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You’ve Reached Your MBS Policy Limit. Now What?

An in-depth investment policy and portfolio review can reveal new options and clarify next steps for growing credit unions.

The credit union industry is experiencing a double dose of pressure on their net interest margins from a bedeviling source. Shares and deposits in credit unions are growing more rapidly than loans outstanding. Combined with a historically low rate environment, credit unions are struggling to deploy excess funds profitably. It is not surprising, given the severity of the financial crisis of 2008 and 2009, that loan growth declined rapidly.

Recently, loan growth has improved. Yet the industry is awash in liquidity and laboring to find alternative sources of investments earning acceptable yields. Investments have grown as a percentage of total assets even though investment yields have substantially declined.

September 2012* December 2011 December 2010 December 2009 December 2008
Share/deposit growth 6.8% 5.2% 4.5% 10.5% 7.7%
Loan growth 4.6% 1.2% -1.4% 1.1% 7.0%
Loans to assets 69.8% 64.7% 61.8% 59.4% 69.8%
Investments to total assets 27.9% 26.7% 26.1% 23.8% 20.5%
Investment yield 1.3% 1.6% 2.0% 2.6% 3.9%


Source: NCUA 5300 Call Report data


The industry has turned to alternative investments to a greater extent than years past. For example, investment in mortgage-backed securities and CMO’s (collectively, MBS) has risen dramatically. They now represent almost 15% of total assets compared to roughly 9% five years ago.

September 2012* December 2011 December 2010 December 2009 December 2008
MBS to total assets 14.6% 13.8% 11.8% 10.0% 8.8%


Source: NCUA 5300 Call Report data
*Most recent information available


What alternatives are there for credit unions reaching their MBS policy thresholds? With the assistance of an investment adviser, the completion of a thorough investment policy and portfolio review is an excellent starting point. With additional risk controls, it may be appropriate to increase limits for MBS. A investment policy and portfolio review can address the following questions:

  • What are the expected cash flows in the current rate environment and in various rate shock scenarios?
  • What premiums are expected and how would greater-than-expected pre-payments affect earnings?
  • What is the geographic location of the underlying mortgages comprising existing MBS? Are there any concentrations?
  • What are the delinquency and foreclosure rates of the underlying mortgages?
  • What are the types of underlying mortgages supporting the MBS? Is there an opportunity to spread risk through diversifying by mortgage type?
  • What is the current weighted average life?
  • What is the weighted average coupon rate?

An upward adjustment of the institution’s MBS policy limit should be accompanied by increased risk controls, including controls like those mentioned above. Additionally, any adjustment in the approved composition of the investment portfolio should be evaluated against the requirements of liquidity policy and plans, and projected lending activities.

Lastly, it is critical that an investment adviser provide a comprehensive set of investment data, including estimated cash flows in multiple rate scenarios. A key component of any policy adjustment is the ability to forecast potential behaviors within the institution’s asset/liability model. Being well armed with an improved policy containing upgraded risk controls and effective financial forecasts will significantly improve the effectiveness of investment activities, and perhaps investment yields.

ProfitStars provides an Asset Liability Management solution that provides a strategic approach to managing risk, offers forecasting capabilities, enables creation and comparison of multiple scenarios, and much more.

William A. Kirsten, a former community bank CFO, is a Client Services Analyst, Advisory with ProfitStars, a division of Jack Henry & Associates, Inc.

This article is sponsored by a recognized solutions provider in the credit union industry. Callahan & Associates does not endorse vendors or the solutions they offer, and the views and opinions offered here might not reflect those of Callahan. If you are interested in contributing an article on CreditUnions.com, please contact the Callahan team at ads@creditunions.com or 1-800-446-7453.
June 3, 2014

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