NEW YORK-If credit unions are relying more than ever on its investment portfolio to bolster ROA, Basel III rules filtering down to credit unions is not good news, assessed Peter Duffy.
The managing director at Sandler O'Neill & Partners reminded that the way to generate income in the investment portfolio is through duration. "The longer the duration the higher the income. Well, the longer the duration the higher the market value changes when rates change. So these Basel III rules, as written on the bank side, actually have some unintended consequences, we believe."
The guidelines could encourage institutions to stay shorter on the bond portfolio to avoid swings in market value and therefore effects on equity, proposed Duffy. "As result of that, the financial institution makes less money that goes into equity. You build equity through earnings, so this is bothersome."
The way around that problem, pointed out Duffy, is to keep investment duration as it is but move more investments into held to maturity instead of available for sale. "If you hold to maturity you don't have to mark to market when market value swings."
But if the institution places a large number of bonds into held to maturity, it has less flexibility in managing liquidity, reminded Duffy. "Then they can only sell their bonds if they mark to market their entire portfolio. This part of the proposed Basel III rules, if it survives, could discourage institutions from generating appropriate earnings."