Credit Risk of Investments
When managing the credit risk of investments, credit unions should be mindful to both diversify and establish concentration limits on their investment holdings. The relevance of these timeless principles has intensified in recent months, particularly for mortgage instruments.
The mortgage market has experienced considerable turmoil as problems with riskier home loans have come to light. Delinquencies and foreclosures have accelerated for the riskiest of these loans, and investors in mortgage-backed securities have come to realize their credit risk exposure is higher than originally assumed. In turn, the value of mortgage assets has fallen.
Even when investing in the highest credit quality mortgage-backed securities, a credit union is potentially impacted by investment credit risk if they aren’t properly diversified or hold too large a concentration in one issuer or obligor.
How can a credit union safely invest its funds and reasonably manage its credit risk exposure? Ultimately, there are two very simple principles that always help to address this question:
1. Diversify holdings across investment types and sectors.
2. Establish a prudent concentration limit on investment issuers and obligors.
What kind of credit risk exposure do you have and how is it controlled? Now is an excellent time to review your investment holdings, policies and practices to determine if you are on top of your investment credit risk and upholding the diversification and concentration principles.
Reprinted with permission from the NCUA.
