Edward Meier
MADISON, Wis.—Three factors have made clear the need for a registered investment advisor for credit unions, according to one company.
Madison Investments said the recession, the corporates’ pullback from investment services, and margin compression have all combined to make it necessary for credit unions to look more closely at such an advisor, the company said.
“Over the last decade, one misconception has been that credit unions don’t need a registered investment advisor,” said Edward Meier, senior portfolio manager at Madison Investments. “Around 2007 to 2008, the loan-to-share ratio was very high. Credit unions were loaned out and those that did invest used a broker as opposed to an advisor.”
But the situation has changed greatly since the Great Recession, emphasized Meier, when loan demand waned and the corporates moved away from investing in in securities, which were the root of the collapse of the corporate system in 2008.
“Prior to the recession most CU portfolios were made up of laddered CDs, or regular callable agency securities. Pretty plain vanilla. So prior to the recession many credit union executives felt there was no need for portfolio management assistance,” said Meier.
Loan To Share Drops
But when loan-to-share ratios fell from historic highs of more than 80%, credit unions needed to place greater emphasis on investments, said Meier.
“What we began seeing as the recession had its impact was credit unions coming to us saying they need help to manage their excess liquidity,” said Meier.
The old thinking among CU executives, said Meier, had been that if they needed to invest that they could simply buy CDs.
“But from 2009-2011, what they found is that a lot of the CD issuers were flush with liquidity as well and did not need to offer CDs,” said Meier.
Credit unions then needed alternatives, said Meier.
“Back in the day, that might have been the structured notes of the corporates. Well, the corporates are not offering those notes so they had to find someone to help them with investments above and beyond the CDs they were buying,” said Meier.
But the big issue that emerged within credit unions was that members were paying off their loans and there was not a ready investment instrument to match the yield the CU had been getting from the loans coming off the books. This puts tremendous pressure on the CU margins and ROA.
“Net interest margins were shrinking dramatically,” said Meier, who said that to address that bottom-line problem credit unions began moving out longer on the yield curve with investments and accepting greater interest rate risk.
Meier noted that going longer on the yield curve quickly drew the attention of NCUA.
“That became an issue with NCUA to the point where they were sending investment experts to do exams,” said Meier. “NCUA became very concerned about the mismatching of assets to liabilities.”
All of these issues, contends Meier, have led to a greater need for credit unions to use a registered investment advisor (RIA), a service Madison Investments provides.
“A registered investment advisor builds an investment strategy around the risk profile and goals and objectives of the credit union,” said Meier. “One misconception is that brokers and registered investment advisors are similar—interchangeable.”
A big difference between the two, asserted Meier, is that the RIA is bound by a fiduciary standard.
“That standard was set up by the Investment Advisors Act of 1940, which said the RIA has to put the client’s interests before their own,” explained Meier. “There now is a duty of loyalty—a bond/trust that ensures the best execution for clients.”
RIA Misconception
What the Act did was require the RIA to disclose any conflict of interest, said Meier.
“If there was a conflict of intertest, the RIA has to come forward and present it to the client,” said Meier. “But broker dealers are bound by a suitability standard, which sometimes can create a conflict of interest. Brokers are paid on a commission basis, per transaction which can lead to a misalignment of incentives. I think that the fiduciary standard is a better match with the interests of credit unions than the suitability rule.”
Meier also added that the thinking that RIAs are expensive is a misconception. He said CUs seem to prefer paying the broker per transaction, as opposed to the RIA flat monthly fee, because it may seem less expensive. But Meier argued that RIAs do much more for the credit union than broker dealers, such as devising an investment strategy matched to the credit union’s strategic goals, and also saving the CU a great deal of time—keeping them from having to carefully review individual investment opportunities from brokers that can flood inboxes.
“I think credit unions often think they are not paying the broker anything since broker fees can be hidden in the yield of the investment, which is reduced to cover that expense,” said Meier. “I think when the credit union looks at what they pay a broker as opposed to an RIA, annually it’s about the same, and they get much greater service—service that is focused on the best interests of the credit union—from the RIA.”