Among the ebb and flow of economic data, pandemic-induced inflation and other financial turmoil we’ve (almost) become accustomed to the past few years, it’s no surprise that liquidity has been impacted.
This continues to be the case as we watched the FOMC meet on February 1, 2023, and raise the funds rate by another 25 basis points in hopes of slowing down the economy and the high pace of inflation experienced over the last couple of years. As a quick recap, the Fed began raising rates last March, starting with a 25 basis point increase, followed by a 50 basis point increase, four consecutive 75 basis point increases and ending 2022 with a 50 basis point increase in December. After the most recent increase, the fed funds rate is now sitting at 4.50 - 4.75 percent. The markets are currently predicting two more 25 basis point increases before the Fed stops raising rates, while most Fed members say they will likely stop once they get to the 5.25 - 5.50 percent range.
The big debate now is how long will the Fed maintain these higher rates before starting to ease again. The markets don’t think it will be very long but Fed members say they plan to hold rates higher for a longer period of time. The markets’ view is that a recession, caused by the Fed raising rates, will force the Fed to start lowering rates even if they haven’t been able to bring inflation down to their two percent target. Recent strong employment data has shifted the markets’ view a little closer to the Fed’s. Regardless of which path financial policy takes, though, the state of liquidity for many institutions is likely to remain precarious.
Liquidity in Today’s Environment
One effect of higher rates and inflation has been tighter liquidity at many credit unions. A number of factors have played a role in tighter liquidity, including increases in loan demand and decreases in consumer savings. Recent reports have shown a drop in consumer savings and an increase in credit card balances as consumers struggle with higher costs for many items. Who would’ve ever thought we’d see egg prices as high as they are?
We are also hearing stories of consumers shopping around for higher deposit rates, something we hadn’t seen much of in the last 10+ years during an extended period of low rates. Before the 2007 financial crisis, rate shopping was more common. The Wall Street Journal recently highlighted the record pace of deposits leaving U.S. banks in the second and third quarters of 2022, a trend that is expected to continue. As is normal at this time of year, tax refunds will provide some short-term relief but refunds are expected to be smaller compared to last year.
Liquidity Solutions on the Rise
The good news is there are a number of ways to increase your liquidity should the need arise. First on most credit unions’ lists is to generate additional deposits or at least maintain current levels from your members. This may mean increasing deposit rates on share accounts or offering CD specials, something we’re starting to see credit unions do more often. Cost of funds has been increasing at credit unions as they take steps to hold on to member deposits. This is likely to continue as consumers move excess funds into higher yielding investments.
Another option, although certainly less attractive for credit unions, is to slow loan demand by increasing rates for credit. Credit unions saw strong demand for all consumer loans in the third quarter, with auto loans increasing 18 percent from a year earlier as credit unions offered lower borrowing rates than their bank competitors. In fact, credit unions’ share of auto financing overtook banks in 2022.
Other Options for Increasing Liquidity
Borrowing from the FHLB
The Federal Home Loan Banking system is reliable and generally one of the cheaper forms of borrowing. They provide numerous loan types and terms that can be customized to fit your credit union’s needs and expectations for future rates and loan demand. The FHLB does require you to purchase stock and to provide collateral in order to borrow, so keep that in mind. Examples of acceptable collateral for borrowing can include marketable securities and certain member loans.
Borrowing from Vizo Financial
Every credit union that is a capital member of Vizo Financial has access to a line of credit which can be accessed as needed. These lines are frequently used for overnight short-term borrowing, often automatically, and can also be used for term borrowing up to a year.
Issuing Jumbo CDs Through SimpliCD
Credit unions can issue CDs to other CU investors through the SimpliCD program. The process is quick, it can be used to bring in large deposits and it allows funds and payments to automatically settle within your Vizo Financial settlement account. While state regulations vary, NCUA regulations allow you to bring in non-member deposits up to 20 percent of total shares or $3,000,000, whichever is greater. SimpliCD can also help you bring in deposits of varying sizes from a nationwide network of credit union investors.
Selling Loan Participations
Credit unions are allowed to sell or participate out loans to other CUs. Generally, the selling institution has to retain a 10 percent interest in the loans being participated out. Vizo Financial has a long-standing relationship with LoanStreet, which can help to facilitate loan participations for credit unions. One nice benefit of this program is the ability to participate out smaller loan amounts than most other companies allow. LoanStreet will provide guidance on loan pricing and you will retain servicing of the loans you participate out.
Selling Bonds or Other Investments
Selling lower yielding investments in a substantially higher rate environment like we have today is often an expensive option for raising liquidity. Not only do you have to recognize what can be a substantial loss on the sale, but you also have to take into account the lost income. However, it may make financial sense to sell some lower yielding investments in order to fund much higher yielding loans. Considering many investments made in the last couple of years have sub one percent yields, the time to recoup the loss from the sale may not be as long as you think.
Vizo Financial can help you when you find yourself in need of additional liquidity. We can analyze costs for the various options so you can make as informed a decision as possible for your credit union! For more information on any of these liquidity options, please contact your corporate account manager.
Scott Wood is Vizo Financial’s portfolio strategist. He is a NASD-registered representative, responsible for assisting the investment and liquidity needs of member credit unions.