How KeyPoint Made $7.2 Million On Investments In 2017

The Silicon Valley cooperative consistently ranks among the top performers nationally in terms of yield on investments.

 
 

Top-Level Takeaways

  • KeyPoint uses investments to fuel loans and support operations.
  • The credit union mixes maturities and leverages its investment in its FHLB.

Tim Green takes a distinctly holistic view of investments as CFO of KeyPoint Credit Union ($1.2B, Santa Clara, CA).

The Silicon Valley cooperative consistently ranks among the top performers nationally in terms of yield on investments, and its 4.59% yield in the fourth quarter of 2017 placed it sixth among the 2,590 credit unions of more than $50 million in assets, according to data from Callahan & Associates.

Green uses a variety of investment instruments and techniques ― including arbitrage and investments in a range of securities and maturities ― to maximize what KeyPoint can do for its owners.

 

 

 

“We’re here to serve members, and investment income, particularly fixed income, is a piece of that,” he says. “A good, steady investment gain helps us keep our loan rates as low as possible and supports investment in other parts of our operation that don’t in and of themselves generate revenue but are critical to our members.”

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Green came to KeyPoint in 2013 after serving as the CFO at a community bank that ran into trouble during the financial crisis and was operating under a consent order.

Tim Green, CFO, KeyPoint Credit Union

“I became attuned early in my career to look for every penny and nickel I could find,” he says.

That’s been a lot of pennies and nickels at KeyPoint. The cooperative made $7.2 million on its investments in 2017 on a $162.8 million portfolio. The credit union, in fact, generates 14.80% of its total income from investments, compared with 8.86% on average for its peer group: the 280 credit unions of $1 billion to $10 billion in assets at year’s end. Those investments help provide the liquidity for a lending machine that increased 15.0% year-over-year. Its loan-to-share ratio was 103.92% at year’s end.

Here, Green shares how KeyPoint approaches investments and manages the portfolio.

What is KeyPoint’s overall strategy on investments?

Tim Green: Investments are an earning asset and need to be managed like one. They are easily pledged or sold and can provide valuable liquidity. We have various ALM policy limits at the individual security level and at the overall portfolio level. That helps ensure the overall portfolio does not take on unnecessary interest rate risk. Within those parameters, we maximize yield.

Our operational strategy emphasizes barbell trades which allows us to maximize yield while limiting price risk. We also want to ensure our portfolio will generate cash flow, so we tend to avoid fixed-maturity, non-amortizing instruments.

KeyPoint’s yield on investments began rising sharply when it began arbitrage trading and more active bond management.

What happened at the beginning of 2014, when yields at KeyPoint started increasing sharply?

TG: That corresponds to our entrance into arbitrage trading and increased active management of the bond portfolio. In the past, the credit union had stayed very short, which limited the yields.

CU QUICK FACTS

KeyPoint Credit Union
Data as of 12.31.17

HQ: Santa Clara, CA
ASSETS: $1.2B
MEMBERS: 56,642
BRANCHES: 8
12-MO SHARE GROWTH: 7.1%
12-MO LOAN GROWTH: 15.0%
ROA: 0.45%

Our finance vice president and controller, Doug Schrock, initiated the arbitrage program. We also had a lot of CDs and other really short investments. When I came in, we started to build out the yield curve. At the same time, the FHLB started delivering some extraordinary dividends, as high as 7% to 11%.

It pays that dividend on the stock you have to buy to be in the FHLB arbitrage program, based on the amount of your borrowings. It’s not much of a risk because the FHLB will buy back your stock if you leave the program. Also, it’s only a $13 million asset on a $1.2 billion asset sheet, and they’re managed well, so we’re not taking on significant counterparty risk with it.

Please explain what arbitrage is and how it works in this instance.

TG: KeyPoint borrows from the Federal Home Loan Bank, places those borrowings with the Federal Reserve Bank, and earns a small spread. We generate some positive earnings and also get significant balance sheet liquidity. It’s a regional situation ― not all FHLBs are offering the same things as the San Francisco FHLB.

KeyPoint’s investment growth dipped sharply in mid-2014 and then rose again. It has since remained above its peer group average.

KeyPoint’s investment growth dipped in mid-2014, rose sharply, and has remained above average since. What happened?

TG: We shed some lower-yielding assets to create capacity, but in general the level of the portfolio is a function of the level of our lending and overall balance sheet size. We had strong loan growth in 2013 and 2014 and were opportunistic in security sales. We stayed between $96 million and $120 million during that time.

