by. Steve Arbaugh
A major focus of NCUA examinations has been the management of liquidity and interest rate risk. As CFO of SECU, Maryland, I would like to share our most recent NCUA examination experience. SECU’s asset size is $2.8 billion but asset size is irrelevant as the principals of asset liability management and liquidity apply to all credit unions regardless of size.
The NCUA is concerned about the credit union’s ability to fund the outflow of non-core deposits in a rising rate environment and the potential for a significant increase in utilization rates on lines of credit as the economy recovers. Credit unions struggle with how much cash and short term investments less than one year to hold in the balance sheet. Holding too much liquidity can be damaging to earnings where as insufficient liquidity may put the credit union at risk and draw the wreath of examiners. In setting SECU’s minimum liquidity ratio, ALCO considered the level of cash needed to fund operations including branches, ATM’s, Federal Reserve requirements and correspondent banking accounts, the potential for deposit surge balance runoff and the potential for an increase the utilization rate on lines of credit.
SECU’s core deposit study identified $525 million or, 21% of SECU’s total deposits, as being surge balances where members were parking funds in share drafts, regular shares and money market shares. The examiners commented that SECU should hold sufficient liquidity, or have lines of credit available to fund this potential $525 million deposit runoff. SECU argued that much of the growth in surge balances was the result of its own members transferring funds internally out of CD’s and into the more liquid deposit products. Given that SECU is a market leader in CD pricing, and based on historical retention data, SECU will most likely retain 85% or more of surge balances. Management did agree with the NCUA’s observation that improved technology and the use of the internet for banking will make it easier for members to shop CD pricing and possibly transfer monies out of the credit union. Looking back to the most recent rising rate environment from 2004 to 2006, when the Fed Funds rate increased 425 basis points from 1.00% to 5.25%, SECU’s actually experienced deposit growth. Using historical call report data, we discovered that SECU actually experienced annual deposit growth of 4.00% during this period of dramatically rising interest rates. This supported management’s claim that SECU had a high retention rate on surge balances. Using all of this data, SECU is holding, $80 million in liquidity to fund potential deposit runoff assuming a retention rate of 85% on $525 million surge balances.
SECU performed a 10 year analysis on unfunded lines of commitment, using historical call report data, to determine the need to fund a potential increase in utilization rates. We looked at home equity lines of credit, personal lines of credit and credit cards. .The analysis showed that during the 10 year period, SECU’s utilization rates never increased by more than 8.00 percent during the entirety of the interest rate cycles. The 10 year analysis captured both a booming economic recovery, where members were borrowing more to purchase goods and the worst recession in 80 years, where members may have been borrowing more against lines of credit to simply survive financially. Using this analysis, SECU is holding $85 million, or 10 percent of unfunded lines of credit totaling $850 million, for liquidity purposes.’continue reading »