Excess liquidity can restrict NorthPark s profitability and have an adverse effect on its capital position.

Transcription

1 Purpose Liquidity Risk is defined as the current and prospective risk to NorthPark Community Credit Union s (NorthPark) earnings and capital position. Potential risk develops when NorthPark s experiences an inability to meet its obligations, pay debts when they come due, or manage its funding sources without incurring unacceptable losses to income and capital. Liquidity risk includes the inability to manage unplanned changes in funding sources. Liquidity risk also arises from the failure to recognize or address changes in market conditions that affect the ability to liquidate assets quickly (example: sell mortgage loans) with minimal loss in value. Excess liquidity can restrict NorthPark s profitability and have an adverse effect on its capital position. Liquidity Management Philosophy NorthPark meets standards of sound business practices by following generally accepted practices with performance measurements and procedures described in this Policy. Goals and objectives of the credit union may vary over time, but these principles should address the following. The Board and Management must: 1. Balance the diverse needs of Credit Union members, both borrowers and savers 2. Manage the total funds of the Credit Union so that sufficient income is generated from earning assets 3. Cover dividend and interest expenses; 4. Meet all operating expenses; and 5. Provide an acceptable level of capital accumulation as a cushion against adverse future events. 6. Give careful and thoughtful consideration to the various sources and uses of Credit Union funds so that management of all assets and liabilities ensures an adequate positive spread between the cost of funds and the yield on assets which these funds support. 7. Maintain sufficient liquidity to cover both expected outflows and unexpected outflows to the extent that these may reasonably be anticipated. 8. Make safety the first criterion in all decisions regarding the sources and uses of funds and the handling of all assets and liabilities so that the Credit Union will not be exposed to undue risk and its continuation into the future not be placed in jeopardy. Sources and Uses of Funds A. SOURCES OF FUNDS 1. Deposits. The primary source of Credit Union funds shall be the deposited savings of Credit Union members. 2. Borrowed Funds. The secondary source of Credit Union funds is borrowed funds. 3. Investments. The third source of Credit Union funds is investments. Investments should be laddered to provide regular and consistent cash flows. If determined to be necessary by the above authorized individuals, certain investments (or other assets) may be used as collateral for additional borrowing or sold if deemed appropriate to provide additional liquidity. Page 1

2 B. USES OF FUNDS 1. The primary use of Credit Union funds shall be loans to Credit Union members. The types of loans authorized to be made shall be set forth in a written loan policy, which shall also set forth the features and requirements of each loan type. 2. The secondary use of Credit Union funds is investments. The excess of savings for which there is not present loan demand nor any other pressing demand is to be invested. 3. The third use of Credit Union funds is in fixed assets such as land, buildings, furniture, fixtures, equipment, and leases sufficient to conduct the business of the Credit Union. The total investment in fixed assets shall not exceed the earning power of the Credit Union to support these non-earning assets, and should be offset by non-costing liabilities. Current Liquidity Strategy Considering current financial conditions, to ensure consistent profitability, it is the intent of Management and the BOD to maintain the following strategies. a.) Hold a maximum loan-to-share ratio to 90.0% b.) Sustain an adequate liquidity ratio level of 7.0% of total assets. A minimum liquidity ratio of 5.0% triggers corrective action. c.) The goal is to maintain a capital ratio above 8.0%, in the well-capitalized range as defined by the NCUA. Expectations are that profitability (retained earnings) will grow capital slowly over time, and d.) Maintain a $5 million line of credit with our corporate credit union e.) Seek to become eligible in the near future for loans from the NCUA Central Liquidity Facility Corrective action is described later in this Policy. Quality Liquidity Risk Management The following indicators, as appropriate, should be used when assessing the quality of liquidity risk management. Strong liquidity risk management is defined as having the following traits. a.) NorthPark Liquidity Risk Policy effectively communicates guidelines for liquidity risk management and designates responsibility. b.) The liquidity risk management process is effective in identifying, measuring, monitoring, and controlling liquidity risk. Management reflects a sound culture that has proven effective over time. c.) Management fully understands all aspects of liquidity risk. Management anticipates and responds well to changing market conditions. d.) The contingency funding plan is well-developed, effective and useful. The plan incorporates reasonable assumptions, scenarios, and crisis management planning, and is tailored to the needs of the institution. e.) Management information systems focus on significant issues and produce timely, accurate, complete, and meaningful information to enable effective management of liquidity. Page 2

