Filene is providing resources every week in line with what credit unions need most. To help you maximize your support to serve members' most pressing financial needs right now, we've asked Mike Higgins, Managing Partner at Mike Higgins & Associates, to provide a list of six things credit unions can do now to set their members and their organizations on a path of financial well-being.
|Download the worksheet from section 4, Emergency Loans, to understand how you can calculate a loan fund for your credit union.|
1. Net Worth
Let’s start with the most important aspect of running a financial institution, especially in an uncertain environment: net worth. The amount of net worth you have is going to determine what you can do to support members.
As an industry, credit unions are sitting on 11.37% net worth as of December 31, 2019 (source: NCUA FPR). Start by setting a minimum net worth target that you don’t want to go below. For perspective, as part of the recent CARES act, the Community Bank Leverage Ratio has been reduced to 8% from 9%, so for credit unions, establishing a minimum net worth target somewhere between 8-9% is not a bad place to start.
Let’s say you are currently sitting on 11% net worth, and determine that in the direst of economic conditions, you never want to fall below 8%. Therefore, you have a 3% buffer. Remember, that 3% buffer is equivalent to a 3.00% ROA, which means you would need to incur operating losses equal to 3.00% ROA before falling to 8% in this example. Understanding this will hopefully give you a sense of relief, and indeed, as the Credit Union National Association’s Chief Economist Mike Schenk has also written (Exercise caution when responding to crisis), credit unions are positioned well to navigate any negative economic impacts of the novel coronavirus pandemic: “Most credit unions,” Schenk notes, “have very strong balance sheets and near-record-high capital levels.” As a buffer against loan losses and falling net income, your capital position is also a resource to support your members, as it will allow you to quantify an emergency fund to help members.
For example, you might decide that you want to set aside 20% of your net worth buffer into an emergency fund to immediately help members.
Now you have a hard number to work with. It’s always better knowing what resources you have at your disposal and what your limits are before jumping in to help members.
Also, don’t forget to look at your bond portfolio. You might have unrealized gains that you can execute upon, which will help with net worth, too.
2. Skip-a-Pay and Deferments
Allowing members to skip or defer payments is a common practice for credit unions and a great way to provide assistance to members immediately. While it does not put cash in hands of members, it relieves the burden of making a payment.
Because there may be a large number of members wishing to utilize programs like this, you need to be aware of the implications upon liquidity. Members are not making principal payments, so you don’t have cash coming back into the credit union. If members are making cash withdrawals, or are no longer drawing a paycheck, then you are getting hit on both sides. Be sure to model this out, or ask for help from your ALM service provider.
Try to avoid binary thinking (on, off) with respect to these programs. I see a number of credit unions offering 90 day deferments, which may result in a lot of liquidity strain, especially if the credit union has a high loan to asset ratio. As an alternative, you could do a full deferment in month one, for maximum impact now, and then do a 50% deferment in months two and three to improve liquidity. You want to do what’s best for your members now, and you want to put your organization on steady footing to be able to help members down the road, too.
In terms of overall credit union liquidity, evaluate what borrowing capacity you have and/or what credit lines you can draw upon. You might find some reassurance here.
You may also have to adjust some of your internal policy limits regarding liquidity in the short run. Those policy limits were set to mitigate risk in normal operating times, and, well, we are no longer in normal operating times. Communicate this to your board and let them know you may want to consider temporary revision of policy limits to help members now.
Lastly, if you find yourself in a severe liquidity crunch, look at participating loans out. The market for participations might not be great right now, but you could offer an incentive by participating out your lowest risk credits, and assuming a disproportionate amount of risk. For example, participate out 50%, but assume 75% of the risk. In part because of the geographic variation in the distribution of COVID-19, there will be credit unions out there that have liquidity but are starving for income.
3. Fee, Overdraft/Non-Sufficient Funds, Late Payment, and Other Waivers
This is another way to reduce burden upon members, and for many who need cash-flow assistance now, getting money into their pockets in the short-term (allowing them to cash checks or withdraw from savings accounts inexpensively or for free) can make a difference.
