The ABCs of crisis management
Navigate uncharted waters with liquidity management, business lending, and use of capital.
Social distancing, event cancellations, school closures, and stay at home orders—all of which are critical to controlling the coronavirus (COVID-19) health crisis—have dramatically reduced routine economic activity.
They’ve also stressed members financially, physically, and mentally—and significantly increased the complexity of operating a credit union and serving our most vulnerable members.
The gradual and uneven easing of widely mandated social restrictions has made leaders’ roles more, not less, challenging, and little things have taken on greater importance.
Here are three factors that matter greatly as you navigate these uncharted waters.
Access to liquidity
The No. 1 killer of financial institutions during a crisis is insufficient liquidity.
Credit unions now have ample liquidity, and recent massive deposit inflows from Economic Impact Payment deposits added billions of dollars to deposit accounts. The credit union loan-to-share ratio is rapidly approaching 75%.
The best time to gain access to liquidity sources is when they’re not needed. Against this backdrop, CUNA, corporate credit unions, leagues, and credit unions have successfully lobbied Congress to improve access to the NCUA Central Liquidity Facility (CLF) in the recent Coronavirus Aid, Relief, and Economic Security (CARES) Act.
The CLF played a key emergency liquidity role during the Great Recession, when it helped corporate credit unions. It now has the potential to play a pivotal role in the COVID-19 economic crisis by helping to resolve any natural person credit union emergency liquidity or system needs.
Congress established the CLF in 1978. It was designed as a source for emergency funding (essentially a backstop) only to be accessed when all other market sources of liquidity were exhausted and it included a prohibition of using CLF funds to “expand credit union portfolios” (which was interpreted to mean loan portfolios).
The CLF has the capacity to borrow directly from the U.S. Treasury and inject liquidity into natural person credit unions (and now, their corporate credit unions as their agents).
As the pandemic and resulting economic crisis passes, loan demand will increase, perhaps substantially. If so, liquidity will, once again, decline. And the need for liquidity sources will become more obvious.
The CARES Act increases the value and usefulness of the CLF to our entire credit union system in several ways, albeit temporarily.
First, it increases the facility’s maximum legal borrowing authority. Next, it makes it easier, with NCUA Board approval, for corporate credit unions to act as agent members of subsets of their own member credit unions. This can help natural person credit unions access emergency liquidity indirectly from the CLF via their corporate.
Last, it also provides more clarity and flexibility about the purposes for which the NCUA Board can approve loans by (temporarily) removing the phrase, “the board shall not approve an application for credit the intent of which is to expand credit union portfolios.”
NCUA is encouraging large credit unions to join the CLF directly as soon as possible because its total borrowing power is limited to a multiple of its stock subscription. There are some good reasons to consider doing so even if your credit union has access to other emergency liquidity sources such as the Fed Discount Window.
The risk of subscribing to CLF stock is minimal. The new law allows the CLF to borrow from 16 to 32 times the CLF’s paid-in capital (and any surplus), and your credit union’s stock subscription, carried as an investment on your books, is essentially risk-free.
NCUA’s revised rule includes this statement made in bold font for added emphasis: “The board urges all natural person and corporate credit unions that do not already belong to the facility to join.”
Immediately following the passage of the CARES Act with the new but temporary powers of the CLF, the NCUA Board took further steps to lessen prior application and approval barriers for natural person credit unions.
For example, NCUA adopted new regulations that eliminated the six-month waiting period for a new member to receive a loan, removed the explicit waiting period for a credit union to terminate its membership, and eased collateral requirements for certain assets securing loans.
The agency is clearly sending a message that they want as many credit unions as possible, especially larger ones, to join the CLF to not only secure an additional safe and reliable emergency liquidity source but to expand the leveraged CLF’s borrowing capacity to ensure the system has ample liquidity available to survive the pandemic-caused economic crisis.
If large credit unions join the CLF in significant numbers, it would help to ensure both small and large credit unions have access to a larger pool of reliable emergency liquidity. That should translate into fewer failures during times of severe stress—like these.
Several significant advantages would occur in this scenario. Fewer small credit union failures will mean less exposure to reputation risk for all credit unions. And it also could mean a lower likelihood of future share insurance assessments. Put simply, a larger CLF is essentially a bigger and more effective shock absorber for the system, which benefits all credit unions, both small and large.