3 Responsibility The primary responsibility for monitoring and assessing the adequacy of the level of liquidity is that of NorthPark s Management, followed by the Asset Liability Management Committee (ALCO), with all members of the Board of Directors understanding the risks associated with liquidity. The Board is responsible for the Policy to be current and relevant, that the Policy is being followed and making sure that the Executive Management is responsible for making liquidity risk decisions. At least annually, the Policy and related strategies are revisited by ALCO and the Board. In the event of a liquidity emergency, the crisis team would consist of the Board Chair and all members of the ALCO. Communication occurring during the crisis should be clear and documented in writing for reporting to the Board and regulators. Quality of Liquidity Risk Indicators and Definitions The following indicators, as appropriate, should be used when defining and assessing the level of liquidity risk. It is not necessary to exhibit every characteristic, or a majority of the characteristics, to be accorded the rating. Low Risk: a.) Funding sources from member deposits are abundant, at reasonable costs and provide a competitive cost-offunds advantage. Funding is widely diversified from across the membership base. b.) As member deposits exceed demand for liquidity, no adverse changes are expected in the next year. c.) There is no reliance on wholesale funding sources such as brokers providing non-member deposits or other credit-sensitive funds providers such as line of credit at corporate credit union. d.) Capacity to augment liquidity through the sales of assets (loan sales and/or securitization) is strong and NorthPark has an established record in accessing these markets. e.) NorthPark is not vulnerable to funding difficulties should a material adverse change occur in market conditions. Moderate Risk: a.) Funding sources from member deposits are sufficiently available which provide cost-effective liquidity, but are reflecting rising costs-of-funds and tightening net interest margins, b.) A modest reliance on wholesale funding via access to a line of credit or non-member deposits purchased through brokers may be evident. c.) The liquidity position is not expected to deteriorate in the near term. d.) NorthPark has the potential capacity to augment liquidity through asset sales and/or securitization, but has little experience in accessing these markets. e.) NorthPark is not excessively vulnerable to funding difficulties should a material adverse change occur in market conditions member perception. Page 3

4 High Risk: a.) Funding sources from member deposits suggest current or potential difficulty in maintaining long-term and cost-effective liquidity. b.) Borrowing sources may be concentrated in a few providers or providers with common investment objectives or economic influences. A significant reliance on wholesale funds from brokers is evident. c.) Liquidity needs are increasing, but sources of market alternatives at reasonable terms, costs, and tenors are declining. d.) NorthPark exhibits little current or potential capacity to augment liquidity through asset sales or securitization. A lack of experience accessing these markets or unfavorable reputation may make this option questionable. e.) Material volumes of wholesale funds contain embedded options. The potential impact is significant. f.) NorthPark s liquidity profile makes it vulnerable to funding difficulties should a material adverse change occur. g.) Potential exposure to loss of earnings or capital due to high liability costs, loan losses or unplanned asset/loan portfolio reduction may be substantial. Sources of Operational Liquidity In the order of preference, sources (as partially defined in NCUA Letter to Credit Union 00-CU-13) that may be used for satisfying liquidity purposes and to correct deficient liquidity levels are: a.) Member deposits held by the credit union in cash, in its overnight account or in short term investments (less than 100 days in maturity), b.) Lines of Credit with NorthPark corporate credit union: The operational line of credit is in writing for an amount up to $5 million with Corporate Central Credit Union. c.) Deposits from other credit unions or banks, through a wholesale broker: When purchasing broker certificates NorthPark should rely on its Corporate Credit Union or on brokers that have been authorized by the NorthPark Board of Directors, and be limited to certificates of deposits in credit unions and banks that: 1. are insured by the NCUA or FDIC (agencies of the federal government), 2. have a contractual maturity of 36 months or less, and 3. are laddered in a manner that takes into consideration liquidity needs. d.) The NCUA s Central Liquidity Facility (CLF), a lender of last resort, is another source of liquidity being considered by NorthPark, but not currently available. At the time of this Policy s creation, Executive Management is researching requirements to access advances from the CLF. e.) Cash received from the sale of assets (such as loans sold into the secondary market): Examples of this source may be from the sale of individual or pooled mortgage loans, from the sale of the credit card portfolio or the securitization and sale of auto loans. This source would be one of last resort, and may not be available in time to satisfy short term liquidity needs. Page 4

