Q2 Investment Trends: Assets Turning into Loans

Source: Callahan peer-to-peer analysis

Credit union balance sheets have seen record growth in their share throughout the pandemic, driven mainly by government relief programs and increased savings rates during quarantines. Despite record mortgage lending, loan balance growth slowed due to a combination of prepayments and credit unions selling low-interest loans to secondary market buyers.

In the first half of 2022, however, these trends reversed. After annual loan growth outpaced deposit growth in the first quarter of the year, all eyes were on a continuation of this trend. The mid-year numbers did not disappoint, with credit union loan balances rising 16.2% on an annual basis, nearly doubling the 8.2% rate for stocks. Of course, this meant that credit union assets were flooded with investments – mostly excess cash balances – and loans.

Total credit union investments fall 9.5%

Total investments held by credit unions, including cash balances, fell 9.5%, or $68.6 billion, in the past three months to $655.4 billion outstanding at the end of the quarter. This is the largest quarterly percentage decline in 20 years, but this superlative is misleading without looking at the bigger picture. Investments by credit unions have exploded over the past two years, from $389.3 billion in December 2019 to a peak of $724.0 billion in March 2022, mainly due to excess deposits held in cash. Even after this recent drop, the industry’s total investments are much higher than they were at the start of the pandemic.

Loan balances increased by $86.8 billion in the second quarter, resulting in a decrease in net liquidity of $82.3 billion. This was by far the largest quarterly liquidity reduction ever in the sector and was three times larger than the most recent significant drop in the second quarter of 2018. After persistent growth in equities over the past two years, liquidity was eventually to reverse. The rising cost of living has reduced savings, while accelerating asset price growth has pushed demand for loans to record highs in dollar terms. This momentum pushed the loan-to-share ratio up 4.5 percentage points from last quarter to 74.7%, a welcome sign for credit union interest margins. Only $7.5 billion worth of mortgages were sold in the secondary market during the quarter, down 73.8% from the same period last year. Credit unions are holding more mortgages on their balance sheets because higher rates make it more attractive to hold these loans. In total, fewer deposits and more loans held will equate to fewer assets held as investments. Low-yielding cash balances were the main victim, with cash balances falling $65.9 billion in the quarter, or 96.0% of the total decline in investment balances.

Credit unions favor the front of the curve

The yield curve flattened after the Fed raised rates by 75 basis points in June and July. Short-term Treasuries, which are the most sensitive to Fed action, priced in expectations of further rate hikes. The two-year yield rose 40 basis points in June after some dramatic swings during the month. It stood at 2.95% at the end of the month after reaching 3.45%. The market has struggled to price both the risk of recession and further Fed rate hikes at the same time, as the two forces are counteracting each other. The 2-year/10-year spread ended the month at 6 basis points, threatening a reversal.

Portfolio allocators took advantage of the rise in shorter-term yields and reinvested funds in securities with shorter maturities. The one-to-three-year maturity category has received $4.2 billion from credit union investors since March, up 3.6% and enough to become the largest non-cash category. Investments in securities are spread relatively evenly over each of the maturity categories in the one to ten year range, which is understandable given recent shifts in the yield curve. Cash represents 28.3% of total investments, down from its all-time high of 42.9% in March 2021. Credit unions have used these large cash balances to fund higher lending activity in 2022 and gradually increased their stock allocations.

graph of the composition of investments by maturity Source: Callahan peer-to-peer analysis

The industry gains 21 basis points

The average investment return rose 21 basis points quarter over quarter, reaching 1.12% through June. Although this is the fifth consecutive quarterly increase, it is the largest yield change since the first quarter of 2019. Declining cash balances and a rising interest rate environment under the Fed’s impulse were the main reasons for the surge. This contrasts sharply with trends in 2020 and early 2021, when the Fed cut rates to stimulate demand and then lowered yields, and deposits drove low-yielding cash to record portions of the portfolio. Of course, with rising yields come unrealized losses on available-for-sale securities, and those losses, perhaps temporary, now total $28.3 billion year-to-date overall. of the sector. Going forward, interest rates are expected to rise further in the coming months with the Fed’s commitment to reduce inflation.

investment return graph Source: Callahan peer-to-peer analysis

Jay Johnson is president of Callahan Financial Services, distributor of the Trust for Credit Unions, in Washington, D.C.

Jay Johnson Jay Johnson