit profile.
Government-guaranteed participations can be considered an investment or a loan, but a loan not subject to traditional participation and lending regulations, according to NCUA. In addition, there are active markets to sell these participations if the need for liquidity arises, unlike traditional participation lending.
Most SBA loans allow quarterly rate adjustments with no periodic caps and floors. And USDA loans are fixed for a short window, then adjustable thereafter, which certainly helps in interest-rate and price sensitivity analyses.
Government-guaranteed participations are more like investment securities. This lets CFOs use their ability to analyze characteristics, such as prepayment assumptions, and to amortize any premiums paid over the average life of the investment.
As in any investment, diversification over multiple guaranteed loans is prudent. There are penalties in many loans that can stem early prepays and, therefore, reduce accelerated premium write downs.
NEXT: Surplus funds
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:
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.