A Primer in Credit Union Investment Risk
Credit union presidents and CFOs are typically expert at analyzing loans because most of them grew up on that side of the business. But what about your credit union’s investment portfolio? And do your credit union’s board members know the basics about managing risk in the investment portfolio?
Parking significant amounts of your investment portfolio in low-yielding overnight investments or CDs may miss out on the opportunity to benefit from higher yields with only a relatively moderate increase in risk. Understanding and managing the do’s and don’ts of risk in your credit union’s investment portfolio can boost its return, thereby increasing your credit union’s net worth and dividends for members.
Credit risk. A bond is really an IOU in which the issuer promises to pay the buyer certain periodic interest payments until the bond matures and then pay back the entire purchase amount (principal) at a certain point in the future (maturity). Also known as “default risk,” credit risk simply refers to the possibility that the entity who issued the security (and who promised the buyer payments of interest and principal) will not make those payments on time or at all.
In other words, the credit union doesn’t get what it bargained for because the issuer doesn’t pay. It used to be that credit unions were one of the few institutional investors that were required to look beyond rating agencies like S&P and Moody’s when evaluating the creditworthiness of securities, but in the wake of the financial crisis, Dodd-Frank now requires banks to do the same.