5 Liquidity Risk Management Measurements and Reporting As defined in NCUA Letter to Credit Union 00-CU-13, on a monthly basis, the Asset/Liability Committee will review liquidity levels and trends. This activity is the best forecasting tool to anticipate liquidity needs. On a quarterly basis, included among the Board Treasurer s ALM Reports, the current liquidity status will be reported to the Board of Directors. The Board of Directors (through the ALM Committee) and Management must review the liquidity position on a quarterly basis. Looking forward, this review should encompass a detailed forecast of imminent liquidity requirements for a minimum period of the next three months documented in a cash flow analysis report. Quarterly, the liquidity position will be reviewed by the NorthPark ALM Committee and reported to the full Board of Directors, revealing the excess or shortage in liquidity. An adequate level of liquidity exists when NPCCU has available liquidity equal to or greater than 7.0% of its total assets. Note: Short-term investments that mature in less than 100 days can be included in the calculation, adding to the cash held in the overnight corporate credit union account. If NorthPark maintains a minimum level of liquidity 7.0% it must seek to meet the following: a.) NPCCU must have a line of credit with its corporate credit union (CCU) for an amount equal to or more than 2.0% of its total deposits. Note: The advised line of credit has terms that can be changed without notice by the CCU to NPCCU. The terms of the CCU line of credit are set out in writing. The NCUA s Liquidity Ratio, as defined in the NCUA FINANCIAL PERFORMANCE REPORTS (FPR) USER S GUIDE, is as follows: Cash & Short Term Investments: This liquidity ratio is an indicator of the level of cash and liquid assets available to meet share withdrawals or additional loan demand. Liquidity Ratio: method of calculation: Cash and Short Term Investments / Assets: Total of Cash on Hand, Total Cash on Deposit, Cash Equivalents, and investments with less than one-year remaining maturity divided by Total Assets. Early Warning Indicators of Tightening Liquidity NorthPark understands and acknowledges there are indicators that Management uses to identify increased risk or vulnerabilities in its liquidity risk position or potential funding needs. Early warning indicators identify negative trends and Page 5

6 cause an assessment and potential response by Management in order to mitigate the NorthPark s exposure to the emerging risk. Early warning indicators (as defined in NCUA Letter to Credit Union 00-CU-13) that liquidity is tightening may include but are not limited to: Rapid asset growth, especially when funded with potentially volatile liabilities, as evidenced by high loan to share ratio, and unused commitments on members credit lines, Declining investments and cash equivalents, as evidenced by high loan to share ratio, occasional or extended use of the NorthPark corporate line of credit, repeated incidents of positions approaching or breaching internal or regulatory limits, significant deterioration in the NorthPark s earnings, asset quality, and overall financial condition, as evidenced by NorthPark s Return On Assets (ROA), Cost of Funds (COF), Net-Interest Margin (NIM) and rising delinquent loan-to-total loans and charged-off loans-to-total loans ratios, rising wholesale costs (from non-member deposits or advances from the NorthPark corporate line-of-credit) or retail funding costs (member deposits), increasing retail deposit outflows (unanticipated member withdrawals), or Negative publicity Liquidity Stress Testing Liquidity stress testing will be performed at least semi-annually as a part of NorthPark s ongoing evaluation of the adequacy of its liquidity position. Stress testing will be performed for scenarios that assume both moderate as well as severe stresses to liquidity. While these tests are not intended to represent events that the Credit Union expects to occur, they do provide analyses that the credit union may then use as a part of its overall evaluation the potential risk to its liquidity position. Corrective Action Liquidity Shortages If negative trends (other than expected increases in seasonal, anticipated deposits such as annual Dow AgroSciences bonus program) creates conditions that lower the capital ratio below the well-capitalized level of 7.0%, Management will take corrective action to improve profitability (simultaneously increasing income and reducing expenses) while attempting to lower total assets. Whenever deficient liquidity levels are discovered, the NorthPark Board of Directors and Management must prepare marketing and financial strategies to align liquidity levels within desired ranges, or take defensive actions. Alternative Funding Plans: As defined in NCUA Letter to Credit Union 00CU-13, in order of the most attractive-to-least attractive option, defensive actions to protect the liquidity position of the credit union would normally include: Page 6

