Fed 'Tapering' Preview of Bond Bubble Burst to Come
In May the Federal Reserve Board discussed reducing its purchases of Treasury and mortgage bonds as signs pointed to an improving economy. The “tapering” comment, as the press reported it, led to a spike in Treasury rates and decline in bond market values. The backup in rates provided a sneak preview of the potential damage to credit union balance sheets, underscoring the importance of preparing for the inevitable collapse of the bond bubble.
The yield on the 5-year U.S. Treasury doubled to 1.49% in the quarter ending June 30. According to Sandler O’Neill research done in collaboration with R.P. Financial utilizing Call Report data from SNL, the rate increase led to significant market value decline in the available for sale (AFS) investment portfolio for many credit unions in the group with assets greater than $250 million (Group).
Investment portfolio structure – The investment portfolio’s results in generating both increased income and adequate cash flow contributes to two of the more critical components of fortifying against rising rates: higher capital and sufficient liquidity. In many cases, we see opportunity for improvement.
Federal credit unions in the Group aggregately hold 25% of investments in callable securities and bullet securities with maturities greater than three years. These portfolios typically feature deeper market value declines and less monthly cash flow, while generating yield that is only on a par with (or even less than) portfolios with higher levels of appropriate mortgage backed securities.