So, the economy may still have a little kick left in it after all. At least that’s the implication of some of the recent economic releases. New home sales last week were a bit stronger than expected, as was the fourth quarter GDP report. But what does all this mean for interest rates as we enter 2007? If you are of the opinion, and we’ll make this case here, that rates will be declining in 2007 – albeit a little later than previously thought -- callable investments may be just the tool needed to offset declines in lending revenues.
It wasn’t but two short months ago that nearly every prognosticator in America was convinced that we were heading for an economic slowdown and then a decline in interest rates. We heard it from all sides: “the housing sector is weak,” “significant job losses are inevitable in 2007,” “…the Fed will have to cut rates by springtime.”
So what happened? Did anything happen? Well, the short answer is that much of the bad news, (that is to say news that can, should, and will cause interest rates to decline) is still pending. Note the word is pending, not cancelled.
As a closer look at the numbers will show, there’s still sound reasoning behind the scenario that has rates declining in 2007. Yes, GDP came in a little stronger than expected, but this is only a preliminary number and may be revised significantly. We received a report last week on surprisingly robust new home sales, but much of the gain was due to unseasonably warm weather. Besides, we got a surprisingly weak existing home sales number just the day before. The clincher is that all of this data relates to 2006 activity and has little bearing on today’s economy.
If there is weakness on the horizon, especially in the housing sector (to the tune of perhaps 800,000 jobs lost this year in that sector alone) it may be difficult to gain any traction in lending.
This is where it can get tricky for investment managers. It’s likely that funding costs for most credit unions are running higher than expected at this stage as a result of rates holding to higher levels than was expected during the autumn planning season. Depending on your lending volumes, which may be lagging as well, this could be the right time to consider some callable investments.
Callable investments pay higher rates than traditional fixed maturity investments. The give up, of course, is that if rates decline, the issuer will be giving you back your principal in a lower rate environment. However, this may turn out be just the right time. Should rates begin to wane, it is expected that there will be quite a bit of refinance activity in the real estate mortgage sector. This should coincide with the repayment of your principal on the callables—a convenient (though admittedly not perfect) funding mechanism.
In addition, even if your callables don’t get called right away (say, due to longer lockouts) you can still pledge them for borrowing at 100 cents on the dollar. And don’t forget the additional 40 to 60 basis points you’ll be receiving while you wait. So if you find your credit union in this situation, sort of “riding out the storm”, this may be just the short-term medicine you need to keep your revenues on track in 2007.
WesCorp is America’s largest corporate credit union with approximately $29 billion in assets and more than 1,000 member/owner credit unions throughout the United States. If you would like to find out more about callable or other investments available from WesCorp, please call (800) 442-4366, ext. 6307, or visit www.wescorp.org.