PLANO, Texas (12/28/09)--Share growth of 10.4% and loan growth of 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 emerged, said Andy Swoger, senior investment officer with Southwest Corporate CU Investment Services in Plano, Texas:
* Leave cash liquid and wait for increasing rates; * Increase holdings of agency callable and mortgage-backed securities (MBS) bonds; and * Increase short-term laddering into bank certificates of deposit (CD) portfolios and corporate certificates.
Credit union cash and equivalents rose 32.8% over the same period in 2008, according to third-quarter National Credit Union Administration (NCUA) data. “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 indicate total investments for the third quarter increased 25.5% over third quarter 2008. 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, bank CD rates “were relatively high compared with 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,” he continued. “In a rising rate environment, agency securities and MBS provide strong relative value due to constant re-pricing.” Heading 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,” he said. “The agency market provides credit unions the ability to put larger amounts of cash to work with relative ease.” As the yield curve steepened during 2009, portfolio managers began extending out investment maturities, Swoger said. Investments with maturities less than one year grew during the first half of 2009, but the trend reversed in the third quarter. Investments with terms of fewer 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 Federal Open Market Committee to keep rates low for an extended period,” Swoger said. “I think credit unions now realize that in order to pick up yield, they have to move a little further out on the curve.” 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 important, on the total balance sheet, Swoger said. A valuable exercise when analyzing this dilemma is to calculate how much rates would have to rise for a credit union to break even on holding short-term funds yielding less than 50 basis points, he said. 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, he added. With economic pundits forecasting low rates for the next six months and slow-rising rates the remainder of 2010, extending duration may be warranted, Swoger said.