AUSTIN, Texas–One former credit union CEO shared what it’s like to learn the very hard way just how important understanding a CU’s liquidity situation really is.
Kevin Parks, the former CEO of a credit union in Nebraska, recalled he thought he had done his due diligence, but when he showed up on the job he found a credit union with $22 million in loans for 87 vacant single-family homes in Fort Myers, Fla., a $13 million loan to an ethanol plant in the Dakotas, and a $2 million loan for asbestos removal at an apartment building. And that was just the beginning.
“The credit union had overreached, did not have ‘good’ growth, and had pursued lending without appropriate controls,” he told the CUNA CFO Council annual meeting here.
How bad was it? Non-performing assets were 85% of the net worth of the credit union. The delinquent loans-to-reserves ratio was 377%. As this was 2008, it had to write off $6 million it had in its corporate, and then write another $3.5-million check to the Temporary Corporate Stabilization Fund. When it lost its line of credit at its corporate and then its back-up line at Wells Fargo, it became a big liquidity issue.
This “morphed into a liquidity issue,” as well, and no liquidity at corporate and back-up line at Wells Fargo terminated.
The credit union, which continues to operate and grow today, only is able to do so because of the hard lessons learned, according to Parks, FVP, director of strategic planning and Federal Home Loan Bank of Topeka. He themed his remarks, “Running out of Cash is Not a Good Business Model.”
“I did realize the obstacles of your past can be the gateways to new beginnings. They made us stronger and better prepared for the future,” he told the meeting.
To help CFOs avoid the lessons he had to learn and to help them prepare for the future, he shared the following:
Lessons Learned
Parks said he learned this lessons:
- Pigs get fat, hogs get slaughtered. “The credit union overstepped, went outside its territories and outside its mission.”
- Don’t take for granted what is–it isn’t.
- The best laid plans—aren’t the best.
- You can never have too much—it isn’t enough.
“So, what was learned from the last liquidity crisis and how will we apply our learnings? The economic growth right now may have only a few years left, so will another liquidity crisis be right around the corner?” he asked. “Certainly, our regulator believes it’s possible and they are ramping up their supervision in this area.”
What is liquidity? According to Parks, it’s the ability to raise money quickly without loss of principal at a reasonable cost.”
“That’s pretty simple, but not always easy,” he observed.
Regulatory Expectations
Among regulators’ expectations, said Parks:
- Effective corporate governance
- Appropriate strategies, polices, procedures and limits
- Comprehensive measures and monitoring
- Adequate levels of highly liquidate assets
“My credit union did not have a capital plan or a liquidity policy, and had a weak ALM policy,” he recalled. “So, the first step is to develop a long-range capital plan” related to ROA etc. From there, the credit union needs to develop annual goals to move it to where it wants to be in the future. The two most important aspects are assets and funding, he noted. “The key thing is growth has to be balanced between loans, shares and capital. And you need to plan for contingent liquidity stress events, including a time horizon.”
Develop Your Core Funding Strategy
That strategy should include:
- Core funding growth and retention
- Product goals
- Changing member demographics and expectations
- Document your strategy and execution plan
Regulatory guidance focuses on assets-based liquidity and use of near/non-core funding, Parks observed. The key core funding steps:
- Establish core funding goals
- Understand your market and competitors. “Other than price, what is your marketplace advantage?” asked Parks
- Identify differentiators and technology as key aspects of strategy
- Evaluate current marketing and promotion
- Evaluate current sales practices
“Do you know who the 20% of members are who have 80% of your deposits?” he asked.
Evaluate Share/Deposit Composition
The ability to evaluate share/deposit composition is especially important given growth in non-maturity deposits, according to Parks.
“Understand your duration and decay rates, and identify rate sensitivity and response to promotional rates,” Parks said.
In addition, he said CUs should identify CDs at risk of repricing, the other relationships the member has, determine what shares/deposits are available for long term.
“Marginal cost of funds is the only way to manage your cost of funds in a rising rate environment,” said Parks, who advised credit unions to back-test assumptions to see if they were correct.
Consider How Wholesale Funding Sources Fit into Your Funding Plan
“As you think about how wholesale funding fits, consider the different sources and uses, balances the use between those different sources, and think about what eligible collateral you have to support access to those wholesale funds,” said Parks, noting the use of wholesale funding is currently at one of its highest levels in credit unions. “I recommend you document for each one of those sources through a funding worksheet how each is going to be used by your institution. What is your assessment of the vulnerability of that funding source for liquidity?”
Measure and Monitor Liquidity
To measure and monitor liquidity, a credit union must take into consideration asset-based liquidity, cash flows, contingent sources, and stress indicators, Parks said. That plan must establish limits and graduated operating ranges for key ratios, and policy limits should reflect cash flows needed to survive liquidity stress events, he told the CFO meeting.
“Use your ALM tools to identify sources/uses or cash flow gaps.”
Build the Policy Statement & Contingency Plan
To build a policy statement and contingency plan, it should include:
- Base liquidity, including cash flow evaluation, sufficiency to cover short-term liquidity stress events and more
- Stress Test Base Liquidity for likely stress event scenarios, modify cash flow assumptions to implement the test. “Consider use of contingency funding sources in test, and identify actions to be followed,” said Parks. “Then document the test.”
- Write an Effective Policy Statement
Managing Examinations: The 3 D’s
“Define, document and defend our liquidity position,” said Parks. “Typically, you are not prepared to respond to questions when examiners come calling. So, define your limits, sources and events. Document your policy and strategies, funding sources and use, and your measurements, analysis and testing. And defend your strategy and know your position. Communicate your use sources with funding worksheets. Be confident and convincing regarding your plan.”