Compliance preparations for the National Credit Union Administration’s new emergency liquidity rule must have been completed by March 31 2014.

The liquidity rule sets up three-tiered emergency liquidity requirements for credit unions with less than $50 million in assets, between $50 million and $250 million in assets, and more than $250 million in assets.

Federally insured credit unions (FICUs) with less than $50 million in assets must maintain a basic written emergency liquidity policy but will not be required to take further action. All FICUs with assets of $50 million or more are required to develop contingency funding plans describing how their credit union will address liquidity shortfalls in emergency situations. FICUs with assets of $250 million or more would be required to have access to a backup federal liquidity source for emergency situations.

Why wouldn’t credit union’s with less than $250 million in assets not want to have access to a backup federal liquidity source such as the discount window or CLF for emergency situations?

The final rule does not include the Federal Home Loan Banks (FHLB) as an acceptable source of emergency liquidity, although eligible credit unions required to meet the federal source provisions would be free to borrow from a FHLB for nonemergency purposes. Without the FHLB, credit unions have two options to ensure a federal liquidity source for emergency situations: Becoming a member of the NCUA’s Central Liquidity Facility (CLF) by subscribing to CLF stock or access to the Federal Reserve’s discount window.

I strongly supports the use of the home loan banks for liquidity.

Why be concerned now about liquidity when most credit unions are still awash with funds resulting from a flight-to-safety fund inflows and loan portfolio outflows due to lack of loan demand?

• Rising rates typically are used to manage economic recoveries. so it is likely rising rates will be accompanied by a return of flight-to-safety funds to the market and a spike in loan demand, putting many credit unions back in the tight liquidity environment of a few years back.

• Many credit unions have rate floors under their variable rate loans.  As rates move up, rates on these loans won’t move for a while. But your cost of funds will.  The result is a compressed net interest margins or NIM

The objective of a viable liquidity policy and strategy is to provide a framework to minimize the adverse effects of a significant and sustained liquidity crisis.  This can result from changing economic or interest rate conditions, deposit outflows, unusually strong loan demand, intense competition, an international crisis, or any other factors that can deplete the liquidity of the credit union.

In the event of a serious and sustained liquidity crisis, various strategies, of which some would be considered preventative and must be implemented prior to the onset of a crisis.  Other strategies are reactive and may be implemented immediately.   The strategies will differ in terms of the implementation time, costs, risks, financial implications and regulatory consequences.

The first place to look for sources of liquidity is within your own balance sheet.

Loan Payments and Prepayments-a credit union may write loans with long repayment schedules, however, with that said; loan portfolios continue to be relatively short term-the turnover rate. Track and test loan payments and prepayments in all economic environments to estimate the level of cash inflow to the credit union under a variety of scenarios. As a reminder, when interest rates are falling-prepayments will increase, and when rates are rising-prepayments will slow down.

Increasing Member Deposits-to bring about an inflow of deposit funds without cannibalizing previously deposited funds are often referred to as “disparity” or “segmentation” strategies. They are designed to identify depositors based on rate sensitivity and encourage an inflow of deposits when needed.  You should be forecasting your liquidity needs and anticipating those needs in the marketing of your deposit products.

Selling of your Assets–mortgage loans written to conforming loan standards can normally be sold in a short period of time with one major issue to remember: Loans will be sold at their “market price”, which may be more or less than their “book value”, depending on the current level of interest rates. Other types of loans have the potential for sale as well, i.e. consumer loans

Non-Member Deposits-non-member deposits, also referred to as brokered funds, can provide near-immediate and short-term funding.  Note these come at a high price and the funds are very rate sensitive.

Loans from the Corporates-the corporate credit union is still the lender of first choice for a majority of credit unions. Loans fall into two major categories: A line of credit and a term loan.

  • A Line of Credit-these come in two varieties: committed and uncommitted. A committed line, most common, the credit union pays a fee based on the size of the line and its duration. There is a contractual assurance that the funds will be available to the credit union when those funds are needed.   An uncommitted line of credit, funds may be available based on the lender’s-the corporate-ability and willingness to fund. Generally, there is no charge for an uncommitted line of credit, but the certainty of obtaining the funds when you need them could be in doubt.
  • Term Loans-these involve a specific amount borrowed for a specific period of time. It may be a bullet loan with the principal due in full at maturity, or an amortizing loan similar to an installment loan. Rates can be fixed or variable.

Federal Home Loan Bank (FHLB)-the FHLB is a quasi-government organization with the objective of supporting and providing loans to financial institutions that make first mortgage real estate loans or that purchase and hold mortgage-backed securities. These organizations offer a diverse line of lending services to qualifying credit unions. Much like the corporate system, liquidity from the FHLB involves lines of credit and/or term loans at fixed or adjustable rates often at more favorable rates than the corporates.

To borrow directly from the FHLB, a credit union must be a member. To be eligible for memberships refer to http://www.fhlbny.com/aboutus/membership.htm.

For a credit union not belonging to the FHLB, check to see if your corporate credit union has an agency relationship allowing the natural-person credit union access to FHLB resources without becoming an FHLB member.

The Central Liquidity Facility-the Central Liquidity Facility is administered by the NCUA Board.  CLF advances to natural-personal credit unions are normally limited to short-term, temporary needs. Borrowing directly from the CLF requires that the credit union apply for membership in the CLF and purchase stock. However, many corporate credit unions are appointed as CLF agents and may be able to facilitate an advance to natural-person credit unions that are not members of the CLF. For more on the CLF refer to Http://www.ncua.gov/Resources/CreditUnionDevelopment/ResourceConnection/Files/Partners/NCUA-CLF.pdf

This blog entry you have just read was written by Edward Lis who is a former senior executive. If you enjoyed this article I encourage you to learn more about Edward by visiting www.cuadvisorygroup.com or by calling 518-420-2108.

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