What happened at SVB, and will it happen at your credit union?
It’s all over the news, bank failures. We can blame it on a failure of the FDIC or the deregulation of the banking industry, even in the shadow of the bank failures that stemmed from the mortgage-backed securities debacle. But two questions remain, why did this happen this time, and are credit unions at the same risk as the regional banking system?
One of the primary reasons for the high-profile failures in the regional banking system was an accounting practice known as Hold to Maturity. What does that mean?
Hold to maturity (HTM) is an accounting method that allows banks to hold investments, such as bonds, until they mature rather than sell them before maturity. While this accounting method can provide stability and predictability to a bank’s balance sheet, it can also adversely affect regional banks.Bottom of Form
First, the HTM accounting method can limit a bank’s ability to generate income. By holding onto investments until maturity, the bank may miss out on opportunities to sell these investments at a profit or to reinvest the proceeds at a higher rate of return. This can be particularly problematic for regional banks that may have limited sources of income compared to larger national or international banks.
Second, the HTM accounting method can also limit a regional bank’s ability to manage risk. If a bank holds significant investments until maturity, it may be exposed to interest rate, credit, and other market risks. If market conditions change, the value of the investments held until maturity may decrease, leading to losses for the bank.
Third, the HTM accounting method can make it difficult for regional banks to adjust their balance sheet quickly in response to changing market conditions. For example, when the Fed raises interest rates, the bank may be unable to sell some of its bonds or loan portfolios to invest in higher-yielding securities. Also, if the bank has held the bonds or long-term loans until maturity, it may not have the flexibility to adjust its portfolio in response to changing market conditions. Think of it this way: if you were a bank with a significant portfolio of 15-year commercial loans at a 4.5% interest rate, the Federal Reserve Rates went to 6%, and the deposit portfolio went to 7%; these commercial loans would represent a loss of income.
The HTM accounting method can limit a regional bank’s ability to generate income, manage risk, and adjust its portfolio in response to changing market conditions making it more difficult for the banks to compete, putting them at a disadvantage in the marketplace.
How exposed are credit unions in this scenario?
Although HTM is a common practice for many credit unions, they often have a different investment strategy than banks. As member-owned, not-for-profit financial institutions, they often prioritize the safety of their members’ deposits over shareholder returns. As a result, they are more likely to focus on investments that provide a secure, steady stream of income rather than capital gains or shareholder gains. Credit unions also have different regulatory requirements and are subject to additional rules regarding investment practices than banks.
Credit unions may utilize HTM investments as part of their overall investment strategy, but because of the cooperative nature of the credit union business model, they carefully consider the risks associated with holding investments until maturity and, when they do, may also carefully evaluate the impact of HTM investments and their members’ deposits to protect their liquidity and ensure sufficient funds are available to meet their members’ needs.
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