Kill the King, or the King will Kill You!

For many credit unions, most share growth occurs in the first quarter of the year. What will credit unions do with the money? Can they, or should they, turn it away?


For the past 18 months or so as financial markets suffered a near cardiac arrest, the institution with the most cash and liquid assets was perceived to be the strongest and most likely to survive. Thus the phrase, “Cash is King.” During 2008 and 2009 investors around the world followed a timeless, yet simple formula: SLY— Safety, Liquidity, Yield.

But now that markets have stabilized — or as some analysts claim, are merely getting worse more slowly — income statements are paying the price for remaining in cash. And the situation may not change: According to St. Louis Federal Reserve President James Bullard the Fed may not raise short-term interest rates until the first half of 2012!

Credit union balance sheets, of course, are not static; their composition changes with member needs. Through the first nine months of 2009, shares in credit unions increased by $83 billion. During the same period, credit unions were able to make only $21 billion in loans to members. The result: total cash and investments now stand at almost $300 billion (up 29% year over year). About 25% of the investment portfolio, or $75 billion, is in cash and equivalents earning 25 basis points at best. Thus approximately 8% of credit unions’ balance sheets is making virtually no return.

Why the Challenge Will Increase in 2010

Without question, growing the bottom line next year will be a challenge. One of the reasons is that members will continue to deleverage — that is, continue to save. Many credit union managers report that the normal summer and fall drawdown of shares did not happen this year. In fact, most credit unions are still growing shares even with savings rates at historic lows.

Accordingly, several CEOs are concerned about what to do when shares come in next year. For many credit unions, most share growth occurs in the first quarter of the year. What will credit unions do with the money? Can they, or should they, turn it away? The environment is not auspicious: Loan growth is slowing, credit standards are tight, and losses are still outside most credit unions’ historical comfort zone.

My Cost of Funds Does Not Have a Zero Boundary (Though the Fed’s Does)

One of the limits of the Federal Reserve Board’s monetary policy is that it cannot peg overnight rates lower than a zero boundary, that is, the Fed cannot make rates negative. In normal environments credit unions also have the option of lowering shares. But this is not a normal environment. The new reality is that credit unions no longer have a zero lower boundary.

What has changed is the cost of insuring shares. At the November NCUA Board meeting, the agency’s CFO showed projections for the two insurance funds (NCUSIF and Corporate Stabilization) in 2010. Taking the high side of NCUA’s presented numbers, credit unions will be assessed a premium of 40 basis points in 2010. The breakdown is 25 basis points for the NCUSIF and 15 basis points for corporate credit union stabilization. Thus credit unions’ cost of funds does not have a zero boundary in 2010. The floor could be as high as 40 basis points. With cash equivalents earning near zero, this means every new dollar of shares could bring a negative return, at least in the short term.

What to Do: A New Approach to Balance Sheet Management

In order to withstand the crush of cash, managers need to rethink every component of the balance sheet, with a special focus on yield to support the income statement. A simple example shows why balance sheet management is important. If a credit union could move  half of its cash (4 % of assets) into member loans and generate a net yield of 3.25% on the loans, it would raise ROA by 12 basis points over the full year.

Waiting for member borrowing demand to return may be too limiting and too late. So many credit unions are actively seeking new direct and indirect loan channels as well as taking a second look at loan participations to more actively manage their earning assets.

In fact, credit unions should examine all sources of funding. Instead of focusing on share certificates, credit unions may want to offer certificates of indebtedness – uninsured, yes, but ranking ahead of shares in creditor priority. The credit union could even pay a slight premium versus rates of insured CDs and still save 20-30 basis points. For credit unions that need wholesale funding, instead of selling CDs to other credit unions (meaning higher premium rates), ask the potential buyer to make a loan to the credit union (secured by assets) and pass part of the savings on in a slightly higher interest.

In sum, what was a strength at the beginning of the crisis – liquidity — could become a drag in the next stage of rebuilding earnings. Waiting for markets and member demand to recover may not be sufficient. A more active approach to finding the right mix and structure of both assets and liabilities (shares) will be more critical than ever. That reality should be a part of every credit union’s 2010 plan.