With S & P Downgrade, Credit Unions Should Review Investment Policies

The recent downgrade of United States debt could impact credit unions’ investment policies.  Credit unions should take the time to carefully review the language in their investment policies to ensure they do not get caught by any surprises.

Standard & Poor’s, one of the world’s three major credit rating agencies, cited “difficulties in bridging the gulf between political parties” as a major reason for the downgrade from U.S.’s AAA status to the next tier down, AA+.

As reported  by the Wall Street Journal, the downgrade reflected the S&P opinion that  “the fiscal consolidation plan that Congress and the administration recently agreed to falls short of what, in our view, would be necessary to stabilize the government’s medium-term debt dynamics.” It also blamed the weakened “effectiveness, stability, and predictability” of U.S. policy making and political institutions at a time when challenges are mounting.

“This is the equivalent of a financial institution getting a terrible Management score in its CAMEL rating.” said John Annaloro, the CEO of the Northwest Credit Union Association, on Friday when the news first broke.  “Dysfunctionality, if unaddressed, can have dire consequences that hurt everyone.”

A key concern will be whether the appetite for U.S. debt might change among foreign investors, in particular China, the world’s largest foreign holder of U.S. Treasuries. In 1945, foreigners owned just 1% of U.S. Treasuries; today they own a record high 46%, according to research done by Bank of America Merrill Lynch.   If the rating lowers demand, interest rates will have to rise.

The amount of government instruments held by WA and OR credit unions was reported in Anthem on July 14th.

As reported by NWCUA, Federal, Oregon, and Washington laws do not explicitly require credit unions to dump their treasury holdings should U.S. debt be downgraded or reviewed. However, there is an implicit assumption throughout that the U.S. government has a strong credit rating.

Of greater concern may be the wording credit unions use in their investment policies, and specifically the reference to the terms “Triple-A” or “AAA”.  With the possibility of other ratings agencies taking similar actions, some credit unions’ investment policies may need more careful wording.

David Curtis, NWCUA’s regulatory analyst, suggests credit unions consider using the language adapted by NCUA for its own investment policy on funds held in the NCUSIF.  It avoids the “AAA” term, and states:

“By law, the NCUSIF is permitted to invest its surplus cash only in interest-bearing securities of the United States or in any securities guaranteed as to both principal and interest by the United States or in bonds or other obligations which are lawful investments for fiduciary, trust, and public funds of the United States. 12 U.S.C. 1783(c). By Treasury Department policy, all securities must be purchased through the non-marketable Government Account Series (GAS) program administered by the U.S. Treasury Bureau of Public Debt.

The Investment Committee is authorized to purchase any securities sold through the GAS program, consistent with the investment strategy with the following constraints:

· Maximum maturity of 10 years.

· No more than 25 percent of the fund may have maturities longer than 5 years.

· The fund is limited to investing in non-callable Treasury Bills, Notes and Bonds. Additionally, the fund may also invest in the U.S. Treasury’s overnight option. “

It is also important to note the joint guidance issued by the NCUA and other federal regulatory agencies:

“For risk-based capital purposes, the risk weights for Treasury securities and other securities issued or guaranteed by the U.S. government, government agencies, and government-sponsored entities will not change. The treatment of Treasury securities and other securities issued or guaranteed by the U.S. government, government agencies, and government-sponsored entities under other federal banking agency regulations, including, for example, the Federal Reserve Board’s Regulation W, will also be unaffected.”

 “Credit unions should remember that credit ratings are just opinions issued by the agencies that reflect their views on the risks of certain businesses and governmental agencies ability to pay their debts.” said Curtis.  “Remember, these are the same people who told you that mortgage backed securities from Goldman Sachs and UBS were AAA paper.” 

S&P said in its report that downgrading the U.S.’s credit rating reflected the agency’s belief that the debt deal Congress pulled together was not sufficient “to stabilize the government’s medium-term debt dynamics.” S&P said that in addition to the downgrade, it is issuing a negative outlook, meaning that there was a chance it will lower the rating further within the next two years.

The agency also lowered ratings on bonds issued by Fannie Mae and Freddie Mac along with long term U.S. government backed debt issues by 32 banks and credit unions.

No matter what the outcome of this issue, credit unions need to review the language in their investment policies.  Having references to “AAA” or “Triple-A” is a fixable issue and only requires a minor change in the wording of the policies to remove these references.

Questions or Concerns? Contact the Anthem Editor: Editor@nwcua.org.

Posted in Economy.