Navigating Liquidity In Testing Times: Insights From Leaders Credit Union

With deposits slowing at financial institutions across the country, credit unions are rediscovering the importance of liquidity in meeting members’ lending needs. For Leaders Credit Union ($924.2M, Jackson, TN), managing liquidity is all about being “cautious but proactive,” says CFO Seth Rudd.

“That begins with knowing our options before problems arise,” Rudd says. “It ends with maintaining our commitment to our mission regardless of economic conditions.”

Of course, there’s more to the matter than simply lending. An adequate liquidity strategy also allows credit unions to comfortably cover withdrawals, operational expenses, and more. A liquidity shortage seriously limits a credit union’s ability to fulfill member requests. It also stifles growth opportunities and can even jeopardize an institution’s stability.

According to Rudd, Leaders’ liquidity management strategies have four primary focuses:

• Member Principal Repayments: Assessing how much liquidity Leaders could gain if lending slowed.
• Loan Participation Estimates: Identifying how much liquidity it could gain if it sold loans.
• Nonmember Deposits Capacity: Determining the maximum nonmember deposits it could buy within its policy and regulation.
• Borrowing Capacity: Calculating the maximum amount it could borrow, if required.

“Knowing exactly how much liquidity we have access to is critical to our liquidity strategy,” Rudd says.

Want to hear more from Rudd on how Leaders is managing the moment? Tune into Callahan’s first quarter Trendwatch webinar, available today on CreditUnions.com. Listen now. 

By The Numbers, And Keeping Track

At the end of 2022, Leaders had a loan-to-share ratio of 104%. Loans-to-assets stood at 87.43%. However, various measures — such as increasing rates, reducing dealer payouts, and enhancing deposit offerings — helped Leaders lower its LTS ratio to 101% and improve its LTA ratio to 86.63%.

Consequently, its liquidity ratio — short-term assets divided by short-term liabilities — notably improved from 8.63% to 11.87%. That’s in line with Leaders’ new policy to keep that key measure between 8% and 10%.

Rudd emphasizes how important it is to regularly assess the institution’s situation.

“Every month, we measure and document our major liquidity options,” he says. “Knowing exactly how much liquidity we have access to is critical to our liquidity strategy.”

The Root Of The Problem

Rising interest rates severely damaged a lot of business models, and Leaders was hardly alone in feeling that impact, including on its own investments. According to Rudd, nearly 500 credit unions have 10% or more of their assets in bonds and mortgage-backed securities with maturities of five years or more, a lot of that from money that came their way during the government’s relief efforts to beat back the pandemic’s economic fallout.

“Because rates have increased so quickly, these investments are now underwater and not accessible,” the Leaders CFO says. “The only way these investments become accessible is if rates significantly decrease or the investments mature.”

Even a bread-and-butter product of credit unions fell victim to rising rates.

“We always assumed we would be able to sell auto loans, and all of a sudden, we couldn’t because rates were moving up so fast that loans that were only two months old were underwater,” Rudd says. “That removed one of our major liquidity options. The levers we assumed we could pull weren’t there when liquidity got really tight in early 2021.”

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A Balanced Balance Sheet: The First Layer Of Defense

Leaders now uses a “balanced balance sheet approach” to meet its liquidity, growth, and profitability goals while offering competitive borrowing and savings rates.

“An imbalance in growth among total loans, total deposits, and total net worth creates a variety of financial problems over time, including interest rate risk, capital risk, and liquidity risk,” Rudd says.

Maintaining that balance involves a lot of tactics, tools, and people.

“Our first layer of defense is always the front lines,” the Leaders CFO says. “We’ve asked our branches, wire department, and ACH department to contact me directly when there is a large withdrawal.”

He says such withdrawals are nearly always part of normal business such as large purchases and real estate closings, but staying apprised of them gives him a feel for the day-to-day activity. Leaders’ analytics department also produces a large-withdrawal activity report that captures all large transactions and compares the transaction trends to previous months, thus putting all that activity into context.

The credit union also regularly evaluates its lines of credit to ensure sufficient borrowing capacity, again in balance, in this case based on capacity, pricing, and risk. Currently, it maintains two lines of credit — one with its corporate credit union and the other with the Federal Home Loan Bank.

“We’re in the process of evaluating potential new sources of credit to increase our borrowing capacity as much as reasonably possible,” Rudd says.

Coming To Terms On The Costs

According to Rudd, credit unions that want to grow and effectively manage liquidity must come to terms with a rising cost of funds.

“On the deposit side, we’re refreshing our deposit offerings on an ongoing basis and matching published certificate rates,” he says. “On the loan side, we’ve increased our dealer network over the past three years. This extended network allows us to look at more applications and become more selective. We don’t have to have the lowest rates to achieve our desired loan volume.”

The credit union is accommodating a changing auto market by, for example, raising its loan cap to $75,000 and adjusting loan-to-value and other limits. It also has added four new positions to collections during the past 12 months that have improved that department’s data access.

“Not all delinquencies are equal,” Rudd says. “Our analytics department has produced data to help prioritize relationships that are higher risk due to recent credit activity and updated collateral value. We’ve also improved the department’s communication tools. We’ve upgraded our texting solution and incorporated a more efficient and user-friendly payment solution.“

Prepared For The Bite From Credit Quality Decay

That’s in line with what Leaders’ leaders believe is a coming decay in credit quality.

“As loan growth slows and global access to liquidity slows, the question is how bad will credit quality get?” Rudd asks. “We’re watching unemployment and household income. If unemployment increases but remains relatively low, we think credit quality will get worse but will not be a credit crisis.”

Still, Leaders keeps in mind what can happen if it does and includes that in its calculations. For example, according to Rudd, if Leaders didn’t make a single loan in a month and current borrowers kept paying, the credit union would earn $20 million in principal repayments.

That’s one source of liquidity, but what if Leaders only pulled in $10 million?

The credit union’s work in that regard also considers the new current expected credit losses (CECL) standards. Rudd says a significant percentage of its CECL calculation is based on charge-off activity during the past two to five years.

“We know charge-off rates since 2020 have been artificially low due to stimulus and extraordinary loan growth,” he says. “So we’ve increased our allowance to prepare for at least a normal credit environment and at worst a stressed credit environment.”

Again, it’s all about preparedness and options.

Capital Isn’t King, Confidence Is

Rudd says a balanced balance sheet is important, and Leaders manages to that effect, but perhaps even more vital is member perception. He points to the example of veteran banking journalist John Maxfield.

“Maxfield has spent the past 20 years studying the banking industry,” Rudd says. “He says the old banking mantra of ‘capital is king’ isn’t true. ‘Capital isn’t king, it’s court jester. Confidence is king,’ he says. What he means is you can have an above-average net worth ratio or capital ratio but if your members lose confidence in you, you’re going to have a problem.”

The Leaders executive points to Silicon Valley Bank’s recent collapse despite its third-highest common capital ratio among the nation’s biggest banks, and how in 1986, Washington Mutual had a stronger tier 1 capital ratio than the other six largest banks.

Liquidity wasn’t the problem that kicked off the fatal rush on those banks.

“It wasn’t the lack of capital but the lack of confidence that caused these banks to fall,” Rudd says. “It was true in 1986. It’s true today. We’re becoming very intentional with our communication with our members. We want them to be confident in our financial stability.”

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