The pressure on margins is refocusing attention on an oft-overlooked aspect of credit union operations: cash management.
"Cash management as a whole, even in the banking industry, is the easiest understood but has the least amount of focus," said Jeremy Calva, VP-investment operations with WesCorp. "The larger the credit union is, and the larger the dollar amount, the greater the potential impact. But it is a short learning curve and an easy fix."
The Credit Union Journal spoke with four corporate credit unions regarding credit unions and cash management, finding general agreement that most are doing a reasonable job managing their daily cash, but many are also missing opportunities to boost their bottom line. Another point of agreement among the four corporates-Woburn, Mass.-based EasCorp, Columbus, Ohio-based Corporate One, Dallas-based Southwest Corporate and, of course, WesCorp: it can be costly to miss out on overnight investments.
Tammy Cantrell, SVP-asset/liability management, for Ohio-based Corporate One FCU, said credit unions would be wise to shop around, because not all overnights are created equal.
"Some corporates offer just one overnight account," she explained. "Credit unions know they are going to earn pretty close to Fed Funds-an OK rate-but they can pick up a nice yield if they look around. We pay well in excess of Fed Funds for deposits of $5 million or more."
Getting Swept Away
WesCorp's Calva said sweep accounts, which take all of the transaction accounts a credit union has in a day and then shovels the funds into one place for the night, can make a big difference, as well.
"Banks offer this for a fee of 60 to 80 basis points off the overnight rate. Some corporates offer the sweep function with no fee, and pay the overnight rate," he said. "At WesCorp, our sweep account basically is an overnight account-a fee-free sweep into the credit union's overnight account."
Alan Bernstein, SVP-business development and strategic planning for EasCorp, said he believes CUs are proficient at cash management and are not leaving a lot of money on the table, but the corporate is working on models to help CUs look at historical cash flow and make projections.
"Our main pricing structure has to do with the term of the investment. Our rates, as with everyone else's, track the yield curve. In a normal yield curve, you get rewarded for going out a little more on your investments. A credit union's interest in improving its bottom line with investments has to do with cash flow predictions and when they'll need that money back."
EasCorp always subordinates its advice to the member CUs' special needs, or business conditions such as the interest rate environment, Bernstein continued. "We'll help them if they want to stay a little bit shorter, but ladder things out a little bit-maybe investments that have call options. Rising or falling rates might lead us to give general tips to credit unions, but integrated with their cash needs."
Southwest Corporate's director of investment services, Zane Wilson, said when managing liquidity, CUs must track the flows of their cash through the various parts of the credit union, including shares, lending, and mortgage lending or servicing.
"There could be some cash flow volatility, but tracking can be as simple as an Excel spreadsheet to monitor each department," he said. "Our corporate offers a range of liquidity products, such as an operating account, where most of the activity flows through, and a performance tiered account, where the money goes at the end of the day and earns a much higher rate."
The corporates generally gave CUs good marks in managing their cash. The highest praise came from EasCorp's Bernstein, who said they have an "excellent understanding" of the subject. He pointed to the post-2000 stock market collapse as an example.
"Deposits were growing by leaps and bounds, but credit unions wanted to stay very liquid for the day things settled down and the money was going to go back out. As a result, large amounts of money remained in overnight certificates or short-term certificates. They erred on the side of caution."
Corporate One's Cantrell said some of the larger CUs are looking for advisory services, which can be expensive. She said the value of paying for these services depends on the size of the portfolio. "We are looking to partner with firms that offer investment advice to be able to offer these services to credit unions."
"Overall, I think credit unions do a pretty good job of managing their cash," she said. "I don't know how much they are leaving in non-interest earning cash. I don't see them looking for a lot of expertise. I know their margins are tight right now. They tend to stay pretty simplistic, which is fine. They take their interest rate risk offering loans to their members, rather than in their investment portfolio."
Some credit unions would like ALM modeling services-not just for cash management, but their entire balance sheet, Cantrell added. "Credit unions need to remember they can't manage their risk in a silo. If they mostly have short-term loans, auto loans, or home equity loans, they can afford to take more risk in investments. Conversely, if they are taking a lot of interest-rate risk, having mostly 30- or 40-year mortgages, then they should not take investment risk."
According to WesCorp's Calva, some institutions have a full grasp on cash management, but, "even many banks don't understand the value of float, earnings credit, the reserve requirement, and how the fee structure can impact their overall return."
"There are so many fish to fry, it becomes a priority issue. Cash management is one of the most ignored areas," he declared. "It is not a hot topic, it always will be there, and it won't create huge differences in performance. If the financial-institution relationship hasn't been changed or analyzed in several years, some CUs might not realize they are missing out on potential earnings."
Brian Turner, manager of Southwest's investment advisory service, said there is a "vast range" of expertise in the space.
"Over the past couple years, credit union managers have become a lot more proactive, both in cash management and overall financial operations. The nature of the business has created that."
Southwest's Wilson noted in years past, credit union borrowing was frowned upon. Today, he said, things have changed: "Managing lines of credit, being able to borrow on a short-term nature when needed, doesn't hurt during cycles of low liquidity. People understand it is efficient cash management."
According to Southwest's director of portfolio management, Cynthia Shi, cash is segregated from overall investment management. "Credit unions shop around for $10-million or $20-million term investments, but they don't pay as much attention to overnights. Some ask what we pay on overnight accounts, some don't. It can be costly to ignore overnight investments."
