Credit union balance sheets taken on a wild ride in last 18 months

WEST PALM BEACH, Fla. – The past 18 months have been quite a roller-coaster ride for CU balance sheets. The story in 2000 was loan growth. Loans were up 11%, or about $30 billion, while shares increased just 6.3%, or $22.3 billion. This year the scenario is reversed. NCUA’s 2001 first-quarter data for CUs with over $50 million in assets shows deposit savings up 6.7% to $325 billion, with loans drying up to just a 0.27% increase. Some say this is nothing more than the ebb and flow of credit union balance sheets and ALM management, however the extra twist with the current situation is the low-rate environment. Credit unions, often reluctant to lower rates on administered rate deposit accounts, are being forced to as the Fed has trimmed the Federal Funds rate to 3.75%. Often investments are called on to pick up the slack when there is a dearth in loan growth. “I think that these last 12 months are a big reason why so many credit unions are looking with a little bit more attention at what can be done with the investment portfolio. Part of the reason there was a liquidity issue in the industry was the lack of cashflow off the investment portfolio due to overpurchasing on callables, callable corporate certificates and agency bonds from brokers,” said Peter Duffy, senior vice president of investments for First Empire Securities, Hauppauge, N.Y., a brokerage firm that serves about 1,200 credit unions. Duffy said as rates have plummeted credit unions that were attracted by the attractive short-term yield of callables found those investments called away leaving them with a lot of money to invest in a lower short-term rate environment – a lesson learned for the future if the scenario repeats itself. Duffy says credit unions now have to move more of their investment dollars longer term. “Sixty to seventy percent of the average credit union investment portfolio matures in under one year. They’re competing with banks that have 60-70% maturing in greater than one year,” said Duffy. “Credit unions know they can’t give away yield. Margins are tightening. They have to go down the middle with things like three to four-year mortgage-backed securities,” said Duffy. Investing heavily in short-term callables earlier this year and late last year could now be looked at as riskier than going farther out on the curve, said Duffy. “Callables put you in the rate guessing game too much. You’re guessing a lot about when they’ll change, and guessing when the next loan spike will be.” Duffy stressed, however, that like any investment there are good and bad mortgage-backs, and CUs need to find quality ones or they can run into trouble. Duffy maintains that CUs have to be educated that they can still go longer with a portion of their portfolio and have enough liquidity to meet a spike in loan demand. He recommends his CU clients have 20-40% of their portfolio in mortgage-backs, depending on what the CU’s individual balance sheet looks like. Some credit unions are going the mortgage-backed route. “We’re mostly in mortgage-backed securities,” said Bobbi Olson, senior vice president of finance for the $744 million IBM Mid-America Employees CU, Rochester, Minn. “We get enough cash flow off of our mortgage-backs and CMOs. The cash flows are pretty steady. We don’t do any treasuries right now. We do have some agencies in the two-to-five-year range,” said Olson, who said the CU does very little with the corporate CU system. The CU has a $300 million portfolio. The $3.2 billion United Airlines FCU, Chicago, is also dabbling in mortgage-backed securities, but very cautiously by avoiding extension risk. “We are certainly looking ahead. We’re not concerned about the current rate environment. We’ve added a lot of LIBOR-based floating instruments, and added a bit of seasoned higher coupon collateral mortgage-backs,” said Tom Moore, senior vice president of finance and administration for United Airlines FCU. Moore manages the CU’s $1.5 billion investment portfolio. Moore said buying very seasoned mortgage-backed securities mitigates the CU’s extension risk to only a couple of years. The rate environment hasn’t changed the CU’s investing philosophy much. “You have to modify a little bit on the rate environment, but there’s no knee-jerk reaction on this one. You ride it out, adjusting your funding side, as opposed to aggressively changing the lending side,” said Moore. Bob Burrell, senior vice president, chief investment officer for WesCorp, said whether it’s mortgage-backs, agencies, corporate CU certificates, treasuries, overnight accounts, etc., credit unions should have a balanced investment portfolio. “Financial institutions are in the business of managing their balance sheets. You have to take that seriously. Understand what each component of the balance sheet does and how it performs. Don’t bet on one thing happening. You should know you’re not going to keep hitting home runs out there, work out what can go wrong,” said Burrell. “There’s a group of credit unions that always invest in mortgage-backed securities. You need to do a lot of homework. Sometimes people rush in and buy for good current yield, and don’t look at all the risks out there,” said. Burrell said mortgage-backs are attractive to some CUs right now and can play a role in an investment portfolio, but CUs shouldn’t get caught up in the hot investment. Burrell lived through the 1993-94 period where mortgage-backs were hit hard by a big refi wave when the Fed Funds rate dropped. In general, Burrell said CUs shouldn’t have all of their eggs in one basket. They shouldn’t have all of their excess liquidity hanging out in daily corporate accounts; shouldn’t completely jump out of callables because of all that’s been called away; and shouldn’t shy away from mortgage-backs as they can play a role. Corporates can be used to give CUs a taste of mortgage-backs by synthetically creating them for CUs, said Burrell. But he stressed that there is no one size fits all investment strategy for