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SAN DIMAS, Calif. – The costs of credit unions holding excess liquidity can result in lost incom,e but remembering the principles of a basic portfolio structure can reap benefits, two experts noted. More than 160 participants logged on to WesCorp’s Webcast May 6 to learn about the effects excess liquidity can have on portfolio management. Dietmar Huesch, WesCorp vice president, Treasury and funding, outlined the four levels of an investment triangle: at the bottom are cash equivalents followed by variable rate liquidity, fixed rate term portfolio with structured investments being at the apex. These components are typically missing in many investment portfolios, he said. “There’s about $9 billion sitting overnight (in cash equivalents), that’s way too much,” Huesch said. “The Federal Reserve tends to lag the marketplace” which results in credit unions giving up income.” Brad Cunningham, WesCorp senior interest rate risk consultant, spoke on portfolio structure including how a laddered certificate portfolio can manage excess liquidity. Many credit unions have chosen to leave funds in the “market daily” in anticipation of increasing interest rates, Cunningham said, adding this can be a costly alternative to investing. To fill in the gaps, Cunningham discussed several types of portfolio. The laddered portfolio invests equal amounts in various maturities over a defined investment horizon, for instance, $2 million in 6 months, 12 months, 18 months or 5 years. They are constructed with non-callable certificates/securities, have dollar cost averaging and are not dependent on “correct” interest rate forecast. The benefits of this type of portfolio are it helps maintain liquidity with a block of certificates maturing each month or quarter and a higher yield can offset increased dividend rates. Cunningham said an agency ladder can be built with bullet agencies with such considerations as having approximately 15 basis points less in yield; the ability to pledge but with “haircut;” the selling of short maturities with little or no loss; and the potential to ride the yield curve. “The question of when to initiate the ladder – now or gradually over time – comes down to having the discipline in execution and (taking) the emotion out of it,” Cunningham said. The length of the ladder will produce a variety of results, he pointed out. “One year does not maximize the steepness in the yield curve, five years and longer will take too long to reprice if (there’s) aggressive tightening,” Cunningham said. “Three or four years will probably (be) the `sweet spot’ (because) risk profile will dictate which to use.” Huesch said the “cash equivalent” component of a credit union’s portfolio typically calls for investment at or near the Federal Funds and the “FOMC tends to lag (the) market.” He used an example of a triangle to illustrate what each section of a portfolio contains. Cash equivalents were placed at the bottom. “Market rates may be moving higher but your investment (is) usually the lowest rate on the rate curve,” Huesch said. In the “variable rate liquidity pool” portion of the a portfolio, term floaters tend to have an increased yield for term investment; float with market interest rates; can be liquidated at or near par with the amount depending on the overall risk profile. The “fixed rate term portfolio” has an investment ladder with the amount and length depending on liquidity position and overall risk profile, Huesch said. At the top of the portfolio triangle are structured investments – callables, capped floaters, index amortizors and MBSs, Huesch explained. Constructing a portfolio using the previously named investments in the order Huesch used could aid in maintaining the right amount of liquidity; building a maintaining a “comfortable” ladder; and diversifying callable and mortgage holdings. [email protected]

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