Small CUs Can Buy Bonds Too
The NCUA's recently announced corporate resolution plan was designed to have minimal effects on the critical functions the corporates provide to their members. However, investment options with corporate credit unions have been significantly impacted by the plan. As part of the corporate resolution, the conserved corporates were barred from issuing certificates longer than six months. The surviving corporates have been affected too with most limiting their term offerings and others lowering the rates they are able to pay on share certificates.
As a result, many credit unions that had used corporates for term investments are now considering alternatives, namely marketable securities like agency bullets and callables. Most larger credit unions are quite familiar with the prerequisites for buying securities, tasks like conducting due diligence of brokers, establishing safekeeping relationships and accounting for the purchased bonds. Smaller institutions may not have these arrangements in place, and before undertaking the effort it makes sense for them to ask, "Is our credit union big enough to buy securities?"
There is no precise way to answer this question. There are quantifiable costs associated with investing in securities, but calculating the benefits, particularly the liquidity advantages that agency bullets offer relative to certificates, is an inexact matter. But if I had to pick a number, I would say that any credit union with more than $10 million in overnights and investments is big enough to consider adding term securities.
How did I arrive at this number? First, all institutions need to maintain overnights for settlements and to provide a ready liquidity cushion. However, low overnight rates and a very steep yield curve mean that there are significant opportunity costs to keeping too much in overnights. We want to pare overnight investments to as low as possible while properly managing the institution's liquidity risk. Let's say that 25% of the portfolio, or $2.5 million, goes into overnights. (Incidentally, for most credit unions, the corporate remains the best place for overnights. The rates are competitive and the temporary share guarantee is a tremendous benefit.) The next place to invest is in short bullet securities. Here, the goal is to build a future stream of cash flows while earning yields better than what you can earn on overnights. In this sector, the decision commonly boils down to corporate certificates or insured bank CDs. Because of limited liquidity-especially for the bank CDs-you don't want too much of your portfolio in this sector, but allocating 25% to 50% to these products works for most credit unions. That leaves us $2.5 to $5 million to invest in securities, and this is more than enough to get started with an investment program.
Many institutions that I work with routinely invest $250k at a time in securities-this figure is not too small. Admittedly, there is a link between position size and the secondary liquidity of that position-you'll get a better bid back from Wall Street if you're selling $5 million of a bond versus $250k, but there are plenty of brokers out there willing to buy and sell these smaller sizes. Our example credit union with $2.5 to $5 million to invest would have 10 or 20 positions on the books if it bought in $250k increments, and this is a sufficient number. What you want to avoid is only having a handful of relatively large positions. If you had a big fraction of your investment portfolio maturing in October 2010, you would not be happy with your reinvestment options at today's low yields. We can mitigate some of these unique reinvestment risks by spreading the portfolio across multiple positions.
Because of slow loan growth and continuing deposit inflows, credit unions are relying more and more on their investment portfolios for income. In this time of uncertainty with corporate credit unions, it makes sense to have a host of investment options available to you, and now's a good time to consider adding marketable securities to your credit union's portfolio.
Andrew McGeorge is a senior portfolio strategist with CNBS in Overland Park, Kan.