Though Structured Certificates May Rebound In A Rising Rate Environment
Despite tightening liquidity during 2004, a hunger for investment opportunities
remained strong last year, though it is clear that credit union managers’
appetite shifted toward fixed maturity instruments.
Among the assortment of investment opportunities, the most common form of certificates
of deposits investments come in two flavors: "structured certificates"
and "bullet certificates."
The structured certificates, with their potentially higher returns, were favored
in 2003. However, credit union managers turned in the direction of "certainty"
during 2004 by investing more into fixed-maturity, bullet instruments. The percentage
of bullet-style certificate of deposits shot up from 38 percent in 2003 to approximately
54 percent in 2004, according to one source. That investment strategy shift
that started in 2004 will likely continue into 2005.
The shift from structured certificates to bullets over the past year is attributed
to credit unions preparing for the liquidity runoff resulting from an improving
economy. Credit union managers stayed relatively short. There is not much yield
pickup or flexibility when investing in structures with short maturities. So
credit union managers opted for bullet investments.
Another reason for the shift may have been a result of the "callable"
feature embedded in many of the structured CDs. The callable aspect can terminate
the investment instrument if rates tumble. That happened with some frequency
in 2003, thus making some investors a bit reluctant to try the structured certificates
in 2004, despite the potential for higher returns.
And finally, another contributing factor to the migration toward bullet investments
was that higher returns were offered as the Federal Reserve started tightening
its monetary policy. It is likely the trend for bullets will persist in early
2005 as there is expected to be lower volatility in the market, a flatter yield
curve and continuing liquidity concerns. These factors might encourage credit
union managers to stay relatively short.
Credit union managers should re-evaluate their decisions frequently. Callables
do perform better than bullets in a rising-rate environment, which we are currently
facing. Different types of structured products satisfy different needs. More
sophisticated products such as step ups, fixed-percentage paydowns (sinking
CDs) and prepayment-linked notes work well when credit union managers have liquidity
Looking into 2005, there are also structures that provide benefits to credit
unions as the yield curve slopes upward. Credit union managers might also want
to look at the capped floaters (with or without call options). They look good
as the curve continues to flatten and Treasuries look so rich.
If allegations of accounting manipulation and reports of inadequate capitalization,
coupled with potential congressional actions and SEC investigations of FHLMC
and FNMA make you concerned, you might want to place your investments in a less
volatile arena. Avoiding "headline risk" and finding certificates
of deposit that provide sound diversification and structure flexibility are
ways to minimize risk.
Organizations like Southwest Corporate Federal Credit Union provide such an
alternative to agencies. Not only are there a variety of investment solutions
to meet the varying needs of credit unions, the instruments provide higher yields
than agencies. Southwest Corporate beat agencies – both on bullet and
structured product fronts – by 10-25 basis points.
Southwest Corporate has the expertise and infrastructure to satisfy investments
needs at credit unions. For instance, many brokers for agency instruments only
take reverse inquiries on orders greater than $25 million, while Southwest Corporate
has a much lower threshold. Southwest Corporate provides sound choices and appealing
flexibility aimed at making the investment function easier and more profitable
at credit unions.
For more information about the special investment opportunities offered by
Southwest Corporate, contact the investment department at 972-861-3000 or visit
online at www.swcorp.org
(Southwest Corporate Federal Credit Union is an $8 billion Dallas-based institution
serving the financial needs of its more than 1,200 member credit unions.)