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How to Get the Best of Both Worlds in Your Pre-Fund Plan

In a year where depositories face ongoing
margin pressure, management teams and boardrooms across the country search for
alternatives that generate additional profits. In many respects, credit unions may
have a more challenging time recuperating lost interest income compared to
their bank counterparts, given the regulatory hurdles they face in both their
loan book and investment portfolio. To provide relief as it relates to the
latter, the NCUA enacted section 701.19, “Benefits for Employees of Federal
Credit Unions”, which allows federally chartered institutions to circumvent
Section 703 of the NCUA rules and regulations. As employee benefits costs have outpaced
the reasonable expected return profile of a federally chartered core bond
portfolio (governed by 703), the need for expanded investment authority was

Institutions have long used various insurance
products as pre-funding investments, either in Bank-Owned (BOLI) or Credit
Union-Owned (CUOLI) Life Insurance form. However, over the last three years,
one of the more popular choices has become a pre-funded securities portfolio. With
nearly a 50% increase between June 2017 and June 2020, according to S&P
Global Market Intelligence, it’s easy to see why this has become a more widespread
investment vehicle. Affording institutions the opportunity to purchase
corporate bonds and equities, securities portfolios provide flexibility in
their mandate, both from an interest rate and credit risk standpoint, with little
barriers to exit, and relatively low management fees (assuming the portfolio is
not managed internally). One of the pitfalls, however, is the mark-to-market
accounting treatment these portfolios receive, giving rise to potential income
statement volatility. To alleviate accounting concerns, and smooth P&L
recognition, institutions are exploring a middle ground, known as a Stable
Value Wrap, or Annuity. We discuss the finer points below:

  • What is a Stable Value Wrap? An annuity, managed in a separate account,
    whose sole beneficiary is the institution, or company. The “wrap” is provided
    by an insurance carrier, which smooths the accounting impact of more volatile
    investment exposures, such as equities. Rather than being classified as a
    trading portfolio, the annuity is considered an insurance contract and the value
    change is managed over an amortization period given the expected return profile
    at inception. The important takeaway is that the “wrap”, or protection,
    is only meant to be an accounting solution, it does not provide any economic

Example: 4% expected return,
with a 5-year “smoothing” or amortization period

  • ABC
    institution credits 4% expected return, straight line, with no volatility

  • ABC
    institution earns 5%. The additional 1% increase is then recognized over the
    amortization period

  • Book 4.20% for year 2
    (1% increase over the “smoothing” period), and reassess annually

  • Beyond friendly accounting, what other benefits does my
    institution receive?
    In the
    “traditional” mold, BOLI and CUOLI have served as the standard bearer. The
    beneficiary’s assets are setup in a general account, meaning they are invested
    in and owned by the insurance provider, often leading to a more rigid mandate.
    The other side of the coin is a securities portfolio, which is typically seen
    as a low-cost, hands-on alternative, offering a better liquidity profile and
    lower barriers to exit. Ultimately, a Stable Value Wrap may give your
    institution the best of both worlds. Managed in a separate account, the assets
    are set up in a bankruptcy remote trust eliminating carrier risk, or risk that
    the carrier should default. Additionally, you have the freedom to change the
    portfolio strategy without penalty and designate an asset manager separately
    from the insurance provider. This allows the beneficiary to more closely align
    institutional goals and risk tolerance with portfolio guidelines, and partner
    with an asset manager your institution trusts.

After a volatile 2020, where rates remain
historically low, and the search for higher returns continues, we believe, a Stable
Value Wrap is a worthwhile consideration for any institution looking to reduce
income statement volatility and maximize earnings. Many benefits provided by a securities
portfolio are still available to the beneficiary, without the headache of mark-to-market
accounting treatment. Uncertainty has loomed large throughout the year, but a Stable
Value Wrap offers more certainty to the way institutions manage and offset an
ever-growing expenditure.

Michael Oravetz

Michael Oravetz joined ALM First Financial Advisors in 2016. Michael assists in delivering holistic balance sheet strategies across a variety of funds managementdisciplines including loan and deposit pricing, portfolioand liquidity risk management, as well as profitability andfunds transfer pricing. Michael participates with implementing firm-wide strategic initiatives and modeling procedures. In addition, Michael conductsresearch for asset liability management strategies, interest rate hedging strategies, ALM model validations, loan pool valuation, and credit analyses. Prior to joining ALM First, he worked as an analyst in the Acquisitions and Capital Markets Group for Reef Oil & Gas. Michael holds a bachelor’s degree in bothFinance and Accounting from The University of Texas at Dallas, where he graduated with honors

Robert Perry is a Principal at ALM First, joining the firm in 2010. Mr. Perry leads ALM First’s ALM and Investment Strategy Groups and is responsible for the development of asset liability and investment portfolio themes for the firm. He also provides strategic focus for financial institution client portfolios that are primarily invested in the high credit quality sectors, and is instrumental in balance sheet hedging strategy development.

Robert Perry

Mr. Perry has more than 30 years of experience in the banking and bank-consulting businesses. Mr. Perry has shared his in-depth knowledge and financial management background at many conferences, training and educational events in the areas of ALM and investment strategy, profitability and portfolio strategies, as well as hedging and derivatives use. Mr. Perry has been quoted and published in various publications including WIB CFO Digest, WIB Directors Digest, Credit Union Business, Bloomberg News, and many more.

Before joining ALM First, Mr. Perry previously served as Managing Director of the ALM and Investment Strategy division of DataTech Management in Los Angeles, California, and Chief Investment Officer for First Coastal Bank in Manhattan Beach. Previously, Mr. Perry was a Principal and Product Portfolio Manager at Smith Breeden Associates, Inc., where he managed Smith Breeden’s Enhanced Cash and Enhanced Equity Strategies. He also managed Smith Breeden’s bank consulting group, which included the non-discretionary asset management and risk-reporting businesses. Prior to joining Smith Breeden in 1991, he worked as an analyst in the risk management area of Centura Bank in North Carolina.

Learn more about ALM First’s Employee Benefits Pre-Funding
Portfolio Management Solutions at or contact us at to discuss your
institution’s specific needs in more detail.

ALM First Financial Advisors is an SEC
registered investment advisor with a fiduciary duty that requires it to act in
the best interests of clients and to place the interests of clients before its
own; however, registration as an investment advisor does not imply any level of
skill or training. ALM First Financial Advisors, LLC (“ALM First Financial
Advisors”), an affiliate of ALM First Group, LLC (“ALM First”), is a separate
entity and all investment decisions are made independently by the asset
managers at ALM First Financial Advisors. 
Access to ALM First Financial Advisors is only available to clients
pursuant to an Investment Advisory Agreement and acceptance of ALM First
Financial Advisors’ Brochure. You are encouraged to read these documents
carefully. All investing is subject to risk, including the possible loss of
your entire investment.

The content in this message is provided for
informational purposes and should not be relied upon as recommendations or
financial planning advice. We encourage you to seek personalized advice from
qualified professionals regarding all personal finance issues. While such
information is believed to be reliable, no representation or warranty is made
concerning the accuracy of any information presented.

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