Don’t put all your eggs in one basket. You’ve probably heard that adage all your life, whether from your mother or school counselor. Don’t tell your mom, but she was right.
Diversifying across different types of investments helps credit unions avoid large losses, because all your eggs aren’t going into one basket. With funds spread across a variety of investments with varying yields and terms, credit unions can put a little in higher yielding investments, some in moderate-yield instruments and some in lower-yielding-yet-more-stable investments. Investing in a variety of instruments helps your credit union to diversify its risk.
Laddering is another type of diversification tool favored by more conservative investors like credit unions. Laddering means the length and timing of the investments’ maturity dates are staggered to return principal at different times. This method helps mitigate interest rate risk by limiting the funds coming due for reinvestment at any one interest-rate level. Small portions of the portfolio mature in regular intervals as interest rates move up and down, allowing your total investment yield to move in greater correlation to your cost of funds. This helps credit unions spread interest rate risk and hedge against unexpected events. While this could result in slightly less yield in some interest rate environments, the trade-off of reduced interest rate risk and liquidity risk is well worth it.
The barbell structure is a popular variation of the laddering technique, used to take advantage of the best aspects of short-term and long-term CDs. In this strategy very short-term and longer-term CDs are purchased. In a normal interest rate curve, longer-term CDs typically offer higher interest yields, while short-term CDs provide more flexibility.
The short-term CDs give an investor the liquidity to adjust potential investments every few months or years. If interest rates start to rise, the shorter maturities allow an investor to reinvest principal in CDs that will realize higher returns than if that money were tied up in a long-term CD. The longer-term CDs give an investor a steady flow of higher-yield income over the term of the certificate. However, by not having all of your capital in longer-term CDs, this limits the downside effects if interest rates were to rise in that bond period.
Laddering and barbell structures are frequently done using a combination of popular credit union investments, like CDs, money market accounts and bonds. LaCorp’s SimpliCD program provides an excellent means of building a laddered portfolio. When constructing a ladder or barbell, a safe, high-yield money market account provides an optimal place to park funds from maturing CDs before reinvesting them.
Permissible credit union investments
As you well know, credit unions are relatively limited in their investment options. You can directly access the secondary markets, for example.
Because we’re positive people, we’ve broken down a list of what credit unions can invest in, as opposed to what is prohibited. For a more detailed explanation, read §703.14 of NCUA’s rules and regs. Generally speaking, permissible investments for credit unions include:
- Variable rate investments, as long as the index is tied to domestic interest rates with a couple exceptions
- Corporate credit union shares and deposits (How about that!)
- A registered investment company (mutual fund), as long as the prospectus limits the fund solely to otherwise permissible investments.
- Collateralized mortgage obligations/real estate mortgage investment conduits
- Municipal securities, again with some caveats and limitations
- CDs, money market accounts and other instruments issued by financial institutions (with, you guessed it, more qualifiers)
- European financial options contract (again with detailed guidelines of qualifications)
- Mortgage note repurchase agreements (with more exceptions)
- Zero-coupon investments (with yet more exceptions)
- Commercial mortgage related securities (with yet even more exceptions)
- Loan pipeline management (you know the drill)
- Embedded options (and again…)
- Mortgage servicing assets from other federally insured credit unions (with conditions, of course!)
And §703.16 runs through a handful of prohibited investments for federal credit unions, including stripped mortgage-backed securities and the vaguely named ‘other prohibited investments.’
Why diversify your credit union investments
In short, understanding your investment options and diversifying across those that are appropriate for your credit union’s risk appetite, in line with your policies, and proportional to your needs will help your credit union balance rate of return with financial stability. Sounds like what you might recommend to your members.
Is it time to reconsider the diversification of and return on your credit union’s investments in the current interest rate environment? LaCorp offers credit unions of all sizes across the U.S. really great rates on our money market account – we mean really great – with unlimited deposits and withdrawals and no minimum or maximum transfers or balances. We’ve also partnered with SimpliCD for some great CD options for your credit union.
If you’d like to explore laddering or a barbell structure, LaCorp would be happy to assist you. From self-service online purchasing to detailed consultation and advice, we offer as little or as much assistance as you would like. Because SimpliCD investments are fully insured, your credit risk is eliminated while interest rate risk is minimized with the laddering structure.
It’s time to think about your corporate credit union. It’s time to think about LaCorp. When you’re ready, let’s connect!