Published by CU Business
In a year where depositories face ongoing margin pressure, management teams and boardrooms across the country search for alternatives that generate additional profits. In many respects, credit unions may have a more challenging time recuperating lost interest income compared to their bank counterparts, given the regulatory hurdles they face in both their loan book and investment portfolio. To provide relief as it relates to the latter, the NCUA enacted section 701.19, “Benefits for Employees of Federal Credit Unions”, which allows federally chartered institutions to circumvent Section 703 of the NCUA rules and regulations. As employee benefits costs have outpaced the reasonable expected return profile of a federally chartered core bond portfolio (governed by 703), the need for expanded investment authority was apparent.
Institutions have long used various insurance products as pre-funding investments, either in Bank-Owned (BOLI) or Credit Union-Owned (CUOLI) Life Insurance form. However, over the last three years, one of the more popular choices has become a pre-funded securities portfolio. With nearly a 50% increase between June 2017 and June 2020, according to S&P Global Market Intelligence, it’s easy to see why this has become a more widespread investment vehicle. Affording institutions the opportunity to purchase corporate bonds and equities, securities portfolios provide flexibility in their mandate, both from an interest rate and credit risk standpoint, with little barriers to exit, and relatively low management fees (assuming the portfolio is not managed internally). One of the pitfalls, however, is the mark-to-market accounting treatment these portfolios receive, giving rise to potential income statement volatility. To alleviate accounting concerns, and smooth P&L recognition, institutions are exploring a middle ground, known as a Stable Value Wrap, or Annuity. We discuss the finer points below:
What is a Stable Value Wrap? An annuity, managed in a separate account, whose sole beneficiary is the institution, or company. The “wrap” is provided by an insurance carrier, which smooths the accounting impact of more volatile investment exposures, such as equities. Rather than being classified as a trading portfolio, the annuity is considered an insurance contract and the value change is managed over an amortization period given the expected return profile at inception. The important takeaway is that the “wrap”, or protection, is only meant to be an accounting solution, it does not provide any economic benefit