Over the past several months, the global fixed-income markets have experienced substantial dislocation. While it began with the domestic mortgage sector–and, most especially, the subprime-mortgage market–the disruption has spread to virtually every non-Treasury sector, as well. Take, for example, the debentures of U.S. government-sponsored enterprises (GSEs), which are now trading significantly higher-yield premiums than at any time since 1998.
Two-year Fannie Mae debentures were trading at 85 basis points on Nov. 23, 2007–more than three times the 25 basis points spread of late May. This yield increase for non-Treasury instruments can be attributed not only to the increase in perceived credit risk associated with them, but equally to the liquidity pressures the market is under.
The deterioration in the fixed-income market highlights credit unions’ need to have well-thought-out liquidity plans and practices in place. It’s important to ensure that your credit union has adequate liquidity, defined as the ability to convert assets to cash or gain access to funding sources, as well as overnight investments. To assess your readiness, ask yourself these questions:
Do your balances meet daily obligations?
Carefully review the historic volatility of your share accounts to both forecast future needs and to consider how much to retain as liquid assets. For example, at Southeast Corporate, we review the average amount kept in overnight or short-term share accounts each month. Then, we compute a standard deviation to determine the proportion of our assets that should remain liquid to meet our needs under a high percentage of potential scenarios. We conduct additional tests to make sure the data displays a normal distribution to verify the accuracy of our analysis.
How does liquidity figure into your investment strategy?
Although many credit unions buy GSE-issued securities, they often think about the yield and length of each instrument but not how liquid it is. Liquidity should be a primary consideration when choosing your credit union’s investment activities.
Also consider the size of your issue. Smaller issues, particularly those under $25 million, will often prove to be less liquid than larger transactions.
Further, a smaller issue generally will only involve one broker-dealer, so that sole dealer is the only path to repurchasing the bond. A large issue will have numerous broker-dealers that were either part of the selling group or have subsequently become familiar with the deal.
Thus, if one of the firms cannot purchase and inventory the security, another is likely to have the capacity.
How easily can your credit union’s loans be sold or participated, if needed?
Research and determine which loans would be the best candidates to be monetized, while also reviewing the likely counterparties. For example, if you hold mortgage loans that conform to Fannie Mae or Freddie Mac terms, they should be among the first to consider selling, as they offer a convenient avenue for liquidation.
How healthy is the liquidity side of your balance sheet?
Having a well-managed liability structure is critical to the fitness of your credit union’s balance sheet. This entails assessing the term structure of your shares and determining whether there is too much concentration in share certificates coming due within a specific time period. Just as with laddering the investment portfolio, your credit union should try to maintain a consistent amount of share certificates maturing over an appropriate timeframe. Management also should monitor the concentration and activity of its largest depositors to aid in determining the credit union’s susceptibility to a large withdrawal.
Can you make non-member deposits work for you?
If your credit union requires non-member funding, there are several options available. Corporate credit unions typically offer competitively priced overnight and term loans. Some other institutions do, too. If your credit union is in a borrowing position, assess how long you anticipate needing to borrow and consider extending your borrowing to match the funding need. Also, periodically test your credit union’s lines of credit to ensure accessibility.
Should you tap into liquidity at your corporate?
Corporates’ prime function is to provide liquidity to the nation’s CUs, and they place a heavy emphasis on ensuring adequate amounts for any phase of the liquidity cycle. Your corporate is your first line of defense for obtaining additional liquidity.
Credit unions also can consider selling their auto loan portfolios to replenish their liquidity pipelines;, however these are less liquid and will require some preparation work that may slow down the process. For instance, the credit union must identify a willing buyer. Then, that buyer will want time to review the performance and characteristics of the loans before purchasing them. And it may also be necessary to negotiate legal contracts. To be best prepared, address each of these factors before you need to generate liquidity. Once again, the Corporate Network offers an excellent option: Charlie Mac is a ready buyer of auto loans through its Carpool program and provides an efficient avenue for increasing liquidity.
Corporates also can help you attract non-member deposits via the SimpliCD product. SimpliCD solicits funds from thousands of other credit unions by offering insured share certificates from various issuers. Depending on how aggressive your credit union wants to be in pricing certificates, SimpliCD can attract millions of dollars quickly. So, given the current market instability, how do you prepare for potential liquidity needs? Assess your credit union’s current and projected liquidity position in a variety of scenarios, and ensure ample liquidity sources to address each situation. Your forecasts and the resulting prioritization of funding options should be documented and retained for future reference. At Southeast, we present our Contingency Liquidity Plan to the ALCO for approval on a quarterly basis and to the board annually. By working through each step outlined above, you can make sure your credit union is well-positioned, come what may.
Gregory Wirthmann, CFA, is Senior Vice President/Chief Investment Officer with Southeast Corporate FCU in Tallahassee, Fla.
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