Reducing Overnight Cash to Enhance Earnings

Through the second quarter of 2020, credit unions experienced an increase in liquidity from slower lending and increased shares. Additionally, credit unions are now experiencing a lower net interest margin. One of the culprits is the mere 0.08 percent they’re earning on overnight cash balances, compared to almost 1.50 percent at the end of 2019. As a result, the cost of excess liquidity continues to be expensive. 

After enduring months of COVID-19 quarantine restrictions, most credit unions have settled into new operating routines. A focal part of these new routines is managing balance sheet changes. The initial credit union response to the global health crisis was to allocate resources to ensure ample stability and liquidity. At the time, there were many unknowns about payroll deposits, loan repayments/deferments and overall member behavior. Since then, most credit unions have experienced share growth and slower loan growth. Annualized share growth for the industry is almost 19 percent through the second quarter, while loan growth is about five percent. As a result, credit unions have substantial liquidity. 

One potential strategy for enhancing earnings is to deliberately reduce overnight cash balances, below normal practices, based on projected investment maturities and expectations for net loan demand.

For example, using the cash and short-term investments to total assets ratio as a liquidity benchmark, a credit union could strategically purchase new investments prior to receiving current investment cash flows that are projected over the next few months. This strategy would temporarily reduce cash positions and the ratio below normal practices.

In the following months, the overnight cash balances and ratio would rebuild to normal levels, based on maturity projections. To further illustrate, a $400 million credit union with $40 million in overnight cash and $2 million a month in investment maturities, would have a cash and short-term investments to total assets ratio of 16 percent. Pre-purchasing the next six months of maturities ($12 million) would reduce overnight cash levels to $28 million, creating a new ratio of 13 percent. At the end of the six-month period, cash balances would be back to $40 million, and the ratio would be 16 percent.

The earnings benefit would be achieved by reducing the amount of overnight cash balances, only earning about eight basis points, and moving them into securities with returns ranging from 25 to 100 basis points. This strategy would reduce the amount of assets producing the lowest return and substitute them with investments earning as much as 8-10 times more.    

Concerning the overall level of interest rates, the Federal Reserve has indicated they have no intention of discussing short-term interest rates for at least a couple of years. With that admission, we can assume interest may be low for an extended period.

For a quick review of broad-based investment yields, credit unions can utilize industry resources such as the  investment yield comparison tool. Catalyst Strategic Solutions’  team of experienced Advisors have the skills and know-how to help your credit union build an effective liquidity management strategy – even in today’s economic environment. For more information, contact us today.