Here are nine to get your brainstorming started.
Credit unions have struggled to manage excess liquidity for the past couple of years. The pandemic forced them to grow their investment portfolios at near-zero rates as deposits ballooned and loan growth was tepid. Now that we find ourselves in a more attractive rate environment, that challenge has reversed. Credit unions have a golden opportunity to improve net interest margins and loan-to-share ratios—if only they had the liquidity to support it!
Causes of the Liquidity Crunch
The struggle to meet liquidity targets is driven largely by these two factors:
1. High demand for vehicle and unsecured loans. Recent CUNA Mutual data illustrated that Q2 2022 set the highest growth rate in vehicle loans at credit unions since 1984.
2. Reduced consumer savings rate and inflation-induced stress. According to the Bureau of Economic Analysis, US personal savings rates were at 5.1% of disposable income, down from around 10% last year and at the lowest level since the Great Financial Crisis.
What Credit Unions Can Do
As we continue to field questions and facilitate conversations for clients about liquidity management, here are nine key initiatives for credit union executives to consider when managing balance sheet liquidity.
1. Increase money market rates. Adjusting money market rates is a defensive move against deposit outflow. Most credit unions have left rates unchanged this year, which has been good for net interest income and ALM simulations. It comes at a cost though, if depositors start moving funds elsewhere in search of higher rates. Money market accounts are the most rate-sensitive deposits on credit union balance sheets and should be the first place to experiment with higher rates. Credit unions cannot compete with online banks in terms of rates but consider your direct brick-and-mortar competition when adjusting your money market tier rates.
2. Modify tiering across all share types. If your credit union does not maintain large money market product balances, your next best option might be to modify (or introduce) tiered rates on regular shares. Because members have been conditioned to accept low rates on shares/savings, this might be the lowest-cost way to improve deposit retainability.
3. Incentivize relationship pricing. To maintain a closer focus on rewarding your most profitable and engaged members, offering rate incentives for members that utilize direct deposit, bill pay, debit and credit, and loan products may be a good strategy. Relationship pricing is a marketing strategy that allows you to advertise higher rates without bearing the full cost of funds. It also is a strategy to increase fee income and gain a larger share of wallet.
4. Dust off the CD specials. CDs have proven to be an appealing product to older generations (e.g., Baby Boomers), but are decisively less interesting to younger members who prefer money market products. However, most credit unions have a membership profile that skews older where CD specials are still appealing. Credit unions can build out some CD special ladders to lengthen liabilities, thereby improving interest rate risk metrics. Although members typically prefer 12- to 18-month CDs, credit unions benefit most from an interest rate risk perspective when issuing CDs longer than two years (or terms longer than the average life assumption for non-maturity deposits in your asset/liability model). When pricing CD specials, be sure to consider the spread to net yields on investments or loans that need these funds to be sure those spreads meet the credit union’s financial goals. Laddering out CD special maturities is especially important when mitigating “repriceability” risk. New money specials can be especially attractive for the credit union but can be limited by operational constraints and risks alienating loyal members.
5. Early redeem direct CD investments. For credit unions with large portfolios of direct placement or custodial CD investments, a popular liquidity option has been to exercise the early withdrawal feature. Typical withdrawal penalties are anywhere between three months to a year of interest. When considering this option, think about how long it will take to break even on the penalty when considering the reinvestment (or loan rate) you will receive on the cash minus the penalty and foregone interest. One word of caution, while CD issuers were more willing to allow early withdrawals a couple of months ago, we’ve encountered more issuers unwilling to negotiate recently due to tighter liquidity across the industry.
6. Raise your loan rates. Without stating the obvious, if your credit union is experiencing huge loan volumes and net interest margin compression, raising loan rates might be the best option to right-size the loan pipeline. Be sure to benchmark your loan rates not only to your competition but also to credit risk-free investments.
7. Develop outlet valves for loans. The loan participation market continues to grow in both breadth and depth for the credit union community, and being an active participant allows access to both buying and selling of loans. High-performing credit unions have outlet valves to sell loans and remove roadblocks for having to say “no” to a member loan. The marketplace for loan participations is diverse and segmented, ranging from peer-to-peer to brokered trading.
8. Review your borrowing strategies and opportunities. Every credit union should have at least one or two liquidity backstops, including lines of credit at a corporate credit union, federal home loan bank, or Federal reserve bank. Develop a keen understanding of how pricing compares across your borrowing options, as well as credit limits, collateral requirements, and ease of use. Furthermore, if you have derivatives authority, using derivatives to convert floating-rate into fixed-rate funding is currently one of the most cost-effective ways to add wholesale funding.
9. Pursue non-member deposits. Credit unions can hold up to 50% of capital and surplus in non-member deposits, yet most small and medium-sized credit unions hold no non-member deposits. While more expensive than core deposits, these deposits are often cheaper than borrowings. Like loan participations, this market is segmented, and funds can be raised peer-to-peer, or through brokers/placement agents.
This list is certainly not exhaustive but a place to start as you brainstorm liquidity management strategies for your credit union. A flexible and diversified liquidity management strategy is key so that you can be nimble when the liquidity crunch eases. Choosing to increase your cost of funds or lending rates is not an easy one, but there are plenty of tools at a credit union’s disposal to manage this process.
JD Pisula is VP/strategic advisory for Accolade Advisory, Columbus, Ohio.