Meanwhile, other credit unions are looking to current coupon mortgage-backs and callable agencies for the higher advertised yields, said Danny McIntyre, senior director, financial product sales at Balance Sheet Solutions, LLC, the brokerage and advisory service subsidiary of Members United Corporate Federal Credit Union.

"Volatility levels remain historically low translating to tighter yield spreads in this paper and therefore may not offer the best risk [and] reward tradeoff for credit unions deploying excess liquidity now," McIntyre said.

The street has introduced several new securities offering high yields and potentially high volatility, McIntyre pointed out. Range notes have been marketed to many credit unions with advertised yields of 7% or more, he added.

"Analysis of this paper, shows the potential, the market value of the paper to materially decline if rates climb two to three hundred basis points so again we don't see compelling reasons to buy this paper," McIntyre said.

Corporate certificates remain the top choice among credit unions, McIntyre noticed. The higher spreads offered on these certificates allow portfolio managers to capture additional yield without adding optionality to the portfolio, he said.

"Deep discount" seasoned mortgage-backed paper as a very good value in the market are also very prevalent, McIntyre found.

"The underlying mortgages on this paper are typically several points below current mortgage rates which stabilizes cash flow for buyers. There is little likelihood that the loans will pay any slower in a rising rate environment and no incentive for prepayments unless rates fall more than two percent," McIntyre said. "The deep discounts offer additional protection for buyers generating high returns if payments would accelerate."

McIntyre surmised, "On the positive side we are seeing a growing number of credit union portfolio managers use the interest rate risk on the balance sheet drive choices to build their portfolios."

Keeping Portfolios On Track

Credit union investment portfolios should be structured to fulfill three management goals–maintain a strong overall liquidity profile, enhance short-term earnings but protect long-term volatility and manage overall risk exposure, said Brian Turner, director of advisory services at Southwest Corporate Federal Credit Union.

"Forward thinking managers whose relative value assessment goes beyond their portfolio's current holding period have greater success than those only focused on existing durations–the rollover effect," Turner said.

As for investments, credit unions should keep cash flows structured in traditional barbell-pattern to enhance current earnings and provide downside protection against falling rates, Turner advised. Fixed maturity or locked-out principal windows create more downside protection.

"Extended average lives" beyond three and a half years are discouraged due to less probability for a deep or protracted declining rate outlook. Relative value of longer-term durations are not present due to the shape of the yield curve, he noted.

One piece of good news is value has returned from mortgage spreads so credit unions might consider layering in amortizing structures over the next 36-months and keeping 30-year collateral weighted average coupons under 6.30% and over 5.85%, Turner suggested. Total return strategies should reflect value derived from three-year amortizing assets with locked-out principal windows, but the vehicles must be premium free.

"Unfortunately, just like a nearsighted old man at the deli counter, many credit union investment managers simply pursue the 'daily special' and oftentimes become overly obsessed with chronic DRS (directional rate syndrome) or HYD (highest yield dysplasia)," Turner said. "They're approached by opportunists that preach so-called new investment strategies that, for instance, purportedly provide protection against declining rates but fail to fully represent the added exposure it presents should rates not decline more than 25 or 50 basis points."

These "opportunists" sometimes represent certain longer-term investment alternatives having supposed total return benefits, but fail to acknowledge it wouldn't apply if the investment is held until its maturity date, Turner has discovered.

When it comes to liquidity, interest rate risk and marginal earnings, Turner advised that credit unions retaining surplus liquidity position will enhance current earnings and enable re-employment into consumer and mortgage loans later this year. Overall balance sheet exposure should be positioned to protect against plus or minus 50 basis points rate shock and the more risk exposure on short-term assets, the more likely there will be little risk exposure on longer-term assets.

Looking forward, "upward pressure on cost of funds as members transition to higher-rate term certificates will continue to do so if lower rates are perceived," Turner forecasts.

"Prudent investment portfolio management requires having properly positioned cash flow structures in place with a full understanding of long-term relative value," Turner explained. "An integral part of relative value focuses on where prevailing nominal rates are in relation to underlying economic growth and inflation."

Diligent management also requires a perspective that surplus cash is an investment asset and how proper allocation between cash and term investments is a vital ingredient to assessing overall return, Turner said, adding all factors take into account the cyclical nature of the credit union's other investment activities such as consumer and mortgage loans.

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