Published by CU Times
Throughout our twenty-five years as advisors to credit unions, we are continually impressed by their true community-oriented strategies. The service and care that they provide to their members is inspiring.
At their core, credit unions are in the business of making consumer loans, primarily auto and mortgage loans. However, shrinking margins, tighter spreads, lower loan demand and higher deposit inflows are creating a challenging environment. More credit unions need simple, modern access to the same balance sheet management tools banks have used effectively for decades to hedge interest rate risk.
An Opportunity to Manage Risk, Do More for Members
The NCUA’s Proposed Rule on Derivative Use is an opportunity for federally chartered credit unions to gain greater flexibility in managing interest rate risk and offering more products to benefit their members.
Like all financial institutions, capital must be built to ensure the safety of the depositors. The reason banks and credit unions use simple interest rate swaps (not to be confused with other types of derivatives) is to hedge interest rate risk.
Taking on more interest rate risk doesn’t add to performance over the long haul, but it sure can interfere with it. Credit unions generally focus on the things they do well (underwriting loans, diversifying them into a portfolio, gathering deposits, etc.) and remove items that are out of their control and may interfere with loan performance, specifically the level and direction of interest rates.
Credit unions will go to great lengths to serve their members. This includes issuing loans that might not conform to GSE standards and are, therefore, not Agency deliverable. If asset duration becomes too long, senior leaders are faced with the dilemma of either having too much interest rate risk or turning down a member that truly needs a loan. Should rates rise, certain derivatives will gain in value. Simply put, credit unions are at risk of asset duration extension should rates rise, and the use of derivatives is to mitigate this risk.