By JD Pisula - VP Strategic Advisory
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!
The struggle to meet liquidity targets is driven largely by the two factors:
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.
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.
As we continue to field questions and facilitate conversations for clients about liquidity management, here are some key initiatives to consider when managing your credit union’s balance sheet liquidity.
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. in search of better yields. 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. Consider your direct brick and mortar competition when adjusting money market tier rates.
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.
Incentivize Relationship Pricing
- Relationship pricing is a marketing strategy that helps you reward your most profitable and engaged members. This strategy could include offering rate incentives for members that utilize direct deposit, bill pay, debit and credit, and loan products. You’ll be able to advertise higher rates-increasing fee income and gaining a larger share of wallet-without bearing the full cost of funds.
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, since most credit unions have a membership profile that skews older CD specials are likely an appealing option for your members. Credit unions can build out some CD special ladders that lengthen liabilities, thereby improving interest rate risk metrics. From an interest rate risk perspective, credit unions benefit most when issuing CDs longer than 2 years (or terms longer than the average life assumption for non-maturity deposits in your ALM 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 spread 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.
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 3 months to 1 year of interest. When considering this option, think about how long it will take to breakeven 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 months ago, we’ve encountered more issuers unwilling to negotiate recently due to tighter liquidity across the industry.
Raise your Loan Rates
- Without stating the obvious, raising loan rates might be the best option to right-size the loan pipeline if your credit union is experiencing huge loan volumes and net interest margin compression. Be sure to benchmark your loan rates not only to your competition, but also to credit risk-free investments.
Develop Outlet Valves for Loans
- The marketplace for loan participations is diverse and segmented ranging from peer-to-peer to brokered trading. It 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.
Review your Borrowing Strategies and Opportunities
- Every credit union should have at least one or two liquidity back stops, 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 funding into fixed-rate is currently one of the most cost-effective ways to add wholesale funding.
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 times 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. A choice 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.
As always, if you would like to learn more about recent market developments and potential investment strategies, please reach out to your Accolade investment adviser representative.