Credit Union Liquidity. Contingency Funding Plans Client Webinar Series Randy Thompson, Ph.D.

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1 Credit Union Liquidity Contingency Funding Plans Client Webinar Series Randy Thompson, Ph.D.

2 Regulatory Expectations - CFP, NCUA issued rule - CFP, establishing requirements for managing Liquidity in credit unions. March 31, 2014 all credit unions should be in compliance

3 Definitions Liquidity is a measure of the ability and ease with which assets can be converted to cash. Liquid assets are those that can be converted to cash quickly if needed to meet financial obligations; examples of liquid assets generally include cash, corporate credit union accounts, short term investments and back up lines of credit. To remain viable, a financial institution must have enough liquid assets to meet its near-term obligations, such as withdrawals by depositors.

4 Definitions Cash and Equivalents Short term investments Back up lines of credit

5 Regulatory Expectations - CFP, Accordingly, (a) of the final rule requires these smaller FICUs to maintain a basic written policy that provides a credit union board-approved framework for managing liquidity and a list of contingent liquidity sources that can be employed under adverse circumstances. Such a policy establishes liquidity measures and associated benchmarks, a reporting requirement to keep the board apprised of the institution s liquidity position, and a contingent source, or sources, of funding, such as a corporate credit union or correspondent bank.

6 Regulatory Expectations - CFP, First, all FICUs should maintain a balance sheet cushion of highly liquid assets as a basic element of liquidity risk management. It is essential for FICUs of all sizes to hold an adequate safe guard of cash and cash equivalents (such as short-term deposits and Treasury securities) on the balance sheet continuously. A balance-sheet cushion affords an institution time to avoid service disruptions and enter external funding arrangements if necessary.

7 Regulatory Expectations - CFP, A second element of liquidity management is borrowing from market counterparties, such as corporate credit unions, correspondent banks, FHLBs, and repurchase agreement counterparties. The ability to borrow from market sources requires having unencumbered assets that can be readily pledged against a loan. Larger FICUs with greater potential funding needs should have multiple stable borrowing sources and a clear understanding of which assets can be pledged.

8 Regulatory Expectations - CFP, The third element of protection is access to a federal emergency liquidity provider: The CLF or the Discount Window. These providers exist to provide backup liquidity in circumstances where on-balance sheet liquidity and market sources prove inadequate. Like the market funding sources, the CLF and Discount Window are both collateral-based lending facilities. The Board believes that, to protect the NCUSIF, it is essential for FICUs with assets of at least $250 million to have this third element of liquidity in place.

9 Regulatory Expectations - CFP, Credit Unions grouped into 3 asset size groups Less than $50 million Written policy with limits, sources and reporting methods $50 million to $250 million Add requirement of multiple contingent lines and contingency funding plan $250 million or greater Add requirement for federally funded credit line & minimum of 3 distinct sources

10 Practical Liquidity Management Balance Sheet Liquidity Cushion - elements Cash Primary sources of liquidity Adequate for normal operations Not a primary source of income

11 Practical Liquidity Management Balance Sheet Liquidity Cushion - elements Short-Term Investments - < 1 year Secondary sources of liquidity Adequate for unanticipated variations in normal operations Not a primary source of income

12 Practical Liquidity Management Contingency Funding Back-up Lines of Credit Corporate lines FHLB Investment houses Commercial Banks Fed Discount window or CLF (credit unions over $250 mil)

13 Practical Liquidity Management Normal day to day operations Moderate deposit run-off Severe deposit run-off These three elements provide the foundation for your Contingency Funding Plan

14 Practical Liquidity Management Normal day to day operations Normal, anticipated variation of deposit balances Net difference of outflows and inflows Outflows include new loans, withdrawals and other clearings Inflows include loan payments, investment cash flow and deposits Normal operations is typically sustained through your cash balances

15 Practical Liquidity Management Moderate deposit run-off and/or loan growth Increased lending volume Unanticipated deposit reductions This may happen as the economy improves and people move into other investments Typically in a quarter This liquidity challenge is typically funded through <1 year investments

16 Practical Liquidity Management Severe liquidity crunch Dramatic runoff of deposits Anticipate the loan production will be inhibited in this case Possibility of reputation risk and run on deposits is high Lines of credit are the primary line of defense in this case

17 Contingency Funding Plan Creating a CFP Step 1 Measure the normal variation in cash flow Should be monitored monthly and updated quarterly Identify cash levels required to sustain that variation

18 Contingency Funding Plan Creating a CFP Step 2 Determine the possible variation resulting from a moderate deposit decrease Typically 3% to 8% Look at historical variation at your credit union over past 3 to 5 years Consider hot money you have accumulated during the past three years Identify investment levels required to sustain that decrease

19 Contingency Funding Plan Creating a CFP Step 3 Determine the potential variation resulting from a dramatic downturn in deposits Typically 12% to 25% Look at historical variations in your market place Consider the worst case scenario if the economy turns sour or your reputation is questioned Be reasonable and realistic Identify back up lines of credit required to sustain that decrease For credit unions over $250 million this must include CLF or Discount window

20 Monitoring and Reporting Regulations require: Targets Monitoring Reporting These can all be accomplished through the Liquidity Tool

21 Considerations Liquidity management is a constant balancing act Inadequate liquidity can pose reputation risk and threaten your survival Excess liquidity can reduce yield and hamper ability to generate a profit Member behavior can differ with changes in the economy Requires regular monitoring and adjustment to match member behavior