The corporate suggested several steps CUs can take in their cash management strategies that could make a difference in their bottom lines.
WesCorp's Calva emphasized the importance of understanding the value of float. He said image processing technology has improved funds availability, and could impact a CU's overnight account. The reason: when checks are scanned electronically and presented prior to the regional time requirement, on average, 90% to 95% become available the next day, rather than 50%.
"It creates for the credit union the opportunity to receive the funds a day early, which it can invest. The image technology solution provider, which some corporates do, should be offering improved funds availability-from two-day availability to day one."
WesCorp analyzed the banks that offer services for CUs, Calva continued. He said these soft-dollar/compensating balance relationships between most CUs and banks are "free," but the banks require a large deposit. Instead of earning interest (the overnight rate at the corporates currently is about 5.25%), CUs earn interest credit towards the fee.
Hard Dollars Versus Soft Dollars
"A credit union might not do its item processing. Instead of paying hard dollars, the bank offers to do item processing for free if the credit union keeps balances that compensate it for fees. Typically, rates for these compensating balance accounts are one-quarter to two-thirds of what they could get from a corporate overnight account. If credit unions put the money in an overnight account and use the income to pay the fees, they'd come out ahead. On top of that, the banks are charged a reserve requirement, which they pass on to credit unions. Some of the banks are really taking advantage of soft-dollar relationships-many of which were set up eons ago."
As for sweep accounts, Calva offered the example of a CU with $1 million in cash. He said sweep account fees can cost 60 to 80 basis points. "It would take a financial analyst about 30 minutes a day to look at that, watch inflows and outflows and do cash balancing for the day. If the dollar amount is big enough, the credit union is leaving a lot of money on the sideline. The important part is analyzing how the credit union manages its daily cash, and who it uses for that relationship."
Cantrell said Corporate One sees CUs keeping a lot of money in overnight funds. She said if they would extend out even three to six months and invest in certificates, they could pick up, depending on which tier they are in, seven to 38 basis points.
"Have a nice, little short-term portfolio," she counseled. "When you are talking about $50 million picking up seven basis points over the course of a year, that's a nice little chunk of change-and it will help the bottom line."
One Factor: Overnight Liquidity
Cantrell said one factor to consider is CUs' overnight liquidity needs: if they have a loan promotion, but it will take months to market and loan out those funds, they can extend out and pick up some incremental investment yields.
Bernstein said EasCorp works with CUs to develop a "good strong ladder."
"We're most interested in understanding their individual strategies. We want them to be comfortable with the risks, and don't want them to be surprised or disappointed."
A ladder is "strong" when, whether rates are rising or falling, CUs have a continuous cash flow from investments, he explained. "If rates are rising, a strong ladder would have some portions of investments maturing monthly. Even if the investment received a lower yield than if they had waited, predicting interest rates is not a business credit unions are in. If their investments are maturing, they can reinvest at higher rates. Even if rates continue to rise, the yield will be better than waiting and investing everything at once. And they will have more liquidity."
At Southwest Corporate, Wilson said for most CUs, small changes are not going to have a major impact on their bottom line. "For credit unions with a low loan-to-share mix, however, it would be bigger. Cash flow forecasting is the most significant way to help the bottom line. If they understand the liquidity flows in every area of the credit union, it would help them not lose basis points by having too much cash at one time."
Added Southwest's Shi: "As a corporate, we can project out two or three years, and based on that, make recommendations. The liquidity pattern is very important, but the other thing that could help the bottom line is correcting the misperception the settlement account is just for settlement purposes-credit unions don't look at it from an investment perspective. The settlement account is not managed by investment personnel, but credit unions potentially could lose a lot of money by not moving it into a sweep account or investment account. The difference can be as much as 3% or 4%, and that is a lot. Different corporates might offer different tiered accounts with different restrictions on transfers, so it is important for credit unions to compare."
Attractive Lending Rates
Southwest's Wilson said the Federal Home Loan Bank, as a government sponsored enterprise, can offer attractive lending rates to CUs. He said repurchase agreements are something that may become more important in the future.
"Our other competition is among corporates-corporates are trying to attract overnight deposits from credit unions, mostly through tiered accounts."
WesCorp's Calva, on the other hand, hesitated to label the corporates as in competition with each other. However, he acknowledged, "The corporate networks used to have regional boundaries, but with image-exchange for share drafts, we might see more corporates making sure members or potential members are getting the best value proposition. Corporates' shared vision is doing the best for our members, and they should go with the best value."
Calva noted banks, community banks and some thrifts offer overnight accounts and sweep accounts. "Where an institution has its settlement typically is where it has its overnight account. Overnight cash is the cash it probably won't need for 30 days."
Cantrell said Corporate One competes with banks for cash management services. She urged CUs to make sure they are comparing apples to apples: "Look beyond just the rate and make sure the institution is paying dividends in the same way, 360 days versus 365 days. When rates rise, the method is a bigger issue."
Corporate One is developing an online currency ordering system that will be available by the end of the year. It says the system will be able to gauge year-over-year cash needs and account for seasonal fluctuations.
Bernstein said EasCorp does not have a lot of competition: "This is the No. 1 thing we do for credit unions. Even for credit unions who maintain a correspondent relationship with banks, it goes to EasCorp through a cash concentration system. The Federal Reserve Bank is a place some credit unions maintain a correspondent relationship, but in most instances, cash settlements take place with the corporate credit union."
