Q2 Credit Union Investment Trends: Securities Holdings Grow as CUs Put Cash to Work

Latent effects from three rounds of stimulus payments translated to annual deposit growth of 14.9% in the second quarter of 2021. However, from the first quarter, share balances rose just 1.1%, down significantly from the 8.3% quarterly growth a year ago but nearly twice the average rate reported in the second quarter over the preceding three years. With direct federal and state benefit payments slowing and ceasing in the second quarter, it’s evident that members across the country are still cautiously managing their finances and avoiding large purchases and investments. A new wave of COVID-related news further clouds the outlook for economic recovery moving forward with more to be revealed in the coming months.

Markets largely interpreted the June Federal Open Market Committee (FOMC) highlights to be more hawkish than prior meetings, notably the shift in median participant forecasts for the Fed funds rate (“dot plot”). The consensus moved from the March meeting where no rate hikes were projected through 2023, to 50 bps of rate hikes by year-end 2023 in the June meeting. Moreover, pressure to address tapering the Fed’s asset purchases continues to mount as the FOMC navigates guidance for a future reduction with many market participants expecting a more concrete plan in the coming months and conversations begin and progress.

Total Investments Decline

Absent additional stimulus and a modest uptick in loan demand, investment balances fell accordingly. On a quarterly basis, total investments declined 0.4% (-$2.9 billion) from March to June and totaled $699.9 billion at quarter-end. In contrast to recent trends and despite a twisting yield curve (two- to five-year note yields moving higher and longer-dated yields lower following the June FOMC meeting), cash balances contracted 11.1% from March, evidence of credit unions’ active participation in putting money to work. Accordingly, investments in securities and certificates expanded at a strong linked quarter rate of 7.6%.

The quarterly change in net liquidity for the industry (change in share balances less change in loan balances) was negative for the first time since September 2019 as loan demand, notably vehicle lending, gained steam. First mortgages again accounted for the lion’s share of growth in the loan portfolio, up 2.7% from March, but auto lending came in a close second with balances up 2.1% on the quarter.

Government & Agency Holdings Drive Portfolio Gains

Cash and investment balances fell $2.9 billion to finish the quarter at $699.9 billion. The primary driver of the net decline was an 11.1% reduction in cash balances at credit unions across the country, while securities and investments grew 7.6%. Credit unions deployed the majority of funds to Federal agency securities MBS (56.7%) and non-MBS (14.9%), and U.S. government obligations (19.5%). In aggregate, credit unions reported $241.7 billion in overnight cash balances, including $184.2 billion at the Fed and $44.1 billion at corporate credit unions. Cash on deposit fell across all segments, with Fed and corporate credit union balances down 10.8% and 16.0% quarter-over-quarter, respectively.

Successful cash deployment strategies translated to a reduction in cash as a percentage of total investments, falling to 38.3% of total balances in the second quarter. Prior to March 2020 when this measure spiked, the average industry cash allocation was 28.6% between 2016 to 2019.

With the exception of bank notes and cash, every major segment of the investment portfolio expanded on a linked quarter basis. U.S. government obligations posted the largest percentage increase in the quarter, 19.6%, as many investors looked out the curve when rates initially surged in the late winter and early spring months. Mutual funds posted the second largest percentage gain, up 12.2%, from a combination of inflows to traditional investments and executive benefit pre-funding accounts. The largest gain in dollars was again Federal agency MBS debt, expanding 8.9% (+$17.3 billion).

Credit Unions Rework Portfolios, Add Duration

Fixed income yields traded in a tighter range across much of the second quarter after the spike in yields in the first quarter overwhelmed the impact of tighter spreads over much of the ensuing period. The Fed’s June 16 FOMC meeting changed the calculus for many as the quarter neared a close. The hawkish sentiment from the meeting notes, specifically timing for a rate increase, pulled forward expectations for repricing, which caused the yield curve to twist around the five-year mark. Yields in the two- to five-year maturity range moved higher while longer-dated yields fell. Excess liquidity returned by the Fed’s balance sheet and U.S. fiscal policy, combined with a shrinking pool of investible assets, pushed short-term and money market rates to all-time lows. The Fed’s technical adjustments to IOER and the reverse repurchase facility offering rate (both increased 0.05% at the June meeting) should alleviate some of the downward pressure on rates at the front-end of the curve, but it is not a long-term solution as the supply/demand imbalance remains an issue, among other challenges.

At credit unions, a decline in cash holdings and an uptick in investing activity led maturities of investment portfolios to lengthen across the second quarter. Investments continue to be targeted at the belly of the curve — three to seven years — where yield spreads were the widest. Every maturity segment of securities expanded from the first quarter. The largest growth in percentage was seen in investments maturing in three to five years. This segment increased $17.8 billion, or 20.0%, from March and accounted for 58.2% of quarterly investment balance growth. Similarly, investments maturing in five to 10 years grew 10.2% across the quarter, contributing 29.1% to portfolio growth.

Sam Taft is Assistant Vice President, Business Development for Callahan Financial Services, Distributor of the Trust for Credit Unions, in Washington, D.C.