Since the financial crisis in 2008, the interest rates and returns credit unions have been able to obtain through investing excess cash has been at historically low levels. While rates have been near zero, there has been little incentive for management to change their investment methods to increase yields on what has been considered to be "not worth the effort." Investing in longer-dated maturities has also been viewed as "not worth locking up your liquidity for a few extra basis points." Thus, many credit unions have maintained cash balances in excess of their actual forecasted and regulatory required needs and invested them in less-than-optimal strategies. Yet, the opportunity for yield improvement is huge, as U.S. credit unions have approximately $1.3 trillion in assets, $400 billion of which is in cash and investments.
Thanks to improved global economic markets, the Fed and global central banks have started to raise rates and signal their continued rise over time to more normalized conditions. In addition, new financial technology capabilities have been applied to disintermediate the FDIC-insured certificate of deposit market, which comprises a significant portion of credit union investments. Now is the time for savvy credit union managers to position their investment strategies to maintain capital preservation while achieving higher levels of yield and liquidity.
New Fintech Methods Optimize CD Investment Benefits
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Credit unions often invest excess cash in CDs through an investment portal such as QwickRate or Bank Rate. However, CDs acquired through these portals are not liquid, involve early withdrawal penalties, do not access the often higher-yielding secondary market and do not optimize portfolio yields.
Fintech is changing the face of this investment landscape. In recent years there have been significant advances in harnessing systems' capabilities to quickly access and analyze big datasets to achieve investment objectives that were not previously attainable. These capabilities have now been applied to the FDIC-insured CD market to bring your credit union significant benefits over current investment methods.
As an example, a market-leading CD investment strategy includes a proprietary system designed to optimize CD portfolio yields and liquidity delivered to institutional investors. The solution tailors separately managed accounts to meet the specific liquidity criteria desired by a credit union such as weighted average maturity, laddering and specific cash distributions. In addition to client criteria, the strategy exclusively acquires brokered CDs that provide liquidity in the daily secondary market and do not involve any early withdrawal penalties. Programed to automatically acquire government-guaranteed CDs available in both the primary and secondary CD markets, it "cherry picks" the highest-yielding CDs that meet all the criteria set. Those CDs are frequently purchased in advance of other market participants. The system offers an informational edge for acquiring CDs at better prices and rebates, as well as distribution fees and discounts to par, which are often kept by other CD acquisition providers. Should a need for liquidity arise before maturity, the fintech provider would sell the client CDs, achieving the highest prices available in the secondary market without charging an additional fee. The fintech provider acts on a fiduciary basis, eliminates conflicts of interest and is compensated by a transparent, low annual basis point fee.
Fintech Solution Benefits
Credit unions can gain significant benefits by utilizing a fintech solution to invest in CDs. Yields are optimized by accessing larger populations of higher-yielding CDs, and leveraging an informational edge to acquire better bid-ask spreads and taking advantage of fee rebates. Liquidity is also increased by replacing non-liquid CDs with early withdrawal penalties with CDs that can be traded in the daily secondary market. Such a fintech solution also delivers significant reductions in staff workloads and the risk of errors while providing an automatic control of laddering and reinvestment of maturing CDs with a fully managed solution.
Credit Union Fintech Case Study
In March 2017, a credit union with $1.5 billion in assets was introduced to a market-leading, fintech-based CD aggregation system and strategy. At the time, it was receiving yields on a portfolio of non-liquid CDs acquired through an investment platform with a weighted average maturity of 18 months yielding approximately 150 bps. Management gave the fintech strategy a mandate to create a similar portfolio of liquid-brokered CDs if it could yield 160 bps. In addition to improved liquidity, the fintech solution delivered the portfolio yielding 180 bps net -20% over returns from internal efforts using the platform. Having exceeded expectations, the credit union gave the fintech strategy a mandate for a $200 million CD portfolio.
By utilizing new fintech-assisted investment solutions and focusing on better management of excess cash, credit unions can significantly increase their net interest margins. Visionary credit union managers will reassess their investment strategies to position their institutions to take advantage of this opportunistic trend.
Actual yields delivered depend on market conditions, and the specific amounts and optional portfolio liquidity construction attributes that a client chooses for their tailored portfolios. However, this is an example of the power of fintech-assisted solutions and what happens when credit unions take a fresh look at investment options and place their constituents' interests first. Market-leading credit union management teams are looking forward to leveraging these opportunities.
John Cravenho is a Senior Advisor for Saxon Securities. He can be reached at 917-693-5435 or [email protected].
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