Month: October 2022

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Keeping the Credit Union Difference Alive

A timeless observation from Ed Callahan:

The disturbing word banded about this year so far is “comparability.” It came up in President Bush’s plan for solving the S&L mess-to make the NCUSIF’s accounting comparable to those other funds. . .

Comparability is also echoed in the phrase, “bank envy” the desire of some credit union people to enjoy more of the powers of banks. . .This comparability stems from a kind of inferiority complex.  Those that embrace the notion that by becoming more comparable, we are somehow elevating ourselves. In fact, the opposite is true. . .

Credit unions are different.  They were set up to be different and should remain different. They are different because we put the emphasis on the people we serve.  Our strength is we help people.  

Callahan Report, July 1989

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A Tale of Two Credit Union Liquidity Options

The dramatic drying up of market liquidity since the Fed launched its fight on inflation earlier this year has been multidimensional.

The 16.2% surge in credit union loan demand in the first two quarters  was the highest this century.  Cash on the balance sheet fell by $66 billion in the second quarter alone.  Investments are 30.5% of the system’s assets, totaling $655.5 billion.   Only 42.6% of this total was under one year maturity at June 30.

Most of the remaining portfolio over one year, would be underwater, that is with book value less than current market.  These funds could be converted to cash only at a loss.

Consumer savings previously buoyed by COVID relief plans, fell to 5% in June, and are at a lower level than historical norms.

Finally market competition for funds is increasing.  The SEC 7 day yield on government money market funds is 2.75%.   Online banks such as Marcus are offering one year CD’s at 3% and higher for longer terms.

Credit union’s are responding with multiple balance sheet straggles, such as CD specials, loan sales for cash, higher pricing to slow loan demand, and looking at borrowing and other funding strategies.

Two Credit Union Created Liquidity Options

Credit unions have created two system options to assist with managing liquidity.  One is industry managed, the corporate network owned SimpliCD, a CUSO.  The second is the CLF, created by Congress in 1977.

Both partner with remaining corporates as one option for access.  Credit unions can also go direct as regular members of the CLF or by calling the CUSO, Primary Financial, directly.

Even though both were created by credit unions and both rely on the corporate network for broad coverage, the results of both efforts could not be more different.

A CUSO’s Results

SimpliCD has posted its activity through the June quarter.  With almost 3,000 credit union investor agreements, the CUSO reported $2.9 billion CD’s placed at June 30.  The current largest outstanding was for $239 million and 228 credit unions report current funding.

President Chris Lewis says the market is the tightest he has seen in his 30 years with the industry.  Some credit unions are making early withdrawals from purchased CD’s or sell at a discount for cash.  Finding credit unions to invest in CD’s is getting harder.  Credit unions generally seek  funds in the 1-3 year maturities.

SimpliCD’s advantages include a centralized way to access CD funding, quickly, in whatever amount needed.   Most of the top ten credit unions have used the service in past with the largest placement at $400 million.  Twenty million can be raised in just a couple of hours.

The funds are unsecured and structured so that the $250,000 NCUSIF insurance covers all issuance.  If the transaction is done via the credit union’s corporate account, all monthly interest payments or receipts are automatically settled with confirmations provided to the credit union.

Two current examples:  A billion dollar credit union placed two CD’s as  of September 30th  via their corporate,  $5.0 million for 182 days at 4.1%, and a second $5.0 million for 272 days at 4.15%.

A $150 million dollar credit union placed a $1.5 million 182 day CD for 4.05% at September month end.

The October 3rd rates for secured FHLB Boston advances for equivalent six and nine month maturities are 4.29% and 4.37%.

The CUSO was originally founded by Corporate One in 1996 and converted to corporate wide ownership in 2004.  In addition to the speed and ease of one stop funding, the CUSO has earned the trust of its credit union users who range in size from the very smallest to the largest.

Lewis comments that the other advantage of SimpliCD is that credit unions can “keep their borrowing powder dry” for use as secondary liquidity.

The CLF Today

Opened in 1978, the CLF was intended to be the third leg of the regulatory structure which added share insurance in 1971 to NCUA’s initial chartering and supervision responsibilities.

Last week I received this query from a colleague:

Today, as interim CEO,  something came up, and I immediately thought of you.  It’s the CLF.   While we are managing liquidity well, but don’t have the FHLB currently – I put it in process –  I thought I read that the CLF was broadened in scope through CARES ACT and was more user friendly.

I contacted the Corporate CU, as we are just under $250M, and asked about it, and they said no one is using it.  I thought that response was very odd considering the drain on the system of over $80 billion from March. 

Seems from what I was told that the CLF doesn’t have much value.  Do you believe this is true?   Am I missing something here?

Any advice would be greatly appreciated.

As of July 30, 2022, the CLF has $1.3 billion in total equity, all invested in treasury securities.  Its total borrowing authority from the Treasury is $29.7 billion.   The 10 corporate agent members, and the 349 direct credit union members cover approximately 26% of all credit union assets.

The CLF has not made a loan since the 2009 financial crisis.  Its major activity then was to lend $10 million to two conserved corporates guaranteed by the NCUSIF.   There has not been a loan extended since.

The CLF currently earns 1.39% on  its portfolio and spends about $1.2 million to keep the CLF open.  It currently pays 80% of its net earnings to its credit union owners.   The CLF continues to add to its retained earnings of $40.5 million even though it has had no “risk” assets for over 12 years.

A Story of Two Systems

Both SimpliCD and the CLF were formed to serve credit unions.  The CUSO managed by credit unions is active at every level providing financial intermediation, funding, and market options to almost two thirds of all credit unions.  It partners with its corporate owners to market, inform about funding options and facilitate transactions.  It is active in both good times and periods of stress.  It continues to innovate, be present and evolve.

