Credit Union Exam Solutions Presents With Flying Colors

On this week's episode I discuss Liquidity with Subject Matter Expert Todd Miller.

Don't miss part 2 tomorrow.

Why discuss Liquidity today?

Many reasons. A great deal of evidence that liquidity risks are increasing. 

Inverted Yield Curve - 85 days as of  11/3/2022

Prior inversions over 10 days

 – 18 days in May/June of 2007

-185 days in June 2006 through early 2007 (15-16 yrs removed from this)

-226 days in 2000

Inflation – Over 5% annualized since June 0f 2021.

·        Last time inflation was over 5% was 1991. (30 years ago).  That was also a recession known today as the S&L Crisis.  Who knows how this may impact loan performance today. In the banking industry net charge offs were 1.4%, 1.61%, and 1.29% in 1990, 91, and 92. Current bank charge off ratios are under 0.3%, very similar to credit unions.

·        Unlikely most management teams today have ever managed in an inflationary environment, compounded by an inverted yield curve.

Prior to Covid the US savings rate was running in the 8% range. It spiked during Covid reaching a high of 33.8% in April of 2020. As late as March of 2021 is was 26.3%. We had 15 months of Covid where the savings rate was in double digits.  It’s been under 5% for all of 2022 and was down to 3.5% in July and August. It dropped to 3.1% in September of 2022, the most recent number I have. You can see this in share growth numbers.

Share growth that was double digits from Dec 2020 to March 2022. From March to June, total shares increased by 2.8 billion, but 2.1 billion of that was non-member deposits. Member deposits grew a paltry $754 million or only .04%. Annualized that is growth rate of 0.49%. 

Borrowed money increased by $19.8 billion over the same 3 months, an increase of 42.2%. Of that $16.5 billion is less than one year maturity – so overnight most likely. NCUA now includes supplemental capital in borrowings. It is not broken out as separate line item. No longer able to determine what part of borrowed funds is actually being included in capital amounts.

I’m sure with treasury  Emergency Capital Investment Program (ECIP) funding, secondary capital amounts also grew.  Treasury’s website shows 70 credit unions receiving $2.1 Billion in ECIP Funds. Supplemental capital rules are also new.   Interesting that NCUA chose to stop displaying secondary/supplemental capital amounts when it revised the call reports in March of this year.

Per NCUA’s financial trends reports, subordinated debt grew 106% in 2021, and 480% during the first 6 months of 2022. No amounts were reported in the trend reports however.

Loan growth in the same period was $85.3 Billion. How was that funded. Investments dropped $2 million, corporate deposits dropped $11.2 billion, cash with the federal reserve dropped $51.1 billion, and cash in other financial institutions dropped $2.5 billion. Cash and short term investment to assets fell from 16.24% to 12.94%.

I have call report data going back to 2000. December of 2018 is the only time cash and short term investment numbers were lower. In 2018, investment portfolios were within 2% of par values so liquidating investments was a cost effective way to raise liquidity.  Current investment portfolio were around 7% underwater in June, probably more today. Liquidating investments may no longer be a reasonable way to raise liquidity.

Asset Quality is still strong from the loan side. Delinquency and net charge off levels are at lowest levels seen in this century. Credit Risk management tools have come a long way in the last 10-15 years. Then again, there has been no inflation in the 21^st century so who knows how loan losses will be impacted. 

The sudden end to share growth is telling though.  We have rising interest rates, and an inverted yield curve. On top of that net worth rates are less today than they were going into the great recession of 2007. Almost all the layers of risk in financial institutions are increasing.

Asset quality issues are at the heart of most liquidity events