Cash Flow-Based Investments, Not Predicting The Market Can Buffer Loan-to-Share Drop

WASHINGTON – When it comes to a credit union’s portfolio, investing “like the best” can mean a myriad of things as investment yields remain at all time-lows. At an Oct. 30 Callahan & Associates Webinar on investment strategies, more than 40 participants logged on to compare notes on what it takes to counter a 68% drop in loan-to share as share growth continues its outpacing of loans. The Webinar featured Jim Schlotfeldt, CFO of Oregon Telco Community Credit Union, who discussed how a cash flow based investment policy not only creates a structure to fund loans but also cover member withdrawals. John Nilles, CFO of Retail Employees Credit Union in St. Louis Park, Minn. reminded participants that with competitive loan and share rates, portfolio income is essential to a credit union’s business plan. For Oregon Telco, which has $600 million in assets, $250 million in investments and a yield of 3.7%, as its portfolio grew, its investment strategy shifted to simplifying portfolio management and ALM through predictable cash flow. As a result, interest rate risk is “reduced by constantly reinvesting cash flows and thus dollar cost averaging as interest rates change,” said Schlotfeldt. Sixty percent of available funds at Oregon Telco for investments were invested in a framework of laddered maturities spread evenly over a 36-month timeframe. As the credit union’s portfolio grew, Schlotfeldt said “we lengthened the ladder from 24 months to 36 months,” which resulted in additional basis points especially when a “steep yield curve” comes into play. “The investment strategy will result in balanced portfolio cash flow generating annual cash flow (principal and interest) of at least 33% of the total portfolio balance,” Schlotfeldt explained. Still, “this target is difficult in a low coupon environment. We had to overweight laddered principal to meet cash flow target.” Oregon Telco’s loan-to-share ratio has run between 60-70% during the last 10 years with more than 50% of loans in mortgages and home equity loans. Because “building the ladder takes priority,” funds in excess of the 60% ladder are invested in mortgage-backed balloons, CMOs and callable investments. Schlotfeldt said the credit union’s selection of “European investments (with one time calls) are favored over continuous or quarterly call features because they are more predictable and if not called become part of the ladder.” Likewise, another strategy was purchasing mortgage-backed bonds “near or below par to reduce premium risk if prepaid.” Share growth has consistently outpaced loan growth over the past 24 months and because of interest rate peaks, investment yields have seen “serious declines,” Callahan reports. Most of a credit union’s portfolio continues to be held in available-for-sale securities as credit union investments have risen more than 21% over the past 12 months. For Retail Employees Credit Union, which has $160 million in assets, $80 million in investments and a 4.3% yield, the “current environment keeps me investing in new positions of less than two years in duration,” said Nilles. Indeed, the liquidity portion of Retail Employees’ portfolio amounts to $20 million mainly through government and agency bullets with one and half duration and $15 million going to amortized securities that mature in 12 months or less. Retail Employees’ total return portion is $40 million through three to five year bullets, taxable municipals and some corporate bonds, Nilles said. “With competitive loan and share rates, portfolio income is essential to (our) business plan,” Nilles said. “Our investment income is 40% of total interest income, the duration is about two years and we have $1.3 million in unrecognized gains – a valuable tool for managing income, capital, and possibly for acquisitions. Both Schlotfeldt and Nilles also weighed in on their use of brokers. “I gather three comparable bids for securities and I rarely buy the bond of the day,” Schlotfeldt said. “Each of my brokers have a special niche in the market.” Above all, “find brokers that understand your objectives and then portfolio management will not take all of your time,” Schlotfeldt added. Retail Employees works with four brokers and Nilles advised using brokers for trade execution, “not ideas” and more importantly, “gain transparency on your investments.” “Keep your fees low by dealing only with bigger issues,” Nilles said. “Act tough with your brokers – tell them how much commission you’ll give them.” -