Comfort Zones
   
   
  By Mike Thomas, Executive Director, Financial Product Sales, Balance Sheet Solutions, LLC

While credit unions today have an increased awareness of contingency planning for their data processing systems and overall operations, it seems many are neglecting a key balance sheet issue: liquidity. For many credit unions, their rising loan-to-share ratios are uncovering a failure to plan for unexpected liquidity needs beyond maintaining a line of credit with their corporate credit union. 

While a line of credit is, and will remain, a fast, convenient and low cost way to generate liquidity, it may not be the best solution for each credit union. Credit unions have a number of options today for meeting their liquidity needs that may be better suited to their particular balance sheet than borrowing.

Before deciding which avenue to follow to generate the liquidity needed to meet ongoing loan demand, managers should determine what impact each source will have on their balance sheet and whether this will allow them to remain within their comfort zones for liquidity and capital. Each credit union’s comfort levels are unique. This is why planning ahead for addressing liquidity needs is very important.

Credit unions with high capital levels would usually would be comfortable with a growing balance that would produce a slightly lower capital level. At the same time, credit unions that have already leveraged their capital and are at the limit of their capital ratio comfort zone would not welcome growth that would produce a lower capital ratio.


Highly capitalized credit unions have room to grow. 


Highly leveraged credit unions may be reluctant to grow. 

This is why it is important for credit unions to calculate their capital ratio comfort zone as part of their annual planning process. This will allow them to select the best options to enable them to retain their liquidity comfort zone, which should also be established during the planning process. 

If you are a credit union with leveraged capital there are ways to generate liquidity that will not increase the size of your balance sheet. Two methods currently gaining attention are loan participations and loan sales. Each of these approaches will generate liquidity without growing the balance sheet. In addition, these transactions can be executed without releasing the servicing of the loans to the purchaser. Both loan participations and loan sales allow a credit union to magnify the effectiveness of their loan departments by recycling loan dollars into new loans. 

Credit unions may also wish to sell other assets, such as their investments to generate liquidity. This approach highlights the importance of having a liquidity comfort zone determined in your planning process. Knowing your comfort zone allows you to determine the limit to set for reductions in your investment portfolio, well before you actually sell investments.

For those credit unions that have room within their capital comfort zone for balance sheet growth, there are also alternatives to the traditional borrowings. Some members have been able to generate as much as $30 million through the issuance of jumbo CD’s through the SimpliCD program at Members United. 

Other credit unions are looking to Reverse Repurchase transactions to create liquidity for their balance sheets. In a reverse repo, members use their investments to collateralize a loan from their broker/dealer. This loan has a predetermined maturity date and rate. At the maturity of the transaction, the security is “repurchased” by the member at a predetermined price. 

Members with the ability to grow can always look to their deposit window for the balance sheet growth necessary to build liquidity. However, this method is not always the lowest cost source of funds. A quick calculation of the marginal costs of the deposits can show managers what the threshold of transfers from regular shares to a new money market program or special CD program should be. As an example, a credit union that has a 1% regular share rate and a 4% special CD program will experience a 4.75% marginal cost for new funds if 20% of the special CD program is funded from regular share transfers. The marginal cost jumps to 6.50% if 40% comes from regular shares. 


Knowing your liquidity comfort zone, and what options are available to you to stay within that comfort zone, is a valuable planning tool. Recognizing the alternatives that best meet your credit union’s unique needs provides the ability to compare options and select the lowest cost option that meets your needs.

As stated above, there are many options available to credit unions to generate and maintain liquidity. Each of the avenues to liquidity discussed in this article is accessible through Balance Sheet Solutions. To learn more, visit www.balancesheetsolutions.org.