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Strengthen Your Credit Union’s Investments
Friday, April 27, 2018 6:45 AM

Steven Houle, CFA, FRM, Director, Advisory Services, Catalyst Corporate FCU

The shape of the yield curve is changing. Is it affecting your credit union’s investment strategy? If so, you’re not alone.

As the interest rate environment and yield curve shift, now is as good a time as any to assess your investment strategy. Prior to the Federal Reserve’s Fed Funds rate increases (which started in December 2015), the opportunity cost of holding on to “extra” cash was very high. Even though the yield curve was at historically low levels, the slope of the yield curve was steep. This provided significant opportunities to pick up income between holding cash and putting funds in term investments.

In fact, one of the most significant attributes to investment portfolio performance over the last few years was how much “extra” liquidity a credit union held. The more they held, the lower their investment portfolio return and vice versa.

However, even though the yield curve has increased, the slope is significantly flatter. What does that mean? Here’s one scenario:

Challenge.
The 2-year Treasury is currently between 2.25 and 2.30 percent and ready to move higher with further Fed increases. Conversely, the 10-year Treasury falls between 2.75 and 2.85 percent, but is consistently struggling to stay near 2.9 percent, given the anemic inflation outlook. The slope, or spread, between the 2- and 10-year Treasuries ranges between 50 and 55 basis points, more than half its level as recently as March 2017.

Strategy.
To navigate the flat curve and future changes, an effective strategy may be a barbell approach to reinvesting excess funds. The objective of a barbell is to add investments with short and long durations at the same time, in similar amounts.

Why?
If a credit union has $5 million to invest, purchasing $2.5 million of fixed-term investments with maturities of less than one year would earn approximately 2.00 percent and roll-off when the Fed increases the Fed Funds rate again. Simultaneously, the credit union could invest $2.5 million in 4- to 5-year investments that earn between 2.50 and 2.60 percent. When the yield curve is relatively flat, with uncertainty as to its future shape, a barbell strategy enables a credit union to play defense and offense at the same time.

Credit unions may find it helpful to work through a few possible scenarios to develop feasible and functional investment strategies. A liquidity stress test, such as the one offered by Catalyst Strategic Solutions’ ALM Service, might also prove beneficial for credit unions. This type of test identifies liquidity shortfalls across a variety of scenarios and projects net cash flows based on multiple factors.

As the curve changes and the status quo shifts, make sure your credit union develops the right strategy (or strategies) to remain successful.

Catalyst Corporate Financial Credit Union is a five-star preferred business partner of Credit Union Resources, Inc., a wholly owned subsidiary of the Cornerstone Credit Union League.