Investment Decisions: Reaching for Yield
As deposits continue to grow and loan growth is a struggle, many credit unions are wondering what they can do with their overnight funds to pull in some extra yield. Below is a case study of a credit union that has positive earnings and not much interest rate risk as seen by the 9.54% net worth ratio not at risk if short- and long- term rates increase to 5% as they were in 2007.
Like many credit unions, the credit union in this case study has a large amount of money in overnight funds, which totals about 15% of assets. What would it look like if the case study credit union reached for 20bps of yield by taking 5% of assets earning 25bps in overnights and invested it in plain vanilla 3-year agency bullets at a rate of 45bps?
The additional 20bps of yield from the agency bullets would help the overall ROA about 1bp but add 50bps of risk to net worth if rates go back to where they were in 2007. The credit union still has 9.04% net worth not at risk with short- and long-term rates are 5%. However, decision makers should consider if a 50-to-1 risk/reward tradeoff is beneficial. More importantly, they should ask the question: How will this decision and tradeoff impact our business model? (For more on investment decisions and business model, see our post: “My investment portfolio is not working for me!”)
