June 10, 2010

Credit Union Management’s Web-only “CFO Focus” column runs the second Thursday of each month.

Credit unions need to develop an effective liquidity and funds management strategy in response to the “Interagency Guidance on Liquidity and Funds Management.” Core funding is the most favored, most valuable, least volatile, and lowest-cost source of funding to a credit union and will be a key element of any good liquidity and funds management strategy. This article will focus on how credit unions can plan for effective core funding growth and retention.

You might ask, “Why would I focus on a core funding growth and retention strategy now, when I’m awash in liquidity resulting from flight-to-safety fund inflows and loan portfolio outflows due to lack of loan demand?” I’m not recommending that you attempt to grow shares now. But you would be well advised to begin preparing your strategy for the next rising-rate environment that some economists are predicting could kick off by late-2010. Why?

• Rising rates typically are used to manage economic recoveries. So it is likely rising rates will be accompanied by a return of flight-to-safety funds to the market and a spike in loan demand, putting many credit unions back in the tight liquidity environment of a few years back.

• Many of you have rate floors under your variable rate loans, especially home equities. As rates move up, rates on these loans won’t move for a while. But your cost of funds will.

So now is a time to get your core funding growth and retention strategy in place so it will be ready when you need it—as the economy recovers and rates lift off. An effective core funding growth and retention strategy has five key components:

1. Integrate core funding strategy development into your asset/liability committee process. It is in ALCO that the strategic goals are set and where the other credit union financial pressure points like capital, liquidity, interest-rate risk, and profitability are managed. ALCO should develop the core funding strategy. The role of the pricing committee should evolve into execution of the strategy developed by ALCO.

2. Make sure you have the correct analysis tools in place to make effective choices between strategies. Decision-making tools include a that help you determine what is well or poorly priced. An example of a set of benchmark rates is Federal Home Loan Bank Advance Rates. Then use marginal cost analysis to choose between strategies. Marginal cost is how much is paid to produce another unit of output. Marginal cost analysis in this case considers both what you pay for new funding and how much you pay up on existing funding in determining the cost of new funds raised.

There are so many factors that drive how members respond to your products and pricing that your approach to strategy development and monitoring should be experimental. Try a strategy for a quarter. Track the pricing decisions relative to competitive and market rates and the resulting effect on demand. Back test the marginal cost of funds raised. If the strategy is working, continue its use the next quarter. If not, tune the strategy.

3. Plug the holes in your product offerings. You may need products designed to go after particular member groups like Gen Y. You may also need to make changes to the way in which you market so your message reaches these target audiences. Other products may be needed to allow you to segment your members, separating those who are rate sensitive from those who aren’t, so you can afford to compete for the rate-sensitive members. A common example is to offer CD specials, allowing you to pay a higher rate for those who shop for the best deal while not paying as high a rate for sleepy members that allow CDs to automatically renew. More on this in the next point.

4. Develop strategies to segment your member base. Some segmentation strategies admit target groups to a product while blocking cannibalization from those you would prefer not to see in the product. A good example is a high-rate reward checking product that admits customers who do transactions electronically (debit, bill-pay, etc) and blocks members who don’t exhibit those behaviors.

5. Execute the strategies you have elected to employ. This requires you get buy-in from other members of the management team. More importantly, you need to get buy-in from your front line. Pricing committees think they set credit union rates. But all too often the pricing decisions are made on the front line. There is a huge difference between the effectiveness of core funding strategies that are understood and supported by the front line and those that are fought every step of the way.

It is easy to grow core funding. If you don’t believe me, set your rates 200 basis points over the competition and watch the funds flow into your front door. Of course, your profits will be flowing out the door. What is not easy is growing shares in the product lines you wish to grow, hitting growth targets on the head, while managing interest expense and net interest margin in the process. That takes a well developed and executed core funding strategy. Are you ready?

Tom Farin is president of Farin and Associates, Fitchburg, Wis.