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Evaluating Investments

This post is a continuation of Investing At “Record” Low Rates… published February 10, 2012.

Investments with complex optionality are increasingly being added to credit union investment portfolios.  As such, it is critical that credit unions have a solid understanding of what they may be purchasing, before the transaction is executed.

First, make sure your broker is providing you with a complete picture of the characteristics of the investment in question.  In general, most brokers provide market value, and cash flow information for the current environment and a +300 basis point (bp) rate change.  However, some investments (in particular some CMOs) may look “okay” if rates go up 300bp, but have the potential for extreme extension risk if market rates go up 400 or 500bp.  Credit unions should ask their broker for cash flow and market value shock data for the +400 and/or +500bp rate change, particularly for investments with optionality.  Remember that short-term market rates were 500bp higher than they are today as recently as 2007.

In addition to cash flows, other optionality features can be very important as well.  For example, if the investment is variable rate, make sure that all of the repricing parameters are clearly understood: repricing frequency, margin, caps, floors, etc.  When the first repricing can occur is particularly important, especially with rates being so low.  For callables and step ups, consider call dates and potential repricing dates.  For step up investments consider if the future step protection warrants the lower starting coupon rate compared to a bullet or callable with the same final maturity.

Working with a trustworthy broker certainly helps in this process, but that does not absolve decision-makers of completing their own due diligence and ensuring an investment fits within their overall strategic objectives.  Keep asking questions until there is clarity on the investment and its structure, consider the other pertinent decision drivers (for example, policy, impacts to aggregate risk position, etc.) and consider the unexpected in the decision-making process.

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Good News! NCUSIF Premium Is ONLY 0.2582% For 2010

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The NCUSIF premium was set by the NCUA Board as 0.1242% on September 16, 2010.  This brings the total NCUSIF refunding cost for 2010 to 0.2582% when the 0.1340% for corporate stabilization is included.  This is in the middle of the 15 to 40 basis point (bps) range originally projected by the NCUA in November 2009.  Before you pass out party favors at your next board meeting, however, consider some of the comments made by the NCUA upon releasing this information:

  • CAMEL 4 and 5 federally insured credit unions (FICUs) increased to 366 from 291 in June 2009 for an increase of 25%.  Total assets for these credit unions increased $20 billion or 74%.  This indicates some larger credit unions have entered this group¹
  • The combined 0.2582% premium will cost FICUs $1.9 billion or 2.3% of their net worth²
  • “…NCUA is stepping up enforcement actions – to control the costs of troubled credit unions before those charges must be passed on to all credit unions³

Considering these comments and the state of the economy, it isn’t time to have a party just yet.  In fact it is even more important now to consider various possible scenarios as you work on your 2011 budget and longer-term financial plans.  Those of you who are regular readers of this blog (we thank you) know we are great proponents of scenario testing.  This has not changed—the use of 26 bps of insured shares would be a prudent base forecast; we also suggest that you consider scenarios at both ends of NCUA’s 15 to 40 bps projection for NCUSIF refinancing costs.  In addition to identifying the potential impact on your earnings, this will help you begin to think about possible contingency plans if the higher end of the range comes to pass.

¹NCUA Board Meeting Minutes 09/16/10

²IBID

³NCUA Chairman Debbie Matz Statement, Share Insurance Fund Premium, 09/16/10