Leveraged Borrowing Could Pay for Assessments
NEW ORLEANS -- If a $1 billion credit union used a series of advances to fund a $100 million investment in new 15-year mortgage pools, it could add as much as $600,000 to interest income in the first year.
CNBS CEO Brian Hague shared that balance sheet strategy and others during CUNA CFO Council's first breakout session last week.
Hague said his clients are increasingly asking for ways to pay for short-term needs like impending NCUA assessments and whole loan losses. Thanks to low loan demand, many are searching for more profitable vehicles in which to park excess overnight funds.
The leader of the U.S. Central spin-off firm presented three possibilities for those funds and their corresponding effect on net economic value risk as defined by NCUA risk metrics. Although a classic leveraged investment strategy involving mortgage-backed securities sounds risky, he showed it offers far less risk than traditional credit union investing in fixed-rate mortgages, which the NCUA advised against in January.
Beginning with an industry average balance sheet with an easily rounded asset size of $1 billion, Hague's base case credit union earns a return on assets of 128 basis points but shows moderate risk in NEV change as defined by NCUA.
Adding $100 million in fixed-rate first mortgages, funded entirely with money market deposits, elevated interest rate risk in three of four categories, despite producing 152 basis points ROA. Hedging that risk by funding the same $100 million in fixed-rate mortgages with laddered advances from the Federal Home Loan Bank lowered risk in three of four categories while adding 6 basis points of ROA to the base case. And because borrowings increase the size of the balance sheet, net income gained almost $2 million.
Removing excess liquidity from the balance sheet, particularly in low-yield overnight accounts, and investing it was the second scenario. The test case decreased overnight accounts by half and split the $85 million into agency bullets and MBS pools and also picked up a $25 million overnight borrowing line.
Credit unions may have to borrow to cover SEG payrolls, Hague said, but when yield curves are steep and borrowing costs are low, "You can do that and still pick up net yield."
Despite the 14 basis point gain in ROA, interest rate risk increased in three of four categories due to longer average asset duration.
In the third scenario, a $100 million investment in new 15-year mortgage pools is offset by a series of FHLB bullet advances. The strategy would improve risk metrics in all four categories and produce 84 basis points in spread in the first year, though that figure that would gradually decrease over time.
Although the strategy is not without risk, it generates current year income, which resolves the problem of finding funds to pay for assessments to cover corporate stabilization costs and share insurance fund losses, Hague said.
When asked for a show of hands of those who attended the session to specifically pay for assessments, only one attendee raised his hand. However, audience members said assessments were just one of many balance sheet challenges they face this year. Others include accounting for loan-loss allowances and charge-offs, losses from investments in corporate capital accounts, and threats of decreased interchange and ATM fee income.