FCUs’ portfolio choices are one way to show commitment to environmental and social causes.
Federal credit unions have an inherently strong, socially conscious business model. Demonstrating the many ways that they may positively impact society can address consumers’ growing interest in choosing a financial institution that aligns with their values.
A way that FCUs can demonstrate their positive impact on society is by highlighting the “impact investments” they can make. These investments are designed to support sustainable, environmental and/or social causes.
To promote the safety and soundness of the credit union industry, the National Credit Union Administration prohibits FCUs from readily investing in certain types of non-government securities for their core portfolios—and FCUs generally have a smaller suite of investment options than what is available to banks and state-chartered credit unions. Yet FCUs do still have options for investing in ways that support environmental and social causes. For example, they can also utilize two exceptions to core investment authorities where regulations permit an expansion into other types of investments, including those that support impact causes.
An FCU’s core permissible investments are limited to certain types of U.S. fixed-income securities. Primarily these are either issued or guaranteed by the U.S. government, its sponsored enterprises, or its agencies (including mortgage-backed securities), as well as securities issued by state and municipal governments and their related entities. Also approved are fixed-income securities issued by bank entities (e.g., banknotes and certificates of deposit). Non-agency residential or commercial mortgage-backed securities are permissible with stringent credit requirements. Noticeably absent from approved investment authorities are corporate bonds; most asset-backed securities; equity securities; and other alternative types of investments (e.g., venture capital funds, private equity, etc.).
Moreover, corporations, including parent holding companies of banks, are now more frequently issuing debt that supports impact causes. Unfortunately, these impact investments are impermissible for FCUs as a core holding. Similarly, consumer ABS backed by electric or hybrid vehicles or solar panel loans are also untouchable by FCUs. Additionally, equity securities from, for example, clean transportation, hydrogen fuel cell or battery technology firms, or perhaps even exchange-traded funds targeting these very sectors, are all mostly unreachable for FCUs. Lastly, alternative investment funds (e.g., venture capital, private equity, etc.) are difficult to access for most investors and not permissible (or even fundamentally appropriate) for FCUs. However, these funds are dominant players in the market for investing in exciting and groundbreaking new green technology, and next-generation energy infrastructure.
Core Impact Investment Options for FCUs
FCUs are not readily participating in the types of impact investment activities that often receive the most headlines in the financial media. Yet, this does not mean that the traditional core set of investments available for FCUs are without any positive social benefit. FCUs’ investment activities can be a strong complement to the value-generating services that they provide to the communities and membership bases in which they are chartered to serve.
For example, Fannie Mae and Freddie Mac are U.S. government-sponsored enterprises, while Ginnie Mae is a U.S. government-owned entity. Collectively, these regulated entities are mandated to support a wide range of residential mortgage loan options while also addressing the needs of conforming borrowers, first-time homebuyers, and veterans. Additionally, they provide commercial real estate owners a means to finance multifamily properties. This includes providing several options for financing the purchase, construction or redevelopment of affordable housing properties. These loans are routinely bundled into an assortment of RMBS and CMBS securities with payment guarantees provided by the agencies.
The securities are ultimately sold to a wide range of investors, including FCUs. Investors can select securities that target specific geographic areas, loan sizes, property types or credit scores. Banks do this regularly to comply with Community Reinvestment Act requirements, although in general, MBS with specified characteristics can be more expensive to trade.
Also available to FCUs are debt instruments directly issued by Fannie Mae and Freddie Mac, which help fund the agency’s mission to support a liquid and efficient residential and commercial mortgage market. These entities have recently launched a relatively small, and still developing, new market for agency CMBS backed by mortgages for green multi-family commercial properties.
Other options available to FCUs that provide a social benefit are securitized pools of small business loans that are guaranteed by the U.S. Small Business Administration. Securities issued by certain small business investment conduits and certified development companies are also guaranteed by SBA. FCUs may invest in debt issued by the Federal Farm Credit Bank, for example, which provides loans to U.S. farm owners. FCUs can also look to purchase securities from the Federal Home Loan Bank, which provides liquidity, banking and various financial services to credit union and national, regional and community banks.
Lastly, state and municipal government-related securities help support funding for essential government services to its citizens and are regularly used by FCUs. In some instances, certain types of municipal enterprises and authorities may issue debt that directly supports local initiatives covering clean water, pollution control, clean energy, waste management or the production of biofuels. There are also municipal authorities throughout the country that finance community development, secondary education, infrastructure, mass transit, housing for at-risk populations (including for the homeless) or affordable housing projects.
How FCUs Can Seize Other Opportunities
Outside of these core fixed-income investment activities, FCUs are permitted to expand into other asset classes in two special cases. First, subject to account size, distribution and other requirements, FCUs can open charitable donation accounts whose returns are used to help fund contributions to non-profit entities. Secondly, FCUs may open another type of account to pre-fund their employee benefits expenses. In this case, the account’s potential excess returns can be used to offset the ever-rising cost of employee benefits. When either or both accounts are used, FCUs could expand into equity, corporate bonds and consumer ABS asset classes. These are normally impermissible as core holdings, yet still have the potential to be very good areas for impact investments, as discussed above.
Either of these accounts could also be an avenue for FCUs to purchase securities from bank holding companies, which are not allowed as a core holding. These securities are now more commonly being issued to specifically support a wide range of impact-related activities, including funding loans for green initiatives, social causes or even responses to the COVID-19 crisis. In addition, these supplemental accounts provide a social benefit themselves by supporting charitable causes and helping to support the very FCU employees who provide value-added benefits to their communities and members.
Impact Investing is Already Part of the Core Business Model
FCUs’ core investment holdings do not normally make headlines. Individual securities are also unlikely to be certified by an outside organization as impact investments. They are perhaps even difficult to map directly into a set of impact banking or investment principles. However, FCUs should still demonstrate how they can support communities and broader society through the government-related securities that they regularly purchase. It is also worth noting that FCUs are obligated to have strict policies surrounding credit, interest rate, liquidity and asset/liability management-related risks. After all, FCUs are, by their very nature, conservative and highly regulated institutions that have a finite set of permissible investment options. If FCUs regularly highlight that their core investment portfolios have always served a positive benefit to society, they may gain additional understanding and recognition from their membership.
Richard Colavecchio, CFA, is FVP/investment management at $6.9 billion United Nations Federal Credit Union, New York. He helps manage an approximately $2.6 billion investment portfolio across a broad range of asset classes. Climate-neutral since 2016, UNFCU is leading a United in Sustainability Credit Union Network. For more information, email UISNetwork@unfcu.com.