December 22,
2009
Investment Strategy for 2010 –
Invest or Keep Liquid?
Substantial
share growth of 10.4% and loan growth of just 2.7% in 2009 have left credit
unions flush with cash during a period of extremely low investment yields. In
the absence of loan demand, what options do credit unions have for excess
funds?
Three
divergent strategies have evolved, according to Andy Swoger, Senior Investment
Officer with Southwest Corporate Investment Services:
1) Leave cash liquid and wait for increasing rates;
2) Increase holdings of agency callable and mortgage-backed
securities (MBS) bonds; and
3) Increase short-term laddering into bank CD portfolios and
corporate certificates.
Third
quarter 2009 NCUA data shows credit union cash and equivalents swelled 32.8% over
the same period in 2008.
“The
increase suggests many credit union portfolio managers are reluctant to
allocate excess funds in the current low rate environment,” Swoger said. “Unfortunately,
unallocated funds coupled with low interest rates are driving down investment
yields.”
NCUA data
also shows total investments for third quarter 2009 increased 25.5% over third
quarter 2008. In fact, credit union investment portfolios experienced
significant growth in every category, with agency MBS ($12.6 billion), agency
bullets/callables ($12.2 billion), bank CDs ($9.8 billion), collateralized mortgage
obligations ($6 billion), and corporate certificates ($3.3 billion) leading the
way.
“As of
early December 2009, bank CD rates were relatively high compared to agency
bullets and corporate certificates,” Swoger said. “As CD portfolios have grown,
many credit unions dissatisfied with CD yield are looking to agency step-ups
and shorter average life MBS alternatives. In my experience, bank CDs
traditionally provide more value in a declining rate environment due to less
efficient pricing methods (lag), but those inefficiencies are also present when
rates turn around. In a rising rate environment, agency securities and MBS
provide strong relative value due to constant re-pricing.”
Moving into
2010, Swoger anticipates that credit unions will continue to grow and diversify
into agency markets, based on the large shift experienced into these investment
vehicles in 2009.
“Credit
unions are becoming increasingly comfortable investing in agency securities. Generating
earnings is more difficult than in the past, and in a cash-rich environment,
evaluating other investment options may be a good idea. The agency market provides
credit unions the ability to put larger amounts of cash to work with relative
ease,” he said.
As the
yield curve steepened during 2009, portfolio managers began extending out investment
maturities, Swoger said. Investments with maturities less than one year grew
the first half of 2009, but the trend reversed in the third quarter. Investments
with terms of less than one year decreased, and investments with one-to-three-year
terms experienced growth.
“The
Federal Reserve has stated that the depressed economy and slow recovery may
require the FOMC to keep rates low for an extended period. I think credit
unions now realize that in order to pick up yield, they have to move a little
further out on the curve,” Swoger said.
Portfolio
managers should always carefully weigh the high cost of keeping funds liquid
versus the impact of interest rate risk on the investment portfolio, and more
importantly, Swoger said, on the total balance sheet.
A valuable
exercise when analyzing this dilemma is to calculate how much rates would have
to rise for your credit union to break even on holding short-term funds yielding
less than 50 basis points. Retaining excess cash flow in overnight cash
accounts yielding 15 to 25 basis points while waiting for rates to rise may not
be the best alternative, especially for credit unions suffering from slow loan
growth. With economic pundits forecasting low rates the next six months and
slow-rising rates the remainder of 2010, extending duration may be warranted.
Southwest
Corporate, in partnership with CU Investment Solutions, Inc. (ISI), can assist
credit unions with their investment strategies. Access to more than 25
broker/dealers currently makes them one of the largest providers of approved
securities for credit unions. The brokerage service is licensed and regulated
by the Securities and Exchange Commission (SEC), insured by the Securities
Investors Protection Corporation (SIPC), and registered with the Financial
Industry Regulatory Authority (FINRA).
For more information, contact an Investments
Officer at 800.405.7067.