7 1. Market to increase member core deposits; NorthPark s most cost effective source of liquidity. Attracting member deposits is achieved through marketing to existing members and the community. 2. Judicious use of line of credit (with the Corporate Credit Union); used to satisfy short-term liquidity needs in conjunction with the curtailment of indirect lending through TCU. Loan runoff would be used to decrease/eliminate borrowings. 3. Calling in short-term investments with maturities less than 100 days can be included as a corrective action, adding to the cash held in the corporate credit union overnight account. 4. Temporary curtailment of lending (temporarily halt or decrease purchase of TCU indirect loans); occurs if the level of minimum liquidity falls below 5.0% of total assets. 5. Use of wholesale brokers to attract non-member deposits (within regulatory limits 20.0% of Total Shares maximum) used to satisfy medium-term liquidity needs if runoff is insufficient to pay off borrowings from the CCU line of credit or marketing efforts to attract member deposits are insufficient to regain a minimum level of liquidity. 6. Recover investments with minimal loss of value, surrender charges or penalties which will have minimal negative effect on earnings or capital. 7. Sales of asset/loans to a third party. This is the least attractive source of liquidity due to the complexities of finding a buyer, pooling loans, pricing the assets and the negative effect on public relations with the members. An alternative liquidity strategy such as an overdraft line of credit held with the NorthPark corporate credit union (CCU) is a recommended, sound business and financial practice. The use of a line of credit permits NorthPark not to jeopardize the effect of calling its invested short-term certificates. Borrowings on a line of credit can be reduced through cash received from the runoff of loans or increases in member deposits or (within regulatory limits) non-member deposits. Curtailment of lending is considered a difficult option, but considering there is no impact to the core membership of NorthPark, the decision to curtail the purchase of TCU indirect loans would be a decision that would be invisible to the membership, allowing direct lending and lending through the NorthPark -indirect loan program to continue. The principal runoff (principle reduction through payoffs and regular monthly payments) of a loan portfolio with concentrations of short-term consumer loans ensures that there is a regular stream of cash to NorthPark to improve liquidity. Excess Liquidity Where NorthPark has experienced significant excess liquidity due to anticipated (example: annual deposits from Dow AgroSciences bonuses) or unanticipated increases in member deposits, Management should examine options to reduce liquidity to an appropriate level. Negative effects on profitability and NorthPark s capital position can occur if excess liquidity is allowed to linger. Normally, with an excess of liquidity, NorthPark would market its loan products. As Management creates a strategy for dealing with excess liquidity, Management must assess the future need for liquidity, the anticipated life of the excess deposits versus loan demand and member use of the deposits, while considering the effects on capital position. Page 7

8 Contingency Funding Plan Contingent liquidity events are unexpected situations or business conditions that may increase liquidity risk. Such events can range from high-probability/low impact events to low-probability/high impact events. Events may be credit union specific or arise from external factors and may include: The credit union s inability to fund asset growth; The credit union s inability to renew or replace maturing funding liabilities; Heavy deposit withdrawals; Changes in market value and price volatility of various asset types; Changes in economic conditions or market perception or Disturbances in payment and settlement systems due to operational or local disasters. Nonetheless, the credit union shall plan for such contingent liquidity events by assessing possible variations around expected cash flow projections and provide for adequate liquidity reserves and other means of raising funds in the normal course of business. As part of the CFP and under adverse liquidity circumstances, the Board of Directors hereby authorizes the ALM Committee to employ as deemed necessary the following contingent liquidity resources: $5M line of credit at Corporate Central Credit Union Secondary Market Mortgage Loan Sales Fannie Mae Secondary Market Mortgage Loan Sales Freddie Mac Short-term Investment Sales Non-Member Deposits acquisition The Federal Reserve line of credit may be established Federal Home Loan Bank of Indianapolis line of credit may be established Page 8