Background on Bonds
Institutions of all sizes invest in agency bonds. More than 2,400 credit unions nationwide currently hold bonds, from small credit unions with a few million dollars in investments to the largest credit unions with substantial amounts of their portfolios invested in securities. In fact, credit unions hold more of their liquid assets in bonds than in any other investment instrument.
Bonds offer many benefits, including:
- Higher rates than share certificates and bank CDs, depending on the yield curve
- Ready source of liquidity — can be sold easily if the credit union needs the funds
- Quick way to invest large amounts of excess liquidity
- A variety of maturities and structures
- GSE (agency) bonds are an approved investment for credit unions
The largest sub-sector of bonds that credit unions invest in is agency bonds, also known as government-sponsored enterprises (GSEs). GSEs are privately-held corporations that were created by the U.S. Congress to reduce the cost of capital for certain borrowing sectors of the economy, such as farmers and homebuyers. GSEs are not direct obligations of the U.S. Government, but carry the implicit backing of the U.S. Government. As such, they offer a yield premium over Treasuries.
Examples of GSEs include: the Federal National Mortgage Association (Fannie Mae), Federal Home Loan Mortgage Corporation (Freddie Mac), the Federal Agricultural Mortgage Corporation (Farmer Mac), the Government National Mortgage Association (Ginnie Mae), the Federal Home Loan Banks (FHLB), and the Federal Farm Credit Banks (FFCB).
Three of the GSEs — the Federal National Mortgage Association (Fannie Mae), the Federal Home Loan Mortgage Corporation (Freddie Mac), and the Federal Agricultural Mortgage Corporation (Farmer Mac) — are owned by investors; the rest are owned cooperatively by their borrowers.
GSEs were established to improve the efficiency of capital markets and to overcome market imperfections that prevent funds from moving easily from suppliers of funds to areas of high loan demand. Congress created the first farm-oriented GSE in 1916 — the FFCB, the first home finance-oriented GSE in 1932 — the FHLB, and the first education-oriented GSE in 1972 — the SLM Corporation, also known as Sallie Mae.
The creation of GSEs led to a secondary loan market as a result of guarantees, bonding and securitization. This market has enabled primary market debt issuers to increase loan volume and decrease the risks associated with individual loans. It also helped drive standardization of securitized investment instruments (securitized securities).
Debt securities issued by GSEs are considered to be of high credit quality. The senior debt of GSEs is rated AAA/Aaa, while the subordinated debt of Fannie Mae and Freddie Mac currently is rated AA-/Aa-. Some GSEs have explicit, though limited, lines of credit from the U.S. Treasury.
How Bonds Trade
Most bonds are traded by institutions such as governments, pensions, mutual funds and financial institutions. The vast majority of bonds are traded directly between two parties, or on an "over-the-counter" market, versus on an exchange market, such as a stock market. Trades are usually conducted on the institutions' behalf by bond dealers, or more specifically, the bond trading desks of major investment dealers. Bond dealers "make a market" for bonds by setting the sales or purchase pricing.
CU Investment Solutions' registered representatives at Catalyst are constantly evaluating the inventories of more than
15 broker-dealers for bonds that are appropriate for credit unions. When a credit union is ready to purchase a bond,
Catalyst/CU Investment Solutions contacts the bond dealer and places the trade for settlement on a specific date. On the settlement date, credit union funds are sent to the seller, and the security ownership is transferred to the credit union through the credit union's safekeeping agent.
Bonds can be purchased at par (100 percent of maturity price), at a discount (less than par value), or at a premium (above par value).
When a bond is purchased, a confirmation and all the associated documentation is sent to the credit union for its files. Thereafter, the safekeeping department sends monthly holding statements and notices regarding the investment to the credit union.
If securities are held in safekeeping with CatalystCorporate, semi-annual interest is paid directly into the credit union's settlement account.
The credit union's CPA can provide guidance on how to account for bonds, generally a simple process. NCUA has credit unions document securities on the Investments schedule and allows bonds to be categorized as "Hold to Maturity," "Available for Sale" or "Trading." "Hold to Maturity" allows the credit union to book the bond at its purchase value, while "Available for Sale" and "Trading" require bonds to be recorded at their market value on a monthly basis.
Catalyst/CU Investment Solutions is always available to provide bond education for credit unions and to evaluate how bonds might contribute to a credit union's investment strategy.
To put this service to work for your credit union, email an investment professional at
email@example.com or call 800.301.6196.