Due to the rising rate environment, the average yield on investments has risen over the last seven quarters to 3.6 percent as of March 2006. Credit union investments have remained relatively short-term, as those with a maturity of less than one year have risen to 57.8 percent of investments from 45.9 percent in June 2004. Given the flat yield curve, credit unions are earning a return similar to what they would earn on longer-term investments and are in a position to reinvest the money should the yield curve normalize.
While average investment yield has picked up, the investment portfolio has declined 5.2 percent over a 12-month period to $210.9 billion. The decline is mainly market driven as loan demand has exceeded share growth, resulting in a liquidity crunch. As of March 31, 2006, the average yield on loans grew to 6.2 percent, 75 percent above the average yield on investments.
The investment portfolio has three primary components:
- Federal agency securities (39.4 percent)
- Corporate credit union investments (16.4 percent)
- Cash at corporate credit unions (15.9 percent)
The investment portfolio composition has changed little over the last few years. Credit unions have slightly lowered their investments in federal agency securities and corporate credit union investments and moved the money to deposits in commercial banks, S&Ls, and savings banks.
Mortgage Backed Securities Offer High Yields
To improve the investment portfolio’s return, credit unions should consider investing in mortgage-backed securities. A mortgage-backed security (MBS) is a bond whose cash flows are backed by homeowners' mortgage payments. There is cash flow uncertainty on the average bond based on prepayment speeds.
MBS investments may pay principal, interest or a combination of the two. Based on the loans/shares ratio of a credit union, mortgage backed securities can be selected so that the credit union maintains sufficient liquidity.
“We look for yield and consider the average life of the securities when evaluating which to purchase,” said Terrie Wollard, CFO of Gulf Coast Educators FCU ($238m in Pasadena, TX). “If interest rates are low, we expect the security will pay back faster so that it wouldn’t make sense to buy it at too much of a premium. Alternatively, if interest rates are rising, we expect prepayment speeds will slow, allowing us to consider buying a MBS at a premium.”
If liquidity is a primary concern, there are approaches to frequently return yield to the institution. “Credit unions can choose to ladder their mortgage backed securities up to a two-year period,” said Peter Duffy, associate director at Sandler O’Neill & Partners, L.P. “The ladder guarantees that credit unions will generate cash flow on a regular basis.”
While many credit unions have been cautious about investing in mortgage-backed securities since the broker investment scandal in the early 1990s, the NCUA currently allows credit unions to invest in certain types of mortgage-backed securities. Investment experts expect the NCUA will further relax MBS regulations in the coming months, as the topic was on the spring 2006 meeting agenda.
To hear from leading credit union executives who have evaluated and decided to invest in certain types of mortgage-backed securities, check out Callahan & Associates’ September webinar, Optimizing Investment Performance by Using Mortgage-Backed Securities.