With planning season in full swing, we highlight six topics that should be top of mind for credit unions in this dynamic market environment:
- Sources of Liquidity
Considering the duration of our historically low interest rates, the speed of their reversal surprised many market participants. As liquidity positions reverse from surplus to scarcity, understanding sources of liquidity is as important as ever.
As the last several months have shown, a credit union’s liquidity picture can change dramatically and quickly – and, often without warning. It is important to appreciate all the available levers of liquidity, and to secure reliable access to multiple sources of borrowing and nonmember deposits. FHLB member credit unions are now regularly accessing advances. Smart credit unions are also increasing the capacity on additional lines of credit. With various non-member funding programs available in the market, credit unions should take the time to investigate the design, intricacies, operational efficiencies, costs, and risks of each of these options. In a dynamic market – where levels are changing constantly – vendors will distinguish themselves by their level of communication and the reliability of their service.
Going forward, credit unions need to think creatively about their deposit products to attract funds in a very competitive environment. At the same time, credit unions must remain discerning when being pitched “untested” solutions that might simply be too good to be true. Here, disciplined vendor due diligence will go a long way to separate those with deep-rooted credit union bona fides from the charlatans.
With volatility, uncertainty, complexity, and ambiguity (VUCA) the new watchword, managing risks is imperative. Tensions between inflationary, deflationary, and geopolitical forces will bring volatility for the foreseeable future, with cycles of rapid and unpredictable change becoming more prevalent. Against such a backdrop, we think a hedging program is a must for prudent and careful credit unions.
Fortunately, the NCUA eased the path to a functioning hedging program by modernizing the derivative rules in May of 2021. However, it typically takes months to implement a proper hedging program. For those who think that the market for hedges is too expensive today, we suggest that you focus on laying the predicate to be prepared to hedge when the need arises. And, we warn that sharp rate moves are likely to persist for some time.
The path to a hedging program starts with education, training, documentation, and the identification of and negotiation with counterparties.
And, there is no time to start like the present.
- The proper level of capital
Capital management succeeds when it is proactive, not reactive. With increased volatility in loans, deposits and investments, the proper level of capital will only take on added importance in the coming months.
The credit union subordinated debt market continues to grow by leaps and bounds. As of Q2 2022, for example, 136 institutions held a total of $3.1 billion of subordinated debt on their balance sheets. Even accounting for the $2.0 billion and 70 institutions that were awarded monies as part of the U.S. Treasury’s recent Emergency Capital Investment Program (as of Q2 2022), the privately issued market has grown from just $291 million (65 issuers) at Q2 2019 to 98 credit union issuers with $1.2 billion today.
We caution that subordinated debt is not for everyone. And, the process of gaining an approval is more than a minor undertaking. Done correctly, it involves a thorough examination of business plans and prospects and a significant amount of forecasting and stress testing. However, we are convinced that even more credit unions would apply for approval if they better understood some of the technical mechanics of the process.
Most specifically, the new Subordinated Debt Rule, effective January 1, 2022, allows successful credit union applicants to hold onto an approval for up to two years after the approval date. During that time, the credit union can go to the private market to access capital whenever it chooses (or, not at all).
As the NCUA noted, upon adopting the new subordinated debt rule:
The Board believes this change in the final rule will provide credit unions with a longer issuance window and increased flexibility to issue Subordinated Debt. After thorough consideration, the Board has determined that a two-year expiration period strikes an appropriate balance between the competing concerns the Board noted in the proposed rule: ensuring that an Issuing Credit Union does not offer and sell Subordinated Debt Notes following a material change in the information on which the NCUA relied in approving the offer and sale of that Issuing Credit Union’s Subordinated Debt Notes, and not unduly hindering the marketability of Subordinated Debt Notes.
As planners and decision-makers, the recent volatility reminds us of two hard earned lessons. First, predicting the future path of interest rates is a fool’s errand. And, it always makes sense to keep all your options available.
Remember, as others encounter rough times, many well-performing credit unions will be shown opportunities to enter new markets or for M&A activity. Often, additional capital is a necessary component to successfully implement such a strategy. In such an instance, having an approval in hand can make all the difference.
- Blockchain Technology
While financial technology is a crowded arena with many interesting ideas, Blockchain stands out in terms of its potential to be profoundly transformational. Not just its manifestation in the form of digital assets like Bitcoin and Ethereum, but in connection with important breakthroughs in Blockchain’s application to business operations and the secure transfer of traditional payments and assets. We encourage credit unions to stay on top of developments in this exciting space. This technology represents more of an opportunity to zoom ahead of others, than to simply keep up with them.
Through Q2, there was still little evidence that credit union delinquencies were ticking higher. Credit quality has been historically strong for credit unions. However, the factors driving that — low interest rates and government stimulus checks — have faded away in recent months. As a result, many credit unions are bracing for a change.
Q2 2022 loan delinquencies for U.S. credit unions stood at 0.42%, an all-time industry low. But, this quarter’s earnings calls at the big banks are have already signaled a change. And so, credit unions must remain hyper-vigilant. For example, the 30-day delinquency rate for Bank of America was 1.38% at the end of the third quarter, up from 1.21% a year earlier. Stimulus funds are cycling out of the system and the last of the moratoria – student debt – is scheduled to roll off in the new year. The Fed’s aggressive tightening will undoubtedly result in increased job insecurity and more expensive loans. And, with inflation taking a toll on personal budgets, your members are in for some rough sledding.
- CDFI and LICU Status
The Community Development Financial Institution and Low-Income Designated Credit Union statuses might be as important as ever. While the CDFI qualification is currently undergoing a makeover by the Treasury Department, both statuses offer credit unions access to pools of grant monies while demonstrating the credit union’s commitment to the communities it serves. And, the low-income moniker allows qualifying credit unions three specific benefits: (1) escape from the cap on member business loans, (2) the ability to take non-member funding from any source and (3) preferential capital treatment on issued subordinated debt.