By Aaron Martini, CTP, Director of ALM Services
Mortgage-backed securities (MBS) often offer higher yields compared to other investment types, making them an attractive investment for credit unions seeking to enhance their income. The higher yields from MBS can help credit unions meet their income requirements and improve their financial performance. However, the benefits of MBS come with associated risks that must be carefully managed.
The potential risks associated with using MBS
One of the primary concerns with MBS is interest rate risk. MBS are sensitive to changes in interest rates due to their embedded prepayment options. In a declining interest rate environment, homeowners may refinance their mortgages, leading to higher prepayment rates on MBS. This results in a reduction of the expected yield and can potentially disrupt the credit union's interest income projections. Conversely, in a rising interest rate environment, MBS may experience a decrease in value as the fixed payments become less attractive compared to newly issued securities with higher rates.
Liquidity risk is also a consideration. MBS can be less liquid than other types of securities, which may pose challenges if credit unions need to quickly access cash. In times of market stress, the ability to sell MBS at favorable prices can be limited, potentially impacting a credit union’s liquidity position.
Recently, we have seen situations where banks have been failing, due largely to the reduction in the market value of their securities. As market rates have gone up, the value of these securities has gone down. Then depositors demanded to withdraw their funds, the institutions had to liquidate their securities far under their book value. With fewer funds received from sales of securities, the banks were unable to pay back the depositors and ultimately collapsed.
Balance these factors with Catalyst ALM
While MBS can enhance yields and provide diversification benefits for credit unions, they also introduce interest rate, credit and liquidity risks. Balancing these factors through robust ALM practices is crucial for maintaining financial stability and achieving long-term success in today’s ever changing economic environment. Our experienced professionals stand ready to help you achieve long-term success. For more information, contact us today.