Joining the CLF at this time is the right thing to do to protect our system from shocks by managing overall liquidity. Cooperatives serve their members most effectively and strengthen the cooperative movement by working together through local, national, regional and international structures. Together, credit unions can reach more people and improve more lives.
In the meantime, CUNA will continue to urge Congress to make further improvements to the CLF by extending the new provisions to temporarily expand the amount of borrowing authority even further.
NEXT: Business lending
Credit unions were created during the Great Depression, conceived as the average working person’s access to loans at a time when banks wouldn’t lend.
Since those beginnings and in each economic and financial crisis since, credit unions kept their laser focus on mission: Lending to help members navigate tough times while banks turned borrowers away to preserve their capital.
Businesses and their employees have struggled mightily during the COVID-19 crisis. That’s especially true for the nation’s small businesses.
The Small Business Administration’s (SBA’s) Payment Protection Program (PPP) has helped—and credit unions stood out as the agency introduced the program. A CUNA survey suggests nearly one-quarter of all credit unions either applied or intended to apply to be PPP lenders.
While the rollout was challenging, CUNA’s survey data from credit union PPP participants reveals that credit unions originated billions of dollars in PPP loans.
The typical credit union originator reported an average loan size of about $55,000. In contrast, the average loan size at the largest 15 bank PPP lenders was about $305,000 in the first round of funding. That’s roughly five times larger than the credit union average and a clear reflection that funds predominately went to larger, not smaller, businesses.
Given the urgent and largely unmet financial needs of so many small businesses, CUNA, leagues, and credit unions are engaged with policymakers to provide credit unions with more flexibility to serve their smallest, most vulnerable business members.
The need is great and will only grow. More than 30 million Americans filed for unemployment in the six weeks ending April 25. Many of these people will engage in “gig economy” activities, and many will need capital to get their businesses going.
In 2008, the first year of the Great Recession, 3.3 million jobs were created by firms that were less than one year old. But that’s only part of the story as many displaced workers will look for capital to pursue a wide variety of more informal income-generating opportunities.
Research clearly shows the Great Recession was the impetus behind a significant rise in the gig economy, and growth in nonemployer establishments dramatically outpaced traditional employer establishments.
As the economy struggles, all available small business credit needs to be deployable. Unfortunately, federal law restricts credit unions’ ability to fully deploy credit to small businesses, capping the amount any individual credit union can lend to small businesses at 12.25% of assets.
This cap makes little sense during normal economic times. But at a time when every available dollar is crucial to reviving Main Street, it makes no sense.
Today, more than 800 credit unions serving 50 million members offer business loans subject to this arbitrary restriction. Nearly 150 of these credit unions, serving 10 million members, have loaned more than 8% of assets to small businesses, making them actively constrained by the cap.
These are exactly the type of experienced business lenders our small businesses need fully engaged in helping the economy recover.
CUNA conservatively estimates that temporarily removing the member business lending (MBL) cap will provide more than $5 billion in capital to small and informal business ventures, creating nearly 50,000 jobs over the course of the next year—at no expense to the federal government.
Therefore, we have urged Congress to enact legislation that exempts credit union business loans made during federally declared disasters and emergencies from the arbitrary MBL restriction.
Failure to do so would leave critical assistance on the sidelines when small businesses and the nation’s economy need it most.
Four representatives introduced bipartisan legislation—H.R. 6550, the Access to Credit for Small Businesses Impacted by the COVID–19 Crisis Act of 2020—to temporarily lift the MBL cap for three years for loans related to COVID-19.
Additional credit union lending will not impede bank lending activity. SBA research shows that roughly 80% of credit union business loans are those banks would not make.
The economic crisis facing America’s small businesses will not end when the declared public health crisis expires. That’s why H.R. 6550 would extend the exemption from the cap for three years.
This commonsense legislation would provide a narrow remedy to ensure small businesses can continue to access essential credit from local credit unions.
NEXT: Capital is king
Capital is king
As not-for-profit, member-owned cooperatives, credit unions view capital as something akin to a “war chest” built up over time to help members battle severe economic strain. It’s seen as a valuable tool.
This perspective sets credit unions apart in the marketplace. Banks exist to maximize shareholder value. Their focus during tough times is squarely on defending (not using) capital.
The credit union approach to capital management has its limits, especially in the context of regulatory minimum capital requirements.
