By Jason Williams, Financial Analyst
One of the terms that comes up regularly in audit and regulatory exams for credit unions is "liquidity." As you evaluate investments, and consider your overall investment portfolio needs for your credit union, liquidity can be an important factor.
What IS Liquidity?
Basically, liquidity is the ability a credit union has to convert any security or investment into cash quickly. Many credit union management teams don’t always remember some of the important considerations relative to liquidity in the investment portfolio. In fact, some credit unions don’t even consider their ability to sell a security after they have purchased it, should the need arise. Some credit union investment options have very low transaction costs and very active secondary markets with lots of buyers. Other credit union investment options have much higher transactions costs and inactive secondary markets with few buyers. There are also credit union investment options that don’t have a secondary market at all. When you're talking about investments, your liquidity is basically how "easy" it is to buy and sell. Even if a credit union intends to buy and hold to maturity all of the securities in the investment portfolio, owning securities that have active secondary markets and active pricing can be great information for the credit union to use in measuring interest rate risk. Getting information about the value of securities on a regular basis after you purchase them can be really important to managing your investment portfolio successfully over time.
Cash is among the most liquid of assets and the lifeblood of a credit union. Depending on the asset class and interest rate environment, securities and investments might not be as easy to convert into cash. If your credit union has large portions of the investment portfolio invested in non-negotiable CD’s, it may not be very easy to tap into that value—especially if we experience another liquidity event similar to the one we experienced in 2008. If there are several credit unions all trying to break non-negotiable CD’s at once, liquidity may be very hard to come by even with steep penalties.
The Importance of Liquidity and How to Access It
It is a fact that credit unions by nature will hold large portions of their balance sheets in illiquid assets (loans to members). As an offset to this fact, it's important to consider having some or all of your investment portfolio in assets that you can sell if needed.
Many, but not all securities that credit unions invest in have liquidity. There is an active secondary market for assets such as U.S. Treasuries, U.S. Agencies, Agency Mortgage Backed Securities, and negotiable CD’s. Non-negotiable CD’s, non-agency mortgage backed securities, and loan participations typically do not have active secondary markets.
As credit union loan portfolios are the most illiquid parts of your balance sheet, it pays to consider secondary liquidity options on the investment portfolio at the credit union. In fact, holding a percentage of your investment portfolio in securities such as treasuries and bullet agencies could be part of your credit union emergency liquidity plan. An awareness of how bonds trade and access to a couple of different pricing sources and brokers or an investment advisor is also very helpful in investing your portfolio for liquidity.
As you manage your investment portfolio, don't forget to consider liquidity. And don't forget about liquidity in other areas of your credit union (backup liquidity facilities, lines of credit, etc.) You might be tempted to buy securities and investments based solely on investment return. But when it comes time to sell, you might be surprised by how differently brokers of securities price your investments or if there is an offer to buy them at all. In the case of some securities like non-negotiable CDs, private mortgage backed, or loan participations, secondary liquidity is limited or non-existent.