DULUTH, Ga. — The good news: some credit unions have grown anywhere from 10% to 30% in asset size over the last two months. The bad news: what to do with all that extra cash?
Credit Union Journal turned to the same people credit unions do to find out: the corporate credit union system.
"Credit unions have a ton of liquidity, a ton of deposits. I have heard of credit unions growing 10% to 30% in the last month and a half, so they have a ton of cash," said Cory Johnston, chief investment officer for Georgia Central Corporate CU. "They're investing it, of course, but yields are low on most products. The best yields right now are in brokered CDs. Brokered CDs do really well in a falling-rate environment because they tend to lag what the Fed is doing."
But the biggest — and most tempting — mistake is to chase yield. "Rates are falling so yields are low, and it's very volatile, so we recommend evaluating an investment for the proper structure instead of just looking at the yield because you're flush with cash. The Fed is still in the process of loweing rates, so we're telling credit unions don't buy the yield, buy the structure."
James Toliver, executive director of advisory services at MembersUnited's CUSO Balance Sheet Solutions, LLC, agreed.
"It is not about the yield you buy, it is about the yield you keep," he said. "Keeping too much of your institution's investment portfolio subject to reinvestment rate risk might eliminate market value volatility risk but introduce greater balance sheet risk of margin compression to falling rates."
Stark Contrast
This is in stark contrast to what credit unions had gotten used to. "When we had a flat to inverted yield curve, there was a high tendency to avoid taking market value risk and still get strong yields that overnight investments offer," Toliver explained. "In this environment, many credit unions did not invest excess liquidity when rates were higher so they are now waiting, and in many cases, building cash. Also, loan activity has not been strong so that is contributing to cash build up."
Although credit unions' overnight balances have ballooned, this is hardly a long-term investment strategy, according to Zane Wilson, VP of Southwest Corporate's investment services.
"The slowing economy has reduced loan demand from credit union members and pushed rates lower, prompting callable investments to be redeemed. These two factors have swelled overnight balances," he commented. "Even so, credit unions understandably still find it hard to move funds into the prevailing lower term rates. But credit unions have faced this situation before. And some understand that holding too much liquidity in overnight accounts — in a falling rate environment — is not the best approach."
If timing is everything, then that explains why it's difficult to get it right as the world waits to see just how long the Fed will continue to lower rates.
"We do not try to time markets or make rate bets," Toliver noted. "Overnight investments might play a role in the sector allocation strategy, but not at the expense of maintaining strong and durable margins and equity regardless of where rates are likely to go. Random investment approaches produce random investment results."
Don't Go Too Long
But credit unions should shy away from going out too long, Johnston observed.
"You have to be aware of the threat of inflation, particularly when rates turn around, and when they do, they could go quickly, so you don't want to invest too far out," he offered. "Since credit unions have brought in a lot of deposits, they can extend duration not by going longer on the calendar but by going bigger. We are advocating larger than normal blocks for three to 12 months. You might go as long as 18 months in cushion callables, but we are really trying to limit investments past 18 months."
Johnston said there are some opportunities to be had in Agency Mortgage Backed Securities — the key is to avoid paying too much of a premium and look for a well-diversified portfolio with a pre-2007 vintage.
Wilson agreed, adding "Agency mortgage yields have been attractive with most short term investment spreads at more than 200 basis points over treasuries. But we advise credit unions to avoid large premiums. Credit unions should consider LIBOR-indexed, floating-rate securities that offer a yield that could provide a spread over the cost of funds, as rates rise."
(c) 2008
