PLANO, Texas (1/13/12)--Catalyst Corporate FCU in Plano, Texas, has three investment resolutions that it says credit unions should follow in 2012. They are: Don't wait for rates to rise--stay invested; don't get lazy with liquidity; and don't fall for the "bond of the day."
While everyone would like to see improvement over 2011, many factors that are beyond credit union control--such as Europe's continuing debt crisis, the November U.S. presidential election, and the nation's unsolved budget problems in Washington, D.C.--have the potential to sidetrack economic progress, the corporate said.
Most credit union leaders have some concern about what to do with the growing investment portfolio that has replaced what used to be a healthy loan portfolio. Even seasoned investors have found themselves in a quandary over the mismatch of basic lessons from Economics 101, according to Sarina Freedland, senior investment officer at Catalyst Strategic Solutions.
"We are beginning to see glimmers of progress in economic growth that would tempt us to believe we are at the beginning of a growth cycle that would lead to higher interest rates," Freedland said. "That means buying short-term investments, right? However, we have heard many times over the Federal Reserve's intentions to keep interest rates at extreme low levels until mid-2013, not to mention the European Central Bank's recent move to actively lower interest rates. So, that means locking up yields for longer periods."
Credit union managers struggling to make sense of these mixed messages have reason to be optimistic, Freedland said.
"A year ago, earning even the slightest margin over cost of funds seemed impossible," she explained. "However, most credit unions managed to eke out enough return to satisfy examiners and members. But, credit unions will continue to rely heavily on investment portfolio income to replicate revenue streams. Currently, every $1 in loan principal received requires $2.65 in investment principal."
Freedland offered credit unions three resolutions to maximize investment returns in 2012:
1. Don't wait for rates to rise--stay invested. Rates have been at their lows for a long period. Recent job reports show net job gains, and housing sales gaining traction rather than falling. Given this scenario, a prudent investor might think it best to hold onto cash rather than lock in low rates. Most individuals believed this a year ago, too, but rates continued to fall throughout 2011.
Staying in cash in hopes of higher rates will only rob credit unions of needed interest income. Investing in a two-year agency at 0.65% could earn an additional 40 basis points over what the credit union would earn by keeping liquid funds in cash, or $4,000 for every $1 million invested (in the first year). If the credit union stays true to its investment ladder with call and maturity dates evenly spread out, it is protected and will have funds to invest when rates do make the turn. Freedland said.
2. Don't get lazy with liquidity. Credit unions added close to $400 billion in new balances in 2011, an increase of 5% in the 12 months ending September 2011. The Credit Union National Association is forecasting another 5% share growth for 2012, while also predicting a 3% increase in loan demand. If reports from retailers about holiday shopping trends are any indication, credit unions could see improvement in loan demand. It remains to be seen whether holiday shopping trends point to improving loan demand, or if high unemployment will hold the line on members' big ticket spending. Maintaining adequate liquidity could be trickier in 2012, said Freedland.
Although today's liquidity profile is strong, credit union managers must continue to protect their long-term cash needs, the consumer is fickle and can change buying habits abruptly due to sales promotions, government tax provisions, even the prospect of landing a new job, the corporate said. Portfolios must be managed proactively through 2013, setting aside a reasonable cushion of available funds and paying greater attention to the investment ladder, it added.
3. Don't fall for the "bond of the day." The bond-of-the-day strategy won't work in 2012, said Catalyst. Credit unions will need to become more selective in their purchases. This year, the structure will be as important as the coupon. The credit union may have to give up a higher coupon to gain some protection. Common sense says to buy along the yield curve, keep a close eye on short-term needs, and watch the portfolio cash flow structure closely, the corporate added.
Choosing portfolio duration is not always straightforward. Strategically, investment duration targets depend on the credit union's prevailing loan-to-asset ratio. The lower the ratio, the further out on the curve a credit union should consider going with its investments. For most active credit union portfolios, that means extending out to the three- to four-year area of the curve. Extending much past four years at this time will not provide enough yield to make up for a lack of liquidity, the corporate concluded.