CUs, so these generalities may not fit for many CUs. Burrell also said that philosophy has to be taken into account for credit union investing. He said the CU’s first job is lending money to its members, with the investment portfolio coming second. The $1 billion Portland Teachers CU, Oregon, has added a few mortgage-backed securities to its portfolio. “We are doing more in the way of mortgage-backed securities than we have done in the past to spread the risk a little. We’re pretty conservative, we tend to keep our portfolio short,” said Roxanne Giffin, vice president/CFO of PTCU. Giffin said only about 1-2% of its portfolio is in mortgage-backs and that percentage likely won’t go up. The CU’s loan to share ratio, which went over 90% last year, is still high at over 80%. Its investment portfolio is about $250 million. The CU does do a lot with callable agencies, and is not scared off by callables despite all that has been called away. “They’re so ugly right now, but we keep our portfolio short so we use callables to pick up yield,” said Giffin. In this low-rate period, The Golden 1 CU, Sacramento, is staying true to its laddered investing approach. “We’ve been sticking with our investment ladder. We invest to fill our ladder, which doesn’t require us to guess on rates, which is good,” said Donna Bland, CFO of the $3 billion The Golden 1 CU, Sacramento. Bland manages a $700 million investment portfolio. The Golden 1 CU’s ladder goes out to 2006. Bland said the credit union won’t do any callables with a call less than 18 months given the current rate environment. Like many CUs, The Golden 1 CU saw a big chunk of its investments called away from it this year as rates dropped. If it does invest in callables, it is only investing in callables with euro (one-time) calls, said Bland. Bland said shares were up $70 million in May, but loans weren’t exactly weak, up $40 million. About $508 million of its $700 million is invested in WesCorp. The CU doesn’t do much with mortgage-backs, preferring to do more mortgage lending, putting the risk in the hands of the members. “You’d rather do the risk with your member, than on the investment side.” While some corporate credit union leaders have called on credit unions to take another look at their corporate in order to bring some of the $50 billion or so invested outside the network, back in, corporates themselves recognize that credit unions are justified looking at agencies, treasuries and other non-corporate CU options. “There are certainly a large number of credit unions going outside the corporate network for investment options. I think our approach isn’t that credit unions need to go outside the network, but in some circumstances for some of our members it makes sense,” said Mike Paton, vice president of marketing for Corporate One CU, Columbus, Ohio. But not investing in a corporate certificate or parking money in a corporate’s overnight account, doesn’t take some of today’s savvy corporates out of the game. Take Corporate One for example. It is one of a growing number of corporates offering broker-dealer services through a CUSO. Corporate One’s Primary Financial Company LLC manages about $1.75 billion in investments. About 90% of its securities are agency callables, 4% agency bullets, 4% mortgage-backed securities and 2% discount notes. The chart on page 1 shows that agency securities (41.1%) dominate the investment portfolios for CUs over $500 million in assets. “Relative to corporate credit unions, the agencies have been attractive to a number of credit unions out there. In presentations I’ve made, I’ve seen a better understanding of credit unions to go into callable agencies,” said Bart Salazar, vice president of investments for Empire Corporate FCU, Albany, N.Y. Salazar said the low rate environment showed some chinks in credit unions’ investment strategies. “There was too much of a willingness to become yield buyers, not recognizing the risks of an issuer to call a security away from a credit union. The credit unions that recognized call risk and incorporated it into their overall expectations were prepared,” said Salazar. Not all credit unions look for their investment portfolios to pick up when lending slows down. “To me it’s a matter of staying conservative. We like working with the corporate. We stay short, don’t buy mortgage-backs. The longest thing in our portfolio is two and a half years,” said Greg Smith, President/CEO of the $1.6 billion Pennsylvania State Employees CU, Harrisburg, Pa. Smith takes a short-term approach on the lending side too. “I don’t want to get S&L disease going long. If you go to the phone book and count the number of S&Ls, there’s not many,” said Smith, who likes to sell mortgages to the secondary market and retain the servicing so it’s transparent to members. Pete Pritts, president/CEO of FirstCorp., Phoenix, says no matter what a CU wants to invest in they should look to their corporate first. “I hear about marketable securities being more liquid, but all of our products are redeemable. Agencies are big for a lot of credit unions, yet every corporate offers products that emulate agencies,” said Pritts. Pritts thinks this is a critical time for corporates to let natural person CUs know just how sophisticated corporates have become. “When I look at the demographics in the CU industry, I see a lot of people at an age where they are considering retirement. We have to do a good job letting these new leaders know who we are. We still need help doing this,” said Pritts, who said new CEOs coming from the banking sector won’t hesitate to invest outside the system. First Empire’s Duffy, who personally assists about 70 CUs with investing, said brokerage firms like his often get a bad rap in the industry because they’re portrayed as working for the highest commissions and not being system players. “There are good salesmen and bad salesmen. I want to make as much money on each trade as I can, but I want to look long-term for credit unions so my business continues to grow,” said Duffy. [email protected]