Q4 Investment Trends: Cash Balances Shrink as Loans Rebound

Source: Callahan peer-to-peer analysis

Credit union stock balances rose 12.7% in calendar year 2021, topping $1.8 trillion for the first time in the fourth quarter and more than double industry totals from to ten years ago. Still, deposit growth has slowed from pandemic peaks. Equity balances rose 2.4% quarter-over-quarter, which was above the historical norm, but well below quarterly rates achieved throughout the pandemic. It’s no surprise that equity growth is declining from 2020, when unprecedented fiscal and monetary stimulus pumped millions of dollars into members’ equity accounts, many of whom were awaiting economic reopening. These actions created an increase in liquidity in many credit unions, resulting in a compression of interest spreads in the industry. As 2022 dawns, the outlook for the industry is more optimistic. Lending is at record highs — especially in the consumer sector — as demand has allowed credit unions to repurpose some of this new equity into performing loans. However, while balance sheets may show signs of stabilizing, the huge inflow of funds in 2020 still poses lingering macroeconomic challenges at present, namely inflation.

In recent months, markets have focused on the Federal Reserve and its response to inflation. The December Federal Open Market Committee meeting confirmed the common expectation that tapering would end in March, and three rate hikes were expected in 2022. The January FOMC meeting was even more eventful, with the Fed signaling that five rate hikes are now the consensus expectation for 2022, and the door has been left open for even more. If they materialize, these increases would push the fed funds rate into the 1.25% to 1.50% range in a relatively short period of time.

After being late to admit that the high inflation data from the Consumer Price Index was in fact not transitory, the Federal Reserve finds itself behind in the battle of inflation management. CPI reports confirmed rising prices over the months, putting a strain on cost-of-living spending for consumers. Raising rates and restricting money supply growth are the monetary tools available to the Federal Reserve to combat these inflationary pressures. However, limiting the flow of “easy” money risks depressing asset prices – especially in equity and real estate markets – and the possibility of a full-scale recession. The economic shocks of the COVID-19 pandemic and previous short-term monetary and fiscal responses have left policymakers stuck between the proverbial rock and hard place. Markets and the general public are eagerly awaiting further signals as to what the Fed will do regarding rate changes, as well as any plans for its nearly $9 trillion balance sheet. The bond market will be watching closely for any indication of when and how it expects to normalize, as a faster-than-expected tightening would be bad news for many investment portfolios.

Flow of money to government bonds

Cash and securities balances at US credit unions rose $8.7 billion from September to end the year at $718.6 billion. A strong 3.4% increase in securities and investments was partially offset by a 1.1% decline in cash balances as co-ops reallocated cash to higher yielding assets.

In dollar terms, credit union cash balances decreased by $2.8 billion to total $263.2 billion at year-end. They used the cash to meet the growing demand for loans and to invest in securities and investments; their balances increased by $15.1 billion during the quarter. Liquid assets now represent only 36.4% of total investments, a drop of 1.0 percentage point since the end of September. Broken down into subcategories and holding locations, nearly all cash holdings declined on a quarterly basis. Cash equivalents and cash on hand were the main culprits, down 18.9% and 8.4%, respectively. Cash balances held at the Federal Reserve were the only category of cash holdings to rise since September, rising just 0.3% to $183.8 billion.

Virtually all of the growth in the industry’s investment portfolios has occurred in securities. U.S. government bonds and investments in non-mortgage-backed securities from federal agencies received the bulk of credit union liquidity. Government bond balances gained $6.6 billion, a quarterly increase of 16.7%. The federal agency’s multi-year streak of MBS as the investment of choice for credit unions ended in the fourth quarter. Agency MBS balances recorded a modest increase of 0.2%, but have not seen a significant increase since the second quarter of 2021.

The influx of investments in government and agency securities pushed this category to 56.7% of the total credit union investment portfolio, up from 55.5% last quarter. Mutual funds represent 1.0% of the portfolio, unchanged from September.

investment portfolio data table Source: Callahan peer-to-peer analysis

The belly of the curve sees entries

Fixed income yields responded to the Fed’s pledge to raise rates by flattening during the fourth quarter and are now back to similar levels at the start of the year. The spread between two-year and 10-year Treasuries fell to 78 basis points after hitting 129 basis points as recently as October during the Delta variant scare. The five-year note rose 10 basis points in December to 1.26%.

Credit union investment managers took advantage of these shifts in the yield curve in the fourth quarter, generally shifting portfolios away from cash toward medium- and long-term securities. Specifically, the three-to-five-year maturity category grew at the fastest rate of any maturity group in the industry’s investment portfolio since September, up 6.9%, or 8, $2 billion over the three months. For the whole of 2021, $53.3 billion has accumulated in this maturity segment, representing an annual growth rate of 70.9%. Representing 17.9% of investment portfolios, durations of three to five years now make up the second largest portion of investments after cash. The five-to-10-year maturity group grew by 3.9% quarterly – and 81.3% annually – and now represents 13.7% of portfolios compared to 9.0% a year ago. Overall, credit unions have moved away from short-term, low-yielding securities in recent quarters towards those three to ten-year terms.

table of composition of investments by maturity Source: Callahan peer-to-peer analysis
Jay Johnson Jay Johnson

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

Garland K. Long