What’s Your Credit Union’s Liquidity Strategy

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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. More

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Concentration Risk

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CU officials and management have a fiduciary responsibility to identify, measure, monitor, and control concentration risk.  Concentration risk must be managed in conjunction with credit, interest rate and liquidity risks; as a negative event in any category may have significant consequences on the other areas, as well as strategic and reputation risks.

Concentration risk has increased in importance during the recent economic recession.  Poor risk management of residential and commercial mortgage loan concentrations, in particular, is having an adverse effect on credit unions nationwide; resulting in significant loan losses, earnings deterioration, capital depletion, and increased credit union failures.

The board of directors should establish a policy addressing its philosophy on concentration risk, limits commensurate with net worth levels, and the rationale as to how the limits fit into the credit union’s overall strategic plan.  Take a global perspective when developing the policy, including identifying outside forces (such as economic or housing price uncertainty) which will affect the ability to manage concentration risk.

The parameters set by the board should be specific to each portfolio and should include limits on loan types, share types, third party relationship exposure, etc.  The risk limits should correlate to the overall growth objectives, financial targets, and net worth plan.  The risk limits set forth in the concentration risk policy should be closely linked to those codified in related policies, including, but not limited to, real estate loan, member business loan, loan participation, asset/liability management (ALM), investment and liquidity policies.  Any Concentration exceeding 100 percent of net worth must be monitored carefully, and the board of directors should document an adequate rationale for undertaking that level of risk. More

Troubled Debt Restructure (TDR)

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Troubled Debt Restructuring Final Rule

The NCUA board recently adopted a final TDR rule (Part 741) and loan workout guidance (Part 741, Appendix C). The final rule sets no limit on the amount of troubled loans that credit unions can work out with members. The rule also removes unnecessary manual tracking procedures and allows credit unions to modify loans without having to immediately classify TDRs as delinquent. Specific changes include:

  • October 2012-Requiring federally-insured credit unions to adopt and adhere to written policies that govern loan workout arrangements that assist borrowers.
  • June 2012-Allowing credit unions to calculate the past due status of all loans consistent with loan contract terms, including amendments made to loan terms through a formal TDR.
  • June 2012-Eliminating the dual and often manual delinquency tracking burden on credit unions for managing and reporting TDR loans.
  • October 2012-Reaffirming current industry practices by requiring credit unions to discontinue interest accrual on loans past due by 90 days or more and to establish requirements for returning such loans to accrual status.

Key TDR Accounting Guidance

• Codification Topic 310-40 (Receivables/Troubled Debt Restructurings by Creditors)

• Formerly: • FAS 15, Accounting by Debtors and Creditors for Troubled Debt Restructuring

      • FAS 114, Accounting by Creditors for Impairment of a Loan

      • FAS 118, Accounting by Creditors for Impairment of a Loan, Income Recognition and Disclosures

Loans that fit the troubled debt restructuring definitions share the traits of modified loans yet have two additional characteristics:

  1. The modification is due to economic or legal reasons related to the debtor’s financial difficulties; and
  2. The modification provides for a reduction in interest and principal.
All TDRs are modified loans; however, not all modified loans are considered TDRs.
In a trouble debt restructuring, the credit union, the creditor, grants a concession to the member, the debtor, that the creditor would otherwise not consider if it were not for the financial difficulties being experienced by the debtor.  These difficulties could be either legal or economic.  Trouble debt restructures are always evidence by an agreement between the parties or based on terms imposed by a court of law.
The benefits of a TDR for the member are as follows:
  1. Assist the debtor through a period of financial difficulty; and
  2. Assist the debtor avoid a repossession or foreclosure.
The benefits of a TDR for the credit union are as follows:
  1. Increases the likelihood of repayment on loans by members having financial difficulty;
  2. Lessens the likelihood of repossession or foreclosure; and
  3. Increases member retention.

Loans that are refinanced or modified just to keep members whose loans are current from refinancing elsewhere for a better rate are not modified loans.

How do I calculate a loss on a TDR? More

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