In 2015, as the balance sheet grew, it was necessary to add some securities to ensure proper asset mixture. We expect to crest at around $160 million in the middle of this year and then go back down to about $145 million at the end of the year.

Doug says until I got there we never sold a bond. Now, we actively manage the portfolio and see changes from prepayments and sales activity.

Treasury securities are notably absent from KeyPoint’s portfolio, but there’s a big emphasis on federal agency debt instruments.

What sticks out about your investment composition and maturities that speaks to your strategy?

TG: We favor agency mortgage and other asset-backed collateral. We have not invested in Treasury securities simply because any fixed duration without optionality is not our preference. I want the portfolio to generate cash flow, and non-amortizing bonds that do not have some interest rate adjustments are not assets we favor.

We’re also not in the camp that short is right. We’ve been hearing for years that rates will go up, and we want to stay short to capture the rate increases. But that wait could go on forever.

Our approach is simple. We look at bonds that will meet a yield hurdle that is accretive to the credit union and within our ALM policy limits. If the yield is right and duration makes sense, we’ll execute. This ensures the assets are accretive instead of purely a liquidity play.

From there we fill out the portfolio with floating-rate assets for interest rate risk mitigation and perhaps a few bonds that have significant upside. In general, we stay with agency-amortizing collateral with somewhat longer duration that has been offset by shorter-duration floating instruments.

Longer maturities hold a spot equal to shorter bonds in the KeyPoint investment strategy.

Do you time the market?

TG: No one can time the market. We don’t try. But if you spend all your time waiting for rates to go up, when will you make a decision? We do anticipate rates will continue to go up, but we’re not going leave all that money sitting on the sideline. That’s why we manage our investment portfolio as actively as we do.

This interview has been edited and condensed.

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Feb. 19, 2018


Comments

 
 
 
  • Those observations are correct in the sense that the removal of the quarter-end assets does drive up the yields. But yields are not the focus of what we do. Our strategy is to focus on opportunities wherever they may come from, and not to simply focus on the yield component. Our strategy has been to create a balanced portfolio and take advantage of the FHLB’s dividend opportunity. By maximizing the level of borrowings, we have ensured the maximum dividend is available to the credit union. We have outperformed peers in yield on our core fixed income book since I arrived, and coupled with the dividend yields (7% to 11%) we have consistently hit yields of over 3%. I recognize that our investment yields can look unusually high but even our core economic results and yields are still well above industry averages. We are simply a high-performing credit union that leverages any opportunity we can to safely and effectively return maximum value to our members. If you have additional questions or comments please feel free to contact KeyPoint’s CFO, Tim Green at tgreen@kpcu.com.
    Anonymous
     
     
     
  • Thank you, James and Moritz, for your comments. We're working to provide a full reply to your observations.
    Marc Rapport
     
     
     
  • Am I the only one who finds said stated yields to be highly unachievable and unlikely in today's marketplace? Nothing I could find within the article adequately or clearly identified 'how' these outsized yields were being achieved. Nothing in the credit union's investment mix or maturities suggest outsized yields would be likely, especially without extension of duration (and even then ...). The FHLB dividend has been very strong as of late, but I find it hard to believe that, in and of itself, it could drive yields so far, and consistently above peer. Call Report yield is calculated with a numerator and denominator, the denominator being average investments for the quarter. Is the denominator being reduced (via repaid borrowings or otherwise) just prior to quarter-end, resulting in an outsized yield calculation? The key appears to be their arbitrage play, not the credit union's regular investment holdings ... yet the article seemed to place equal, if not more, focus on the make up of the institution's holdings. The danger here is that other credit unions' executives and boards will read this and wonder "what are we doing wrong?!" and push investment executives to pursue greater risk with little understanding of what is truly happening behind the scenes.
    Moritz Wohanka
     
     
     
  • No you are not, Moritz. Pursuant to reading the article and before I read your response, I spent some agonizing minutes trying to ascertain how such yields were achievable, especially given the large increase in yield from 12/31/16 to 12/31/17 of 91 bps (3.19% to 4.11%) per a high-performance peer report comparing KeyPoint CU to its Top 25% CUs with assets > 500MM from data generated by SNL. Those minutes were agonizing as I am a veteran broker who takes pride in offering my CU customers strategies and products so that they can become one of the top 25% among their high-performing peers. Have I overlooked something? Without having read your comment, I forwarded an email with a link to the article to my senior Fixed Income Strategist that closely mirrored your concerns. His response was to laugh and refer to me to your comment. I thoroughly enjoy reading the excellent articles on this site, but this one has at lease three of us flummoxed! It would be great to see a follow up article that offers a little more clarity.
    James H.