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c. notes – Liquidity: Shifting Gears

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Liquidity as an industry issue took a long hiatus.  Now that it’s back, it is clear that the situation and methods to manage it will be different than they were in the mid-2000s.  Liquidity that used to act like a faucet you could turn on and off with rates may not work that way this time around.

Take control of your liquidity issues today.  To read this article and others, please visit our c. notes page.

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Core Conversion: Where is the Summit?

If your core conversion happened months or even years ago, and you’re not feeling as great as you thought you would about all the new functionality, you may be wondering what went wrong.  You’re not alone.  That feeling is as prevalent as the common cold, but there is a cure.

Credit union core conversion - where is the summit?

A conversion requires tireless focus and heavy resource usage.  The more distant goals can get lost in the immediacy of the conversion and the aftermath of catching up on the things that were set aside during the thick of it.  Take a deep breath and celebrate the successful data cleanup, conversion, and initial gains that came with the new core.  Then keep going.

Regroup, Clarify, Prioritize

Take a pause.  You know much more about the system now than pre-conversion.  What were you expecting from the new core back at the beginning?  If there wasn’t clarity then, and even if there was, it’s helpful to revisit those expectations:

  • Create or update the list of desired capabilities
  • Assess the current status of those capabilities
  • Write clear objectives statements with measurable goals for each
  • Prioritize, using the credit union’s strategy as a filter
  • Set them in motion as resources and other priorities allow

Writing clear, effective objectives statements is one of the keys to reaching the summit.  For example, if funding loans through the system is a desired capability, the goals should include what percentage of loans will be funded through the system and by when.  This eliminates the unfortunate situation where the capability is implemented but not fully utilized.

Be particularly aware of the processes surrounding the new system.  Are they processes from the past that have just been crammed around the new system?  Evaluate and improve those processes.  For each process, get the doers and decision-makers in the room to understand the current process and identify non-value add activities.  Always use the member experience as a decision filter.  Make sure that people who understand the full capabilities of the new core and any associated third-party software are involved.  Working together and sharing knowledge of system functionality and the way the system is really used by the doers results in superior process design.  While the groups are still energized, create a clear plan for implementation of the improved process and begin executing the plan.

While major member-facing processes often get the most attention for process improvement, don’t forget other activities such as month close, collections, accounts payable, servicing, account maintenance that are just as vital for the smooth and efficient operation of the organization.

The core conversion itself only takes you halfway up the mountain.  Reaching the summit requires clear objectives and continuing focus.  Even if the core has been in place for some time, you can still get there.

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Opportunities within the Treasury Yield Curve

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Much has been written about the U.S. Treasury yield curve recently – it’s narrowing, it’s widening.  It’s nearly impossible to predict.  While there will always be uncertainty regarding market interest rates, the current shape of the yield curve offers credit unions some opportunities to explore.

Consider the decision to borrow funds.  Many credit unions are feeling liquidity pressure and structured borrowings are a viable option to help improve liquidity.  Along with borrowings comes the important decision of term.  Depending on the risks that the institution is looking to address, the yield curve is creating unique cost versus risk trade-offs to consider.

For example, in the following table let’s evaluate two potential borrowing terms, 3- and 5-year Federal Home Loan Bank (FHLB) fixed-rate advances:

FHLB Dallas – Fixed-Rate Advances (as of 02/13/18)

Table of fixed-rate advances from the Federal Home Loan Bank as of 2/13/18

As expected, the 5-year borrowing rate is higher than the 3-year borrowing rate.  However, the difference between the 2 rates is at some of its narrowest levels in the past 10 years.  The credit union pays an extra 0.27% per year for 2 additional years of funding and protection from rising market interest rates.  However there is always a trade-off, and market interest rates could stay relatively flat or not increase as much as expected.  The possibility needs to be understood and tested with what-if scenarios.  That being said, some decision-makers are finding the risk return trade-off between these 2 points along the yield curve is quite advantageous for their risk profiles.

Likewise, there are similarities with the Libor Swap Curve.  Notice in the graph below that the highlighted points between the 3- and 5-year Libor Swap Curve are among the flattest of any point along the 30-year curve.

A graph of a 3-month LIBOR Forward Swap Curve (last 4 months) showing a flattening between 3-year and 5-year marks.Note:  Analytics Provided by The Yield Book® Software

Swaps and other derivatives are additional tools that can decrease interest rate risk in a rising rate environment.  The challenge for some can be that along with derivatives comes material increases in operating expenses like accounting costs, expertise in the form of staffing, and additional A/LM analysis, to name a few.  With that in mind, the flatness in the swap curve is an opportunity some feel could be a good fit for their risk profile.

Another area impacted by the slope of the yield curve is the investment portfolio.  For example, a simple fixed-rate, 3-year agency bullet is currently yielding roughly 2.30%, while a 5-year agency bullet is yielding close to 2.55%.  As demonstrated in the following table, the risk versus return of the 3-year agency bullet is more favorable now, in a +300 bp shock, than the risk versus return of the 5-year agency bullet.

A table comparing a 3-year agency bullet and 5-year agency bullet in an investment portfolio

The yield curve will continue to change, along with the unique opportunities it creates.  While the actions of the Federal Reserve and the level of interest rates continue to get most of the attention, it is important for credit unions to look for opportunities created by the differences between short-, intermediate- and long-term rates.  In addition, twists and changes in the yield curve also need to be modeled routinely as part of asset/liability and interest rate risk management.