Published by CU Today

DALLAS—One ALM expert believes NCUA’s new rule on derivatives not only solves a “classic” dilemma for many of the very largest credit unions, it may also provide some assistance for credit unions further down the asset scale.

Feature Derivatives LOW
“These fairly simple instruments can go a long way in fixing this problem,” said Robert Perry, principal partner with ALM First.

Perry noted that many of the very biggest credit unions have substantial mortgage operations, and regulations previously in place that restricted the use of derivatives has hampered their growth.

“The numbers were just too small in the previous rule for a big mortgage lending credit union. So, that’s been removed,” he noted. “The instruments have been broadened a little bit, which will help on mortgage risk. And if you really think about it, the risk in the credit union space comes from mortgages. You have consumer loans of fairly short duration, and then you have loans in the 10- and 15-year part of the yield curve. It’s the classic derivatives dilemma—there’s a lot of funding on the short end of the yield curve and there’s a fair amount of risk that’s on the longer part of the yield curve. NCUA’s new rule can go a long way to fixing the problem.”

As reported, the NCUA board approved 3-0 a new rule that updates the derivative investment authority for credit unions.

According to NCUA staff, approximately 30 credit unions are currently using derivatives to manage risk, but feedback indicates that number will grow. To take advantage of the new authority, credit unions below $500 million in assets must apply to the agency, and all CUs must apply to use derivatives if they have a management rating below two.

‘Pretty Simple’ Process

As also reported, NCUA staff said the application process will be “pretty simple” and will require an ALM model that incorporates a swap or a cap.

“We applaud NCUA for passing what they passed, moving to a more principles based rule,” Perry said. “The industry should be able to hedge its interest rate risk, that’s the bottom line. And any barrier to entry that’s put out there should be removed and make things simpler and easier for credit unions to use derivatives. That’s been our position the whole time.”

NCUA, when it passed the rule during its May open board meeting, emphasized boards at CUs investing in derivatives must educate themselves and be knowledgeable about what’s involved before the agency will approve.

“It’s pretty clear this is going to require a lot of board education,” said Perry. “You can’t avoid the responsibility of doing your due diligence, and have things in place–ALM models, systems and board training and policies to successfully use derivatives. This new rule does not remove that need for an institution to have those things in place, which were required in the previous rule.”

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