A ratio that helps credit unions measure and manage profitability is net interest margin. For more than a decade, NIM for credit unions has been under significant pressure. NIM is impacted by a credit union's lending and investing strategies. While credit unions deserve an A+ for how well they have managed lending activities, industry data suggest there is room for improvement in regard to investment management.

Inside the Numbers

U.S. credit unions hold assets worth $1.3 trillion, $386 billion of which is cash and investments. Nearly 80% of credit union investments are allocated to either agencies or savings and loans/banks. The average yield on investments is 1.3%.

With a significant concentration to but a few sectors of the fixed-income market and a pedestrian 1.3% average yield on investments, credit unions could strengthen NIM by improving investment results. This can be accomplished in two ways: By utilizing a broader range of securities in their investment portfolios and actively managing those portfolios. The problem, however, is that as lending institutions, the majority of U.S. credit unions lack the necessary resources to fully engage and commit to actively managing a diversified investment portfolio. As a result, investment returns suffer.

At worst, investment management is non-existent as many credit unions hold only cash and/or CDs as investments. Other times, investment management is one of several items listed on an executive's to-do list.

If investment returns were improved by just 20 basis points, roughly $775 million of additional income would be produced for the industry.

While many factors drive investment returns, optimal risk-adjusted returns can only be achieved through diversification and skilled, active portfolio management.

Diversification

A primary means to achieving diversification in a fixed-income portfolio is through the purchase of different bond types. This is because different sectors of the fixed-income market behave differently with respect to interest rate changes and other market forces. With roughly 80% of credit union investments allocated to agencies and banks, credit unions are not utilizing many of the Part 703 permissible investments that are available to them.

U.S. Treasuries and Municipal Bonds

Consider U.S. Treasuries, for example. Viewed as the least sexy of all investments, the primary advantage of U.S. Treasuries is safety. No other investment carries as strong a guarantee that interest and principal will be paid on time.

U.S. Treasuries play vital roles in diversified portfolios. The income stream from U.S. Treasuries is predictable and dependable. The benefit of predictability is enhanced by the fact that Treasuries do not have call provisions and carry a multitude of maturity schedules that can put the investor anywhere along the yield curve.

U.S. Treasuries have performed well for several years on a total return basis. Even so, Treasuries are hardly utilized by credit unions as only 6% of total credit union investments are allocated to Treasuries.

Another underutilized segment of the fixed-income market are municipal bonds. Municipal bonds are the debt obligations of states, their political subdivisions, and certain agencies and authorities. At $3.7 trillion, the municipal bond market is twice the size of the agency market and one of our nation's most remarkable financial institutions.

Like Treasuries, munis have performed well (year to date, our clients have achieved total returns of 15% from investment grade municipal bonds). Municipal bonds typically carry positive convexity which can help reduce interest rate risk (bonds with positive convexity will have larger price increases due to a decline in interest rates than price declines due to an increase in interest rates). Municipal bonds represent a compelling fixed-income option for credit unions, offering high quality and attractive yields, yet very few credit unions own them.

Treasuries and municipal bonds are but two examples of permissible securities that are missing from most credit union portfolios. Excluding these securities from investment portfolios inhibits total return potential while limiting risk reduction techniques.

Skilled, Active Investment Management

There are many reasons why U.S. Treasuries, municipal bonds and other Part 703 permissible investments are underutilized: Buying an agency is “easy,” brokers aren't typically calling with the “hot” new Treasury of the week, municipal bonds require thorough and extensive credit analysis, and actively managing a diversified portfolio of fixed-income investments is difficult and requires tremendous resources.

How then, can credit unions better diversify investment portfolios and reap the benefits associated with skilled active management? For smaller to mid-sized credit unions the answer is clear. Consider outsourcing investment management duties to an external asset manager.

Roughly 85% of U.S. corporations that invest in individual securities utilize external investment managers to manage their portfolios to specific mandates and benchmarks, according to a 2014 U.S. Corporate Benchmark Survey. Should credit unions be any different? External asset managers play a crucial role in helping organizations execute specific investment mandates, achieve higher yields and gain more nuanced liquidity control. Credit unions should consider this approach as they are not only likely to capture extra basis points by way of investment returns, but the hours saved each month by finance personnel would be priceless.

Matthew Butler is founder and managing principal of Elite Capital Manageement Group, LLC. He can be reached at 203-699-9662 or matthew.butler@elitecapgroup.com.

Instant Insights /

Boost Profits With Prudent Investment Management

Related Stories

Recommended For You