Publications & Resources

January/February 2009
Focus: Funding & Liquidity

Creating a Contingency Funding Plan 

By Karl Nelson

If one were looking for a “Perfect Storm” in terms of the financial services industry, we would be hard pressed to find anything quite like 2007-2008. Certainly, we have seen actions taken by our Federal Reserve and Treasury that few would have contemplated prior to this time. This period has also elevated our understanding of the “L” in CAMELS and heightened concern about finding sources of funds in difficult times. It was December of 2005 when this writer first saw increased attention to this issue from the FDIC. This issue was raised in a Funding Workshop in Atlanta in a discussion of Liability-Based Liquidity and has become increasingly important since that date. The key to this discussion turns out to be a Contingency Funding Plan (CFP). For many of us, this represents an expansion of Ratio Analysis to a more proactive and complex concept and better prepares us for a true liquidity crisis.

Creating a Contingency Funding Plan is one of our more challenging tasks in that we are being asked to contemplate events that we have rarely, if ever, witnessed in our banking careers. As such, we must have a clear understanding of the various funding sources that go beyond traditional core deposits. And, for many, this also translates into identifying and adding these sources to our arsenal of funding concepts. These “wholesale funding” sources or techniques are already in use by many banks – Federal Home Loan Bank Advances, Brokered Deposits, CDARS, and Fed Funds to name a few. However, for purposes of the CFP, we are being asked to look at these sources in a new way. For example, for those who lean toward brokered deposits, your CFP may contemplate dropping below “well capitalized” and losing this funding source. What would you do to replace these deposits? So, what does this CFP look like for community banks?

My sample CFP starts with an Overview that describes the various wholesale funding sources that I have lined up to support my liquidity program. These include both the type of funding source as well as limits I place on each one. Overall, I place a 40% (of assets) maximum on these sources and break that down with FHLB Advances (25%), Brokered Deposits (25%), CDARS (15% - encompassed in Brokered category but separated due to their “customer” concept), IDC Deposits (10% - same idea as CDARS), Repurchase Agreements (15%), Fed Funds Purchased (15%), Internet CDs (15%), and Discount Window (20%). Obviously, staying within the overall 40% limit is crucial to this issue. I then describe each of these sources including information on what kind of facility I have with each, how much I use, who I call, etc. The depth of this information is important as you must show these are real sources of funding for you. In my CFP, I then describe the role that both my securities play in creating liquidity as well as how I might use participations to sell loans. I am, however, careful to note the fact that these sources may not be available in certain more dire situations. My CFP Team comes next and this is where I fully describe each member of this group along with phone numbers, addresses, and responsibilities. I think that this team should have members who cover all constituencies in a liquidity crisis – local press, shareholders, directors, employees, etc. 

The final issue in my CFP is to describe three scenarios – one is my “normal” cash flow view of the next 12 months (month by month). My second cash flow is a short-term, external crisis that could impact my liquidity. I believe that this event can be shown as short-lived, perhaps 2-3 months, and is the result of something external to my bank. Examples include natural disasters, PR events involving a competitor that play badly on banking in general, etc. In this scenario, I look at finding new funding equal to 10% of my bank's assets and am confident that most of my Funding Sources will work in this event. My third and most difficult scenario is one that is internal and longer in nature. This is my bank moving from a CAMELS 1 to 5 rating over an extended (12 months) period of time. In this scenario, I will have to find funding at 20% of assets and must be careful not to include those sources that will disappear in this kind of situation. For instance, your Fed Funds facilities will, likely, disappear or be tightened considerably in this scenario and including them is your solution may not be appropriate. This final scenario is, clearly, the most difficult to describe but is the one that “saves” you in your most dire of circumstances.

Creating your own CFP is hard work and will test both your board and management in a way that may be useful in best understanding a true liquidity crisis. By creating this now, I believe you will be one step ahead of your regulator and will find the exercise useful for your bank. For those who would like a copy of my sample CFP, please email me at knelson@silvertonbank.com and ask for the plan.

Karl Nelson is senior vice president and director of industry and governmental relations for Silverton Bank, N.A. in Atlanta GA He can be reached at  770-805-2265 or knelson@silvertonbank.com.

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