Corporate Liquidity Robust, Could Fuel Industry Market Share Growth
TALLAHASSEE, Fla. -- Despite all the negative news coverage regarding foreclosures, devalued investments and their effect on liquidity and capital, the credit union industry is in great shape, said executives from two corporate credit unions located in areas with high foreclosure rates.
Southeast Corporate Senior Vice President and Chief Investment Officer Gregory Wirthmann, CFA, and WesCorp Executive Vice President and Chief Financial Officer Todd Lane shared their investment practices and liquidity strategies and with Credit Union Times, and echoed what many in the industry have already said: Bank liquidity struggles present a golden opportunity for credit unions to gain market share.
Two major differences between credit unions and banks have given cooperatives the edge in today's financial marketplace: the credit union value system that places responsible stewardship over profit and a robust corporate system that provides a liquidity buffer for natural person credit unions.
On March 3, Federal Reserve Governor Randall Kroszner spoke to the Institute of International Bankers about yet another bank liquidity snarl: structured investment vehicles. Kroszner said traditional U.S. bank risk-modeling methods didn't adequately predict risk in SIVs, which borrow short term but invest long term, resulting in outpayments being due before inpayments are received. Unable to refinance short term to make up the difference, some banks are left with no choice but to sell the asset in a depressed market.
Kroszner said banks also failed to take into account the possibility that "the same factors that led to liquidity problems for the SIVs could also lead to high liquidity demands in other parts of the financial market and might also put pressure on the banks' own liquidity."
By contrast, because corporates were created primarily to provide overnight liquidity to natural person credit unions, both Wirthmann and Lane said they take liquidity into account first when considering any investment vehicle.
The responsibility of maintaining huge overnight accounts forces corporates to invest in the short term, only tying up "core holding" funds -- those assets far above and beyond what is needed to cover overnight accounts -- in longer-term investment products.
Southeast reviews monthly overnight deposit balance averages to determine core holding, Wirthmann said. Risk assessors use a guideline of two to three standard deviations below the mean in order to guarantee enough liquidity for member credit unions in up to 99% of situations.
Both corporates manage accounts with US Central Federal Credit Union, though Lane said WesCorp bucks the corporate trend a bit by not relying on U.S. Central as its primary source. Lane mentioned the San Francisco office of the Federal Home Loan Bank as a popular liquidity source for WesCorp as well as natural person credit unions in California, and Wirthmann mentioned Southeast is in the process of adding the FHLB's Atlanta office to its liquidity source list.
Another liquidity advantage the credit union industry has over banks is the ability to raise funds from the well-capitalized ranks of natural person credit unions. The credit union business model, which typically has lower loan-to-share ratios than banks, presents corporates with a vast reservoir of cash to tap into, requiring only an attractive certificate rate or participation loan offering to bring in deposits.
"WesCorp has a long history of being able to raise money from members, and that's where most of our assets and liquidity comes from, the credit unions we do investment business with," Lane said. "Our borrowing capabilities are just there to round out the balance sheet."
Wirthmann said he realizes all the bad press about liquidity and downgraded securities could have credit unions worrying about corporate investment practices, but said Southeast has "very clean assets on our balance sheet."
Both Southeast and WesCorp invest primarily in AAA-rated securities. Southeast reported 96.4% of its securities had AAA as of January 31, while WesCorp's security portfolio shows 87% rated AAA as of Dec. 31.
Despite being located in two of the toughest mortgage markets in the country -- Florida and California -- the corporates reported that subprime mortgages don't take up much space on their books. Southeast said that as of Jan. 31, subprime notes represented only 3.7% of its total portfolio, while WesCorp's Dec. 31 numbers reported 18% of its portfolio was subprime.
Lane said WesCorp's subprime investments are older vintage, from 2005 or earlier, which means they've already reset. And in California, where even condos are too pricey for conforming loans, Lane said many prime borrowers with good credit and high incomes chose subprime loans simply for the affordability gain.
"Subprime loans aren't the same across the board," Lane said. "We feel good about that 18%, because they're all very highly rated because they have seasoned and the credit enhancement we have is high.
"The credit enhancement was around 16% when we bought it, but today it's in excess of 40%, so these will definitely cash flow. There's no question about receiving the principal and interest payment on these."
Wirthmann said Southeast's subprime securities have 54% credit enhancement, and average a loan to value of 75%.
Both men said that although some of their securities investments have been downgraded, others have actually upgraded -- Lane said WesCorp's upgraded securities outnumber the downgraded ones four-to-one.
Wirthmann said despite headlines about credit unions incurring losses, as a whole the industry is extremely well capitalized, and should come out of the current subprime crisis smelling like a rose.
"That capital gives credit unions a competitive advantage over banks, because they can take advantage of opportunities as they arise," Wirthmann said. "And generally, credit unions know their members better, so they can make better credit decisions. Because of those two advantages, they should be able to build market share."