PHOENIX-Yet more regulatory fallout from the recession is a proposed rule from NCUA relating to liquidity risk-which two experts said is all about a credit union having enough "levers" to pull during a crisis.
John Myers, president of c. myers corporation, and Adam Johnson, EVP/principal of the Phoenix-based consultancy, told attendees of the recent CUNA CFO Council Conference here that the proposed rule carries different requirements for various asset size categories.
Per NCUA, which offers details at [http://www.ncua.gov/Legal/Documents/Regulations/PR20120724MaintainAccessEmergLiq.pdf], the proposed rule requires federally insured CUs with assets of $10 million or more to maintain a contingency funding plan that clearly sets out strategies for addressing liquidity shortfalls in emergency situations. FICUs with assets of $100 million or more must have access to a backup federal liquidity source for emergency situations, while FICUs with less than $10 million in assets are required to maintain a basic written policy that provides a "board-approved framework for managing liquidity and a list of contingent liquidity sources that can be employed under adverse circumstances."
Flight Of Safety
The regulator's liquidity concerns have increased in part due to a consumer "flight to safety" that started approximately five years ago. Myers noted this event brought a lot of deposits to credit unions, but also increased risk.
"Do not think of those as core deposits, because when conditions change they can go out the door," he advised. "The ease of moving money means change can happen very fast, which is why having a liquidity funding plan in place is important. Interest rate risk and credit risk can cause liquidity problems."
Stress Tests
Johnson noted that examiners are expecting to see stress tests that probe for liquidity risk.
"This is about making sure CFOs have thought through everything, that the credit union has enough levers it can pull to satisfy liquidity needs," Johnson said. "Use the liquidity forecast as a baseline, and then identify bad-case liquidity scenarios. Start with history, meaning know your credit union's actual liquidity events and what caused them. Move forward to combinations that can bring worse scenarios."
Once identified, the next step is to quantify the impact of various stresses, Johnson continued. He said CFOs have to constantly ask questions: What about deposit outflows? Will lines of credit be available to the CU? What about large numbers of members utilizing unfunded commitments such as lines of credit? What if there are disruptions to asset cash flows?
Modeling Impacts
"Model how these impacts can be solved relative to the credit union's limits," Johnson counseled. "Every credit union CFO needs a realistic plan that includes steps that will be there when needed, and take action if necessary."
Among the action steps Johnson recommends CUs have in their liquidity plans:
* Separate internal and external liquidity sources.
* Know the role of the Fed discount window or the Central Liquidity Facility.
* Timeframes, ranging from short (a few days) to long (up to 12 months).
* Simulations for bad cases and potential solutions.
Bad Case Scenarios
Myers said CUs have a number of options available to them, even in a bad case liquidity scenario, starting with changes to their investment portfolios.
"They could keep all investments short term, they could sell AFS [available for sale] or even HTM [held to maturity] investments, or they could enter repurchase agreements," he offered.
"Credit unions also could adjust deposits," Myers continued. "They could increase rates to attract deposits, although this could be a costly option, or they could do brokered CDs. However, they need to keep in mind brokered CDs could be cut off in a bad case scenario."
Johnson said CUs should not forget about changes they could make to their lending programs to address a liquidity crunch, although he cautioned not every solution would that follows will work:
* Increase loan rates.
* Stop approving loans ("Would this work?," he wondered aloud).
* Stop funding loans.
* Reduce lines of credit.
* Use cash flows from existing loans ("This only works in case of negative loan growth").
* Sell loans.
Other Options To Consider
Other options include implementing accounts payable changes, increasing income from fees ("Of course, it can be difficult to generate enough fee income to offset a liquidity crisis"), and selling non-earning assets.
"After identifying all the things the credit union could do, decide what you as the CFO would do," Johnson told the audience.
"CFOs have to have options that can be counted on in a crisis. Only count on liquidity sources you have experience with. If there is a line of credit that has never been used, try it out to understand before there is a crisis. Know all the costs of implementation, plus the business costs of preparation.
"The CFO needs to feel prepared," he said.
