Interest Rate Risk Goes Beyond Mortgages
Like most financial institutions, Eagle Community Credit Union has weathered what CFO Scott Rains described as several years of blustery economic conditions.
What’s more, the $206 million institution, located in Lake Forest, Calif., has prospered almost in spite of guidance given by its examiners.
Eagle Community, which serves 18,000 members, including many federal employees, has few mortgages on its books and is primarily focused on short-term member loans.
To help the credit union stay financially viable as the loan market softened in recent years, Rains rolled 50% of the credit union’s assets into investments. But volatile interest rates and a changing economic climate have started to threaten earnings even from that portfolio.
“We’ve had some pretty substantial unrealized losses [on investments] in the past nine months,” Rains said. “It’s about $2 million on an $80 million portfolio, but we’re very comfortable with that and I don’t have anything better to put my money into right now.”
The losses occurred on the investment’s mark-to-market values, which measure lost revenue potential through rate changes rather than a declining principle value. Unfortunately, the NCUA examiners under whose scrutiny Eