Credit union earnings have been suffering throughout the global pandemic. Board members are concerned with the potential for loan defaults as the uncertainty of COVID continues. Credit unions we’ve spoken to are concerned with three key objectives: the “New Normal” business model, growing your member base, and maintaining earnings during these uncertain times. How can you optimize your credit union balance sheet to help address the income aspect of those goals?
In the last few years, credit unions had the luxury of overlooking potential sources of additional income. Lack of extra bandwidth and lending activity often pushed alternative income sources to the wayside. The massive drop in interchange and fee income in the first and second quarters of 2020 changed that focus. Now, we hear of more and more credit unions looking for all sources of prudent, accounting-friendly extra yield. Further, progressive credit unions are looking for sources of income that don’t necessarily directly correlate with lending activity.
On top of the need for extra income, credit unions are flush with liquidity. The 2020 federal stimulus, PPP loans (and forgiveness), Federal stimulus round 2, PPP round 2, and future stimulus activity will likely cause this dynamic to continue. Additionally, while lending activity has picked up, loan demand is not as consistent as in the past and delinquency concerns are still present. Finally, current yields are very low, especially at the point where credit unions tend to invest. Recent short term yields ranged between 0.08% and 0.13%!
To summarize; credit unions have excess cash, loan demand isn’t excessively robust, and normal places to put excess cash aren’t offering much of a return.
Against this backdrop, many credit unions are considering alternative income streams. One strategy that is getting much more attention is benefit funding offset (or benefit pre-funding) using higher-yielding investments than those traditionally used on your balance sheet. These alternatives can take many forms and have widely varying characteristics and potential for impact to the credit union. Diligent consideration of all potential avenues is vital for credit unions entering this arena.
Alternatives Credit Unions are Considering:
Stock and Corporate Bond Investments:
Under investment authority available to federally chartered credit unions (and many state-chartered CUs as well) investments in corporate stock and corporate bonds are allowable to fund employee benefit obligations and charitable donation efforts. While the return profile and transparency of this approach is attractive, the potential for volatility to the CU’s income statement is a key drawback and should be weighed carefully when considering this alternative.
Managed Investment Portfolios/Mutual Funds:
While the diversification of investments using mutual funds and/or managed investment portfolios can reduce some volatility risk, these options still come with the potential for significant income statement swings. Additionally, the added expenses for management of the fund or portfolio can serve to further eat into the credit union’s net return. Again, the credit union needs to conduct a multi-faceted risk evaluation to ensure they are comfortable with all potential outcomes.
Credit Union Owned Life Insurance – General Account
CUOLI is an option used by many credit unions. The more stable return profile of this asset is lower than might be attained under a “pure” investment strategy. This asset generally has a more predictable return pattern and is providing much higher yields than those provided by other standard credit union investments. The credit union needs to understand contract terms under this type of arrangement as well as maintain a close eye on the health of the carrier backing the policy.
Credit Union Owned Life Insurance – Indexed
Indexed Universal Life policies are a form of CUOLI that utilizes the return of an identified market index in the calculation of the policy return. These are more complex instruments than the non-indexed version but provide the potential for a greater return outcome than a basic general account option. These are often positioned as capturing part of the upside of market fluctuation with principal protection for the credit union should the index return turn negative. Again, the complexity of this instrument means that a thorough analysis of all potential outcomes must be conducted by the purchasing credit union.
Other “bespoke” alternatives
Credit unions of larger size ($1 billion +) may be able to access alternatives that are customized in nature. By regulation, these cannot be publicly marketed or demonstrated. To explore this universe, the qualified organization would need to seek a provider with a proven track record in the placement of such instruments. Such a provider will thoroughly understand maintaining compliance with applicable local and national regulations as well as ensuring appropriate treatment under the credit union’s regulatory and financial reporting framework.
All of the options above can help generate added income by offsetting your employee benefit expenses. For credit unions today, you no longer have the luxury of bypassing the improvement to income offered by these strategies. The key to your successful use of this tool is partnering with a highly-capable provider with the depth, expertise, and experience needed to prudently guide you through your evaluation, selection, and implementation.
Newcleus Credit Union advisors are backed by the strength and breadth of Newcleus Financial Group, which have been serving the needs of their more-than 44,000 policyholders across 750 institutions representing $12 billion in assets under administration over the past 25 years. We welcome the opportunity to bring that strength and experience to you and your credit union.
Balance Sheet Management: How to Pull Ahead of Your Peers
Margins are under pressure. As deposits increase inflow of funds and investment portfolios grow the uncertainty of COVID and the possibility of defaults down the line on the myriad loans that are being written looms large in many Board members’ minds.
How do you defend profitability?
Your Net Interest Margins and the management of the Net Interest Income will set your CU apart from the rest.
Capital is the cornerstone of the balance sheet where you can create income where there are few regulatory options available.
With rates ultra-low, pressure on earning asset yields is compounded by funding costs already nearing historically low levels. Excess cash is expensive and significant asset-sensitivity represents an opportunity cost as the Fed and the market forecast a low rate environment for the foreseeable future.
Focus on adjusting your asset mix, not only to improve your earnings today but to sustain it with higher, stable earning asset yields over time.
This means revisiting assumptions and looking at alternative income streams.
- Cost of carrying excess cash is up – Most institutions are now earning just 0.10% or less on their overnight funds.
- Consider options such as CUOLI, Deferred Benefit Plans, LINQS and split-dollar solutions.