Get under the hood with your funding sources
Regulatory pressure around liquidity is palpable for the first time in a long time. As a result, we are having funding discussions multiple times a day at CMS with credit unions of all sizes. In a recent conversation with a credit union, I was surprised at how little emphasis was given to the source of funds. Heavy emphasis was given to the duration and the cost, but little to no attention was given to the most important component: Source.
Not all sources are the same based upon market conditions. Some funding sources perform better than others depending upon the shape of the curve and the anticipated of rates in the future. The FHLB will perform differently versus other sources as rates fluctuate. Brokered CD platforms and rate listing services all have specific market conditions that provide favorability. All of these data points should be discussed as you further develop a well-diversified liability policy.
Still, I think the most important data point is perhaps being overlooked. What is the source the liquidity you are utilizing?
Consider for a moment how many sources completely revolve around just credit unions – credit unions as the issuer of funding and credit unions as the investor in those offerings. Aggregate 5300 data supports that many credit unions have already played the investment portfolio liquidation card.
That said, will credit unions continue to be a viable/reliable source of funding prospectively? Maybe, but I think most are unwilling to pin the success of raising non-member deposits from other credit unions on a maybe. Hope is not a strategy.
That is exactly what strikes fear into regulators. Sources that served us well historically may not be able to support us going forward. This is not due to poor management or a bad business model. It’s simply due to the ever-changing balance sheet composition within the credit union space. Robust loan growth provides wider margins, which is a benefit to field of membership. As fixed income portfolios continue to shrink, credit unions will become less reliable as CD investors, and thus less reliable as a source of funding.
What are we to do? We have to get under the hood and understand where our funding is ultimately derived and how that distribution source will react in various markets. Additionally, you should be supporting CUSO efforts to open other channels not previously available to credit unions. Many of you may have noticed brokered CD issuance among low-income designated credit unions has increased dramatically in the last six to 12 months. CUSOs like ours participate in that marketplace with regularity. One big push for CMS in 2018 is to establish meaningful retail distribution for the credit union movement.
Our FDIC insured counterparts have enjoyed retail distribution for 20-plus years. This is a huge marketplace with more than $600 billion outstanding, providing liquidity across the entire curve. Large retail wire houses, as well as thousands of downstream broker dealers, utilize this supply chain to source FDIC insured CDs into mom & pop retailers, corporations, trust departments, endowments, foundations and municipalities. This is a completely different source of liquidity than those that focus on just credit unions and municipalities. The $600 billion FDIC insured market, with its deeps roots into almost every natural investor in CDs, will react very differently in times of stress than underdeveloped or overconcentrated markets.
How will your sources react when you need them most? Do you have not only availability but efficiently priced availability on the point of the curve that makes sense for you balance sheet? These are the hard questions that must be raised. Our discussion needs to include pricing and duration, but it also must include the source of the liquidity being utilized. Credit unions over the next three to five years could find themselves with robust loan demand. If that occurs even on a small scale, how reliable will they be as a source of liquidity?