Texoma Community Credit Union

Asset Liability Management & Investment Policy

I. PURPOSE OF ALM MANAGEMENT POLICY

II. OBJECTIVE OF POLICY

III. ALM COMMITTEE

IV. CAPITAL (NET WORTH)

V. INTEREST RATE RISK

VI. CASH MANAGEMENT

VII. BORROWINGS

VIII. SALE OF LOANS

IX. INVESTMENTS

X. CREDIT RISK

XI. CONCENTRATION RISK

XII. AUTHORIZED INVESTMENT SERVICES

XIII. SAFEKEEPING AGENT

XIV. CAVEATS

ALM COMMITTEE AGENDA

BOND RATING SYSTEM

I. PURPOSE OF ALM MANAGEMENT POLICY

  1. The ALM Management Policy (Policy) provides guidelines and objectives for the management of interest rate risk within the credit union’s balance sheet. The goal of properly managed interest rate risk is to properly protect the underlying capital of the balance sheet (net worth).
  1. Interest rate risk exists in the relationship between earning assets and cost bearing liabilities (borrowings and members’ shares and deposits). The goal of managing interest rate risk is to maintain an efficient spread between interest income and cost of funds through proper pricing, understanding the impact of duration, and strategic placement of products in the local market.
  1. Ancillary to interest rate risk are other risk factors that can impact capital. Liquidity risk, credit risk, and concentration risk are inherent in both assets and liabilities. Proper recognition and management of these risks are as essential to the preservation and growth of net worth as is the management of interest rate risk. This policy recognizes these risks and urges the management of these risks while managing interest rate risk tacitly if not overtly stated within these pages.
  1. The Policy also sets forth guidelines and restrictions for investment transactions that are essential in identifying and controlling risks arising from investment transactions.

II. OBJECTIVE OF POLICY

  1. The objective of this Policy is the safeguard the safety and soundness of the credit union balance sheet and the operations reflected in the balance sheet. This objective is met by the following:
  2. Protecting and maintaining an adequate level of capital,
  3. Identifying and managing interests rate risk,
  4. Setting guidelines for liquidity levels,
  5. Identifying suitable investment vehicles,
  6. Setting guidelines for concentrations, and
  7. Establishing ALM oversight through the ALM Committee.

III. ALM COMMITTEE

A. This policy establishes an ALM Committee charged with the responsibility to prosecute the purposes and objective of this policy. The Committee may consist of any number of persons as deemed desirable at any time but must include two (2) members of the Board of Directors (at least one of which must be a table officer)(and never more than three (3) so as to not consititueconstitute a quorum of the Board), plus the Committee is represented by the credit union President, Chief Financial Officer, Chief Operations Officer, and Chief Lending Officer and Assistant to the President shall serveserving as Secretary (as a voting member of the Committee. The Committee may also include a qualified individual from the membership at large. All members of this Committee shall have an equal vote in the matters of the Committee. A simple majority of the members present is sufficient to pass a motion. Guest may be invited by the Chairman. The following guest(s) are regular attendees: Lauren McKechnie, Marketing Director.

B. The Committee will meet as needed but at least one time quarterly prior to the regularly scheduled meeting of the Board of Directors. The Committee will follow its agenda (Appendix 1) and keep minutes of its meetings that shall also be distributed to the members of the Board of Directors.

C. A quorum must be present to conduct the business of the Committee. A quorum consists of three members, one of which must be a member of management and one of which must be a director. The president of the credit union serves as the chair of the committee and the ranking table officer director serves as the vice-chair.

IV. CAPITAL (NET WORTH)

  1. Capital in this Policy is defined as net worth and includes the Regular Reserve, Unrealized Gain/Loss on Available for Sale Securities, Undivided Earnings, and current Net Income.
  1. TCCU recognizes that the balance sheet is a dynamic document and ratios within the balance sheet will fluctuate with conditions in the market and as strategies are applied. For this reason, this Policy seeks to maintain net worth within a range from 11.0% to not more thanof 10%- 12%. This range suggests an optimum net worth ratio of 10% but allows for fluctuations due to growth or other environmental causes.
  1. At all times the net worth ratio must remain above 7% in order to comply with Prompt Corrective Action rules. Should the net worth ratio drop below 7%, the credit union must take immediate action to raise the ratio above 7%. In this event, the Committee is charged to develop and document a planfor Board approval to restore the net worth ratio to at least 7% promptly.
  1. If the net worth ratio reaches and/or exceeds 12% the Committee must make a recommendation to the Board of Directors on whether to allow the ratio to exceed 12% or to reduce the ratio to around 10% through growth or fiscal means (such as capital purchases, interest rebates, or bonus dividends).

