ALM in a World of Shrinking Spreads

Credit Union Magazine
November 19, 2009 | COMMENTS

In the wake of corporate credit union stabilization, asset/liability management (ALM) software and service vendors are seeing distinct reactions from credit unions—frustration, says Denny DeGroote, manager of ALM financial management services at The Members Group.

As anticipated, NCUA approved a 0.15% of insured shares assessment on federally insured credit unions to shore up the National Credit Union Share Insurance Fund. Additional assessments could be imposed in 2010 and 2011.

Many credit unions would have preferred to pay the entire assessment at once, DeGroote says, instead of stringing out payments. “But, like it or not, at least there's now a plan for paying this out.”

This assessment could cost a $60 million asset credit union about $100,000—a chunk of change it can't invest in new services or infrastructure, he says. “In most cases, you're talking about 15% to 20% of net income.”

Earnings pressures are most keenly felt at small credit unions, according to the CUNA's economics and statistics department. But earnings for credit unions of all sizes are at historical lows.

In the meantime, says Scott Burwell, Symitar's strategic initiatives group and solutions manager, NCUA is sponsoring town hall meetings where the future of corporate credit unions is a big item of discussion. “What form will they take? Perhaps one giant entity. Or there's the ‘Five Theory' that says five regional corporates will emerge that offer short-term investments and services. It's too early to tell.”

Jerry Boebel, business consultant for Profitstars, hopes the agency won't issue share insurance fund assessments after this year. But he isn't optimistic about that possibility given instability in asset-backed securities and the real estate market. He sees some credit unions diversifying their risk by limiting the assets they hold at any particular corporate credit union or other entity.

Until the dust begins to settle, probably in the spring of 2010, DeGroote says, ALM vendors are advising credit unions to plan for a period of much lower earnings. “If they have reserves and good management, they can endure. They'll need to offer products and services that let them stay in the game.”

DeGroote encourages credit unions to focus more on gross spread—the difference between earning asset yield and cost of funds. Then, “be consistent and manage that spread within a 40 basis point range from quarter to quarter.”

He also says gross spread probably won't be enough to cover the cost of operations, so credit unions need to look for other income sources beyond current earning assets.

“But don't just look at conventional new sources, such as extra fees,” DeGroote advises. “Instead, look for possibilities under your nose.”

He recalls what one client told him about a conversation between a teller and a small-business owner who was looking for payroll processing because the task had become too big to do in-house.

“The teller told management about it, and they realized the credit union had the technology and personnel to handle payroll,” DeGroote explains. “Thanks to that conversation, the credit union found a whole new revenue source. The lesson? Listen to your employees and don't get locked into conventional approaches.”

Burwell says members need credit unions most during a down economy. “It's a call to arms, and credit unions respond well. I'm seeing credit unions setting loan origination records, increasing their car loan market share, getting into student loans, and increasing their credit card share as banks pull back. They haven't resorted to teaser rate come-ons so they've been good at protecting their assets and attracting creditworthy borrowers.”

Credit unions have taken a secondary hit, though, from borrowers whose defaults on bank-held mortgages created a ripple effect that affected, for example, auto loans that credit unions were holding.

Jon Heath, senior financial consultant for Fiserv and creator of the company's Wisdom Asset Liability Management System, agrees that corporate credit union stabilization will squeeze credit unions' bottom lines, “but there's nothing they can do about it. It's something they have to live with and take into account.”

The way to do that, he advises, is through aggressive ALM. For example, Fiserv's ALM system helps credit unions:

• Plan for the future by forecasting up to 16 future periods and developing comprehensive business plans that match budgets.
• Reduce costs and increase operational efficiencies.
• Track allowance for loan loss requirements; changes in equity, cash flow, and liquid cash; and investments.
• Audit the credit union's financial statements with the ability to view clear and concise reports with all key ratios.

Heath says there's some art involved in the process. “ALM isn't a crystal ball. But one thing that's handy about the software is that if you create a budget for a year, it will replace your assumptions with what really happened as the months progress. It helps refine the model and give you an ever more accurate idea of how you're doing.”

Heath says credit unions have different motivations for using ALM. “Some realize it's something they should be doing and are aggressive about it. Others are reacting to an examiner who wagged his finger about something and they aren't sure what to do.”

In any case, he says, “I'm seeing more people ‘cruising' with models. They're not just sending out data to be processed by an outside service. They're finding that isn't responsive enough.”

Heath advises credit unions to take ALM procedures into their own hands. “Take the classes and the training so you can do it yourself. Getting reports from ‘out there' is no magic bullet. The information is old and you have no control over how it has been manipulated or interpreted.”

Reprinted with permission of Credit Union Magazine Online.