At the same time, understand that non-interest income is a vital part of your income statement. In 2019, fee and other income was 1.35% of assets for credit unions (source: NCUA FPR). The ROA of all credit unions last year was 0.94% (source: NCUA FPR). So fee and other income represents 143% of net income ROA. That’s a large number. I support putting fee waivers into effect but understand the implications of your actions before doing so. Consider setting a limit or doing partial waivers—again, avoid binary thinking and be creative.
4. Emergency Loans
Here’s something you can do right now to put cash in the hands of your members. Understand, you do not have an unlimited amount of resources, so prioritization is going to be important. Let me give you some things to think about to help with that prioritization process.
For example, some credit unions are emphasizing service to existing members. Members who joined the credit union by a certain date—say, January 1, 2020—are served first. Others’ needs can then be evaluated and met with the resources available after the credit union has taken care of its other members.
Next, I would want to help members that are making a contribution to the credit union and helping sustain the cooperative for the long-term. For example, I would exclude indirect members who have a loan and no other product apart from the minimum savings account necessary to join. You can help these members with skip-a-pay and deferments, but they would take a back seat to members who have direct deposit, for example.
Where I can reduce or eliminate risk, I want to provide maximum benefit. For example, you can provide a CD-secured loan to members, with virtually no risk of credit loss. A CD-secured emergency loan is a no-brainer.
Finally, I arrive at my core members. These are the people I want to take care of the most. An emergency loan can put cash in their hands now.
So, how much emergency lending can we do? Go back to your calculation of your organization’s emergency fund. Earlier, we landed on an example emergency fund of $3 million. Let’s say we are going to allocate $1 million to fee waivers. That gives us $2 million for emergency loans. How many emergency loans can we make? That depends upon the anticipated losses and average loan size. Let’s break it down in rough figures and assume the following:
- $2 million emergency fund
- 10% anticipated loan losses
- $2,000 emergency loan amount
- 1.00% interest rate (to cover cost of funds)
With these assumptions, you could leverage the emergency fund into $20 million of emergency loans ($2 million emergency fund / 10% anticipated loan losses = $20 million of emergency loans).
If the emergency loan is $2,000 then you could make 10,000 emergency loans ($20 million / $2,000 = 10,000 emergency loans). That’s assistance to lot of members!
The lower the anticipated loan losses, the more loans you can make. The higher the anticipated losses, the fewer loans you can make.
Yes, the math indicates the emergency fund is fully depleted at the end of the program. Let’s be frank: it’s time to use some of the profit you have taken from members and stored away as net worth. Return that value back to your members at a time when they need it the most.
Want to run the numbers yourself?
|Download this worksheet to run your own numbers and help think through a loan fund for your credit union.|
5. Mortgage Loan Re-Amortizations
In the intermediate term, a low-risk way to provide relief to members is in the form of loan re-amortizations. This is not a “cash out” refinance. Instead, you are simply pushing out the maturity date of a loan to lower the monthly payment. Let me give you a specific example.
- $200,000 original loan amount
- 4% interest rate
- 30 year amortization
- $150,000 current principal balance
The monthly principal and interest payment on this loan is $954. If you re-amortize the current principal balance of $150,000 over thirty years at 4% interest rate, the monthly principal and interest payment drops to $716. That’s a reduction in monthly payment of $238 per month, or $2,856 over twelve months.
Some might say that’s just putting someone in debt for a longer period of time. My response? We need low-risk ways to help members now. The member can always make a larger monthly payment to get out of debt sooner, or eliminate their debt entirely if they want to sell their house at some point in the future. Paired with topline service and strong financial coaching and well-being tools, this is a strong option to help relieve any cash-flow shocks members with homes may be experiencing due to a loss of income or unanticipated expenditures.
6. Appoint a Historian
Credit unions have long put their members’ financial well-being first. But they don’t always tell their story as well as they could. As a final step, I recommend appointing a “historian” for your pandemic response, someone to document the decision points, actions taken, results, and more. The record that person produces will serve both as a valuable reference guide should a similar situation arise in the future, but also as a resource to share with others and to demonstrate the credit union difference.
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