V. INTEREST RATE RISK

  1. Interest rate risk policy guides the management and Board of Directors (Board) in the decision making process regarding lending, investment activities, and dividend policies. It plays a critical role in balance sheet management. It is TCCU’s policy to avoid undue interest rate risk by managing mismatches in the rate sensitivities of earning assets and funding sources to reasonable limits as established in this policy. The Committee will monitor interest rate risk at least quarterly during each fiscal year. Risk Measurement methods include:
  1. GAP Analysis (short-term):
  2. Cumulative six-month repriceable GAP to total asset ratios (ie: GAP ratios) within 10% implies a matched balance sheet from a short-term perspective. This is a very desirable positon.
  3. GAP ratios of+/- 25% are considered low risk, from a short term interest rate risk perspective. This is a desirable position.
  4. Cumulative 6 month GAP ratios of +/-35% are to be avoided.
  5. Whenever a GAP ratio exceeds these limits, the ALM Committee will monitor TCCU’s GAP ratios monthly and present to the Board at its next regularly scheduled meeting a plan to bring TCCU’s GAP ratios into compliance within the next 6 months.
  6. Net Interest Income Simulation (Long-term):
  7. Longer term interest rate risk is measured through the modeling of interest rate shocks ranging from negative 300 basis points (bps) to positive 300 bps using a 12 month Income Simulation. An interest rate shock illustrates the impact on interest income when cash flows from assets and liabilities are repriced at the level of the shock. This produces a change in the amount of income and cost of funds according to the amount of the shock and adds those streams into the remaining cash flows over the period of the shock. The effects of the shock are stated in terms of the percentage of change in the net worth ratio as the result of the new income and cost streams.
  8. Interest rate risk is of concern when interest rate shocks decrease net worth significantly. This can happen in either rising rate markets or falling rate markets and if repricing gaps are either negative or positive. It is common for shock tests to project decreases in net worth, which is in itself of no particular concern; it is the degree of decrease that is of concern. The parameters for defining the degree of interest rate risk for the balance sheet are:
  9. Low Interest Rate Risk: at 300 bps shock the change is less than or equal to 20%.
  10. Medium Interest Rate Risk: at 300 bps shock the change is between 20% and 30%.
  11. High Interest Rate Risk: at 300 bps shock the change is equal to or greater than 30%.
  1. In addition to these change factors in net worth, these changes should be weighed against the value of net worth coming from the shock. For example, the change might be negative 35% indicating high interest rate risk but the resulting net worth ratio may still be within the acceptable net worth range. In such a case, the impact of this interest rate shock should be examined over a period greater than one year as it may turn out that the interest rate risk is mollified by cash flows beyond one year.
  1. The credit union’s optimum net worth is identified as 910% (see CAPITAL, above). A drop in net worth to 7% (NCUA threshold for well capitalized designation) is a negative change of 22.22%. This amount of change would place the balance sheet in a Medium Interest Rate Risk profile. A drop in net worth to 6% (NCUA threshold for adequately capitalized designation) is a negative change of 33.33%. This amount of change would place the balance sheet in a High Interest Rate Risk profile.
  1. Based on the above data, this policy requires the balance sheet to have an Interest Rate Risk profile not greater than Medium Interest Rate Risk at a change value that does not reduce the net worth ratio below 7% over two years.
  1. A single period shock test of 300 bps that projects a net worth ratio under 7% will not require corrective action. Management must identify and evaluate the causes of this change and monitor balance sheet activity during the next 90 days at which time another shock test will be applied to the balance sheet. If the projection is still a net worth ratio under 7%, the Committee must report this fact to the Board of Directors and recommend a plan of action to adjust the net worth projection at a 300 bps shock to 7% or greater on a two year horizon.