The CLF does not interact with credit unions.   It has created no programs or options.  Until the leadership of the CLF engages with its member-owners and the system to develop solutions relevant for them, it will remain unused, untried and without purpose.  A vestigial regulatory organ frozen in bureaucratic time.

 

 

 

 

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What is the “New Normal” Interest Rate Curve?

The recent Federal Reserve increase in short term rates to fight inflation, is seen by some to be a “temporary” increase.  At some point when relevant price indices have fallen into an acceptable range, the Fed will settle back to some lower initial reference point such as 1%.  Interest rates will then revert to the pattern of the decade of the 2010-2020 pre-covid era.

But what if that assumption is wrong?  What if the Fed’s definition of normal, a 2% real rate of interest on top of an assumed 2% long term growth rate, means the overnight baseline is closer to 4%?

Today the overnight rate is 3%.  The Fed is promising at least two, maybe three, more rate hikes this year? How would  a “new” 4% normal affect the rest of the curve?   What pricing and investment assumptions from the most recent decade would have to be rethought?

What If  Recent Past Rates Are Abnormal?

A commentator on MSNBC observed this past week, that interest rates have not been “market determined” since at least 2008.  He commented that the Fed policy of low overnight rates and quantitative easing created an artificially low interest rate curve to respond to economic crisis and to get the economy growing.   Some would move the starting point back to the post 9/11 era of lowered rates to avoid a recession following the attack on the World Trade Center.

Two analysis can help address this question of what the “normal” post Covid, inflation fighting yield curve might be like.

One is a May 4, 2022 article by Tony Yiu, which asked Why  was there Basically No Inflation in the 2010’s?  Here is part of his analysis.

Why did inflation not arrive earlier during say 2014? Or 2017? After all the Fed had been stimulating the economy and markets using easy monetary policy and QE since 2008. So why did inflation not spike until a few months ago?

So back to the question of where was all this inflation in the 2010s? My theory is that during most of the past decade, the stock market (both private and public), the real estate market, and new markets like crypto acted like a massive sponge that soaked up all the money that could have otherwise gone towards pushing up the prices of goods and services.

This created a positive feedback loop where:

  1. Stock prices and home prices go up incentivizing people to put more money in the stock and real estate markets.
  2. Money going into asset markets instead of chasing goods and services keeps inflation low (home prices are ironically not a part of CPI).
  3. Low inflation allows the Fed to keep interest rates low, which stimulates credit growth (along with rising collateral values).
  4. Credit growth causes even more stock and home price appreciation as significant amounts of the newly borrowed money gets plowed back into asset markets. And back to step 1 to repeat the cycle all over again.

Notice two things about this. First, this feedback loop results in the financial economy getting increasingly bigger than the real economy as money keeps getting sucked into well-performing assets like stocks and real estate.

And second, it’s not just low inflation and low interest rates that cause asset prices to go up. But because of feedback, there’s a causal effect in the other direction as well where increasing asset prices help soak up money keeping inflation low.

This positive loop obviously can’t go on forever. At some point, like the players in the casino, people will start to realize that there’s just not enough real stuff to go around (and not enough future earnings to justify the valuations). People seem to be finally realizing this based on the massive declines of stocks like Zoom and Netflix.

This realization kicks off a rush for the exits and a decline in asset prices. And because rising asset prices helped keep inflation low, the reversal into a negative feedback loop forces all that soaked up money to pour back into the real economy to chase goods and services, thus higher inflation (and higher interest rates).

Finally, a unique aspect of this current selloff is that where Treasury bonds are usually a place that investors can escape to during a market downturn, they’re part of the problem this time. Near zero nominal yields (and extremely negative real yields) mixed with high inflation makes Treasury bonds all risk and no reward (I first wrote about this here).

Long-Term Mortgage Market Rates

The decade of 2010 also saw the lowest 30-year mortgage rates ever, fueling a housing boom with double digit price appreciation.

Jim Duplessis of Credit Union Times published a September 26 article which examined the outlook as current mortgage rates hit a 20-year high.    His analysis with the relevant data link follows:

Rates in the 7% neighborhood might feel high for those who started buying houses in the last 10 years but they are on the low side for the past 50 years, based on Freddie Mac data published by the St. Louis Fed.

For more than half of the 2,687 weeks from April 1971 through Sept. 22, the rate was at least 7.4%. The median was 9.1% from 1971 to 1999 and 4.8% from 2000 to the present.

Rates peaked at 18.63% for the week ending Oct. 9, 1981 when the Fed under Chair Paul Volcker was battling inflation that had started during the Vietnam war. Volker’s aggressive rate hikes sent the nation into a recession, but knocked back inflation.

The lowest rates from 1971 to 1999 were 6.49% for the week ending Oct. 9, 1998, when the nation was in an economic boom. The lowest over the past 51 years was 2.65% for the week ending Jan. 7, 2021 at the peak of the refinance boom that vanished as rates rose this year to tame inflation.

A “New Normal”

Both analyses suggest the most recent two economic decades are an aberration in terms of a significantly lowered interest rate yield curve.

The efforts to reduce inflation will be a central part of where current rates end up.  But then what?

History suggests that the yield curve will shift to a higher level versus what many consumers, businesses and investors grew accustomed to since 2008.

There are other factors as well.   There is increasing evidence that lower rates while seemingly consumer friendly, do distort the allocation of economic gains disproportionately to higher income individuals while incentivizing multiple forms of financially driven wealth (speculative) strategies.

Anyone can predict the future.  No one knows it.   But believing that recent experience is the best or only guide to future rates, would appear a much too narrow perspective.