Selling Investments for Liquidity
November 13, 2014
A few weeks ago, we discussed increasing loan-to-share ratios resulting from loan growth outpacing share growth. The blog went on to discuss the potential liquidity pressures some could experience, today or in the future, if this trend continues.
To keep the lending machine going, many decision-makers maintain that to fund future loan growth they will sell investments in the future. While this may be an option worth considering, market rates in the future are uncertain and it can take a considerable amount of time to offset losses you may take on the sale of investments. Let’s walk through an example:
Assume a credit union is experiencing continued loan growth and it also holds a $100M agency bullet, with three years remaining until maturity, earning 0.75%. Their liquidity analysis is projecting they may need to sell this investment in 12 months to help fund loan opportunities.
Rates could go in any direction but what if rates increase 1% in the next 12 months? The credit union sells the $100M investment, now with two years remaining until maturity, at a $1.6M loss. If rates increase 3% in the next 12 months, the loss is $5.4M.
Beyond asking if the credit union is willing to take the loss, the next question should be, How long it will take new lending opportunities to offset the loss? Assuming loans will yield more as rates go up, it could take up to six months to recoup the loss on the sale in a +100 basis point (bp) increase in rates and 17 months in a +300 bp increase in rates.
The objective here is not to advocate a particular strategy, rather to encourage thorough analysis and provide a different perspective for credit union boards and managements to understand the trade-offs of difficult decisions.