VI. CASH MANAGEMENT (Liquidity)

  1. Cash management is the first line of defense in liquidity risk. Catalyst Federal Corporate Credit Union (Corporate) is the designated depository for the credit union. As such, it is the designated place of presentment for cash items drawn against the credit union. The credit union will maintain a Cash Management Fund (CMF) for processing routine financial transactions, a Performance Tiered Account (PTA) for the purpose of a cash reserve, and an Excess Balance Account (EBA) through the agency of Corporate for the purpose of transferring excess balances of the balance sheet of Corporate.
  1. The Chief Financial Officer or designate (CFO) will monitor cash flows and determine an average balance to maintain in the CMF. This amount will be the primary liquidity to maintain on a daily basis to fund all transactions through the CMF.
  1. An amount not less than the average balance of the CMF will be maintained in the PTA as a cash reserve to fund unusual or seasonal fluctuations in the balance of the CMF. The PTA will be used also to store funds on a temporary basis that exceed the required amount. This excess cash would be held temporarily for anticipated loan volumes, anticipated deposit withdrawals, or future investment purchases.
  1. The maximum combined amount that may be held on deposit between the CMF and PTA is 300% of the credit union’s net worth if the net worth designation of Corporate is well capitalized under the rules of the NCUA.
  2. If the net worth designation falls into the adequately capitalized designation, the maximum amount that can be held in both the CMF and PTA cannot exceed 200% of TCCU’s net worth.
  3. Swept funds placed in the EBA at the Federal Reserve Bank are not counted in the amount deposited with Corporate.
  1. An additional cash reserve may be maintained in the form of a maturing investment ladder. The investment ladder should be structured so that an amount equal to one-half of the primary liquidity need matures every month. If this part of the reserve is not needed for liquidity purposes, it may be reinvested in other investment vehicles.
  1. Therefore, the cash management requirements require an amount equal to two-and-a-half times the average balance needed according to the cash flow model. A negative variance 15% will be tolerated and there is no limit to the amount of a positive variance.
  1. Liquidity is determined to be “tight” when the Loans-to-Shares ratio exceeds 94.00% for three consecutive months. (This is increased from 92.00% to 94.00% as TCCU has managed exceptionally well with a “tighter” liquidity ratio. In the prior several years there has been almost never rarely been an occasion to even access the first tier of liquidity.) When Loans-to-Shares exceeds 92%, Management shall discuss a solution among themselves. When Loans-to-Shares exceeds 94%, Management shall present to the ALM Committee alternatives and recommend to the Board solutions to relieve the tight liquidity.

VII. BORROWINGS

  1. The credit union is authorized to enter into both short-term and long-term borrowing arrangements. Short-term borrowings are limited to line of credit borrowings from Corporate to fund shortfalls in the CMF. Such shortfalls would happen only if the PTA and maturity ladder have been depleted. Long-term borrowings are funding sources to support loan demand. The Federal Home Loan Bank of Dallas (FHLB) is authorized in this Policy as the source for longer-term borrowings.
  1. Line of credit borrowings can happen automatically should the CMF become overdrawn. In the event of a line of credit transfer, the CFO will determine if the need for the line of credit advance will be of short duration or if other liquidity arrangements are necessary and report this information to the credit union President. Additionally, anticipated shortages can be funded through the Advantage LOC by moving funds prior to overdrawing the CMF account. If the borrowings will be needed for fifteen days or less and is less than the amount of the line of credit, no other action is necessary other than to repay the line of credit after the liquidity has been refreshed. If the need for borrowing extends beyond fifteen days, the CFO will determine strategies to replenish liquidity and report this information to the credit union President. Such strategies could include, but are not limited to, such things as selling loans, redeeming investments early, taking on deposits, or seeking long-term borrowing.
  1. Long-term borrowings from the FHLB are for the purposes of supporting loan demand. Wholesale borrowing is usually more cost effective than buying funds in the local market or externally through deposit brokers. The President and/or the CFO are authorized to enter into borrowing transactions with FHLB as approved by the Board of Directors. Funds borrowed from FHLB are transferred to the CMF by wire transfer.

VIII. SALE OF LOANS

  1. Selling pools of loans from the credit union’s loan portfolio can be an advantageous way to manage both interest rate risk and liquidity risk. There are active secondary markets for both automobile loans and mortgage loans.
  1. Selling loans addresses interest rate risk in two ways. First, in a rising rate environment, the credit union can sell loans at a discount to reinvest the funds in higher rate loans. The discount is a cost to the bottom line that must be offset and exceeded by the increased rate of return on the portfolio sold. Loans may be sold to a buyer to yield a return less than the weighted average yield of the portfolio. The residual interest collected on the loans increases the yield on the loans replacing the pool that was sold. If loans are sold to fund deposit withdrawals, the cost must be less than the dividend (interest) saving on the deposits withdrawn.
  1. Mortgage loans can be sold when the interest rate environment is rising to replace low interest rates with higher interest rates on new mortgage loans. These loans will usually be sold at a discount and for the purpose of reinvesting the funds in new mortgage loans that bear higher interest rates than the mortgages sold.
  1. The CFO will determine funding strategies through the budget process. If it has been determined that selling loans is a viable funding strategy under the budget and such selling of loans is approved by the Board of Directors through their approval of the budget and a later resolution to sell such loans, the President is authorized to search out suitable buyers and negotiate the sale of loans.

IX. INVESTMENTS

  1. Investments are intended for a long-term storage of excess liquidity for periods longer than one year. The total amount of investments will vary depending on the asset size of the credit union and the loan-to-deposits ratio. As this ratio increases there is less need for investments and as it decreases there is a greater need for investments. As total assets increase over time the actual amount of static investment dollars will automatically increase and the nature of investment vehicles must adjust to accommodate this relationship and to improve the yield from the portfolio.
  1. Permissible investments are authorized for credit unions under the Texas Financial Code, Title 3, Subtitle D, Chapter 124, Subchapter H, Sections 124.351 and 124.352.