Prompt Corrective Action (PCA) regulations require supervisory authorities to address safety and soundness concerns in a timely, predetermined manner with progressively severe actions when credit union net worth ratios fail to meet predetermined threshold levels.
NCUA has distributed interagency guidance indicating flexibility in applying PCA to credit unions serving members during the current crisis. But credit union managers have concerns about the agency’s patience and uneven interpretation among examiners.
A focus on capital—a sense of its durability, a plan for its use, examination of scenarios, and clear communication and documentation—is crucial as we face economic challenges.
CUNA prepared a simple capital planning calculator to help estimate and evaluate your credit union’s likely financial stress and resilience during the COVID-19 crisis. You can access the calculator at cuna.org/economics.
As a starting point, this simple model looks at your credit union’s historical experiences through the lens of the Great Recession. Evaluating this experience can help you make reasonable assumptions about expectations during the COVID-19 crisis. The model summarizes the relationships between asset growth, earnings, and capital.
Thinking about reasonable assumptions for the capital calculator can be challenging, especially now. A variety of factors outside of your control will drive asset growth rates, and for most of these factors we have little in the way of historical context.
In the first four months of the year, credit unions experienced typically fast seasonal deposit inflows (buoyed by income tax refunds), although asset growth was relatively strong compared to previous years.
The economy had begun to slow, and members focused more on slowing their borrowing and increasing their savings.
In April, massive fiscal stimulus caused deposits to grow significantly. Will they be sticky or will consumers spend those funds? The answer to that question will greatly influence overall growth for the year.
In addition, the extended tax filing deadline may give rise to unusually fast growth that extends well into the second quarter and perhaps the third quarter. As the crisis passes, members may concentrate on building (or rebuilding) rainy-day funds.
Higher levels of precautionary savings and associated fast asset growth may be the new world order. In a similar vein, earnings will be severely constrained. Many credit unions are building allowance accounts.
At the end of 2019, the typical credit union reported allowance account balances equal to 1.6 times full-year 2019 net charge-offs. That will most definitely change going forward.
Courtesy pay and nonsufficient funds (NSF) fee income has plummeted because consumers aren’t spending much (leading to fewer fees) and because institutions are waiving most NSF fees.
Interchange income has fallen as consumer spending eased. And net interest margins are under severe pressure mostly due to the combination of near 0% interest rates and low loan demand with fast growth in low-yielding investments.
Interest rates will play a key role going forward. CUNA economists expect market interest rates across the yield curve to remain low throughout the remainder of our 18-month forecast horizon. But they could go lower. And the Fed could push the federal funds interest rate into negative territory.
Low interest rates typically are associated with weak or disrupted economies and periods of high unemployment. Consumers tend to save more and spend less during these periods.
Lowering rates is the primary way central bankers attempt to nudge consumers and get the economy back on track.
Lower interest rates discourage saving and make borrowing cheaper, boosting spending.
While we’ve never experienced negative interest rates in the U.S., several other central banks (e.g., euro area, Switzerland, Sweden, Denmark, and Japan) started setting negative nominal interest rates after the 2008 financial crisis to lower savings, increase spending, and revive their respective economies.
Negative market interest rates can stimulate the economy by lowering the rates commercial banks charge on loans. They can also encourage savers to switch to riskier assets and/or to spend rather than save.
Developed countries that have adopted negative nominal interest rates have generally seen banks lower loan interest rates but have not experienced a decrease in retail deposit rates below 0%.
The effectiveness of this varied widely, although negative rates generally were much less powerful than rate cuts of similar magnitude when rates remained positive.
For credit unions, the initial impact of a negative federal funds rate most likely would be to increase profitability because net interest margins would increase as rates on deposits fell faster than average loan rates.
If depositories here collectively behaved as they did in Europe and Japan—lowering deposit rates only to 0%—then loan and investment yields could decline more than deposit prices, which would reduce net interest income.
In that same economic environment, those net interest income declines might be partially offset by rising noninterest income as NSF, courtesy pay, and late fees increase.
All of this underlines the critical need to think about scenarios. Varying both asset growth and earnings to gauge comfort with the likely path of your capital ratio is a good idea.
Having an informed opinion about your willingness and your ability to engage with members in impactful ways will be crucial in the coming months.
MIKE SCHENK is CUNA's chief economist and deputy chief advocacy officer.