Record Setting Investment Balances Continue to Rise
Callahan Financial Services takes a deep dive into credit union investment trends from the third quarter of 2020.
Following a record setting second quarter, investment balances at credit unions rose 3.4% from June (up by $18.1 billion), totaling $551.9 billion at the end of September 2020. Within the portfolio, credit unions worked to deploy excess cash into traditional investments to mitigate rising earnings pressures following Fed rate cuts in March. Cash balances fell 2.5% from June, while investments in securities and certificates expanded 7.4%.
Despite segments of the economy in varying stages of re-opening this summer, deposit growth continued to outpace historical rates as consumers remained hesitant to resume spending at pre-COVID levels. In total, share balances rose 2.4% from June, and 18.1% over the last 12 months. Keeping with recent trends, core deposits (checking, savings and money market accounts) accounted for 113.4% of inflows, surpassing the 100% mark due to a contraction in certificate accounts. This marks the second consecutive quarter of certificate run-off after peaking in March 2020, as credit unions today face starkly different liquidity challenges than just nine months ago.
Similar to prior quarters, first mortgage gains accounted for the majority of balance sheet growth (73.9%), with balances rising 2.6% from June but below the pace reported from the first to second quarter of this year (3.5%). An uptick in used vehicle lending, rising 1.7% over the quarter for its fourth consecutive quarterly increase, helped push total credit union loan balances 1.6% higher on the quarter and 6.2% higher since September 2019. Aggregate loan portfolio growth was understated as credit unions sought to reduce interest rate risk and take advantage of historically wide margins on mortgage sales; first mortgages sold to the secondary market accounted for 41.2% of year-to-date originations as of the end of the third quarter, its highest level since September 2016.
Agency Allocations Rise as Low Rates Weigh on Earnings
Cash and investment balances grew $18.1 billion in the third quarter to $551.9 billion as credit unions increasingly deployed excess liquidity to Federal agency securities. In total, credit unions reported $186.2 billion in cash balances at financial institutions, of which $134.6 billion was at the Fed and $39.0 billion was at corporate credit unions, up 0.2% and down 6.0%, respectively, since June 30.
Cash at other financial institutions, primarily Federal Home Loan Banks, fell 10.4% across the quarter, accounting for $12.5 billion, or 6.7% of overnight cash balances. In contrast with the first and second quarters of 2020, credit unions have actively worked to place funds that are not being lent into traditional investments in an effort to stabilize investment yields that have trended lower since March when the interest rate on excess reserves (IOER) fell from 1.60% to 0.10% in a matter of days.
Despite their efforts, cash as a percentage of total investments still accounts for 38.3% of total balances, the second highest level on record that was set in the second quarter at 40.6%. Beyond cash, nearly every other segment of the investment portfolio expanded on a linked quarter basis. The largest gain was seen in Federal agency debt, with MBS investments expanding 10.0% ($14.4 billion) and non-MBS securities growing 11.5% ($5.8 billion). Mutual fund investments posted the third largest percentage increase in the quarter, growing 7.5%, due to a combination of portfolio valuations moving higher in the summer months and credit unions’ growing appetite for yield.
Credit Unions Target Longer Investments – Cash Balances Down 2.5% Quarterly
Maturities of investment portfolios at U.S. credit unions lengthened in the third quarter of 2020 as portfolios shifted away from cash. In a departure from the first two quarters of the year, every segment except for cash expanded from the second quarter. Cash and cash equivalents declined 2.5% on a quarterly basis, falling from $216.8 billion in June 2020 to $211.4 billion in September 2020. As a result, this segment’s share of the portfolio fell 2.3 percentage points, largely due to declines in corporate and other financial institution cash balances. The largest growth in balances was seen in investments maturing in one to three years, rising $8.0 billion, or 7.4%, from June. From a percentage growth perspective, investments maturing in five to 10 years posted the largest increase, up 20.2% from June, with balances in this segment increasing $7.6 billion in the quarter and their share of the portfolio rising 1.1 percentage points.
Yields Fall 8 Basis Points Despite Growth in Longer-term Investments
The average yield on investments fell 8 basis points from the second quarter, hitting 1.45% at the end of September, in line with March 2017 when the average yield was 1.44%. With the effective rate floor at the zero bound and IOER sitting at 0.10%, credit union investment earnings continued to decline. Although credit unions reported modest growth in non-cash investments, the earnings gains were not enough to offset the marginal returns from the nearly 40% industry cash allocation, pushing yields lower. From a portfolio earnings perspective, investment income in the third quarter alone totaled $1.5 billion, down 18.8% from the $1.8 billion reported in the second quarter. Lagging consumer loan demand and uncertainty surrounding the stickiness of deposits in the current economic environment continue to compound growing earnings pressures as credit unions seek to manage risk and capital targets.
Shrinking Cash Allocations Lengthen Weighted Average Life
As of Sept. 30, the weighted average life of all credit union investments was 1.83 years, up from June 2020 (1.72), due to a shift in portfolio composition. Specifically, an increase in intermediate and longer maturity segments (one to three years and five to 10 years up 7.4% and 20.2%, respectively) combined with a decline in cash and equivalents (2.5%) collectively lengthened the weighted average life of the industry investment portfolio.
Derivative Program Participation Grows, Balances up 2.1% From June
Notional balances rose to $31.7 billion – a $656.5 million dollar increase since June – and finished the quarter up 124.4% annually following substantial growth in the first nine months of 2020. The 2.1% gain in the last three months and balance of $31.7 billion marks an all-time high for the industry. Corresponding with the increase in derivative balances, the number of credit unions that report derivative usage increased by five institutions, from 78 in the second quarter to 83 in the third quarter of 2020.
Sam Taft is Assistant Vice President, Business Development for Callahan Financial Services, Distributor of the Trust for Credit Unions, in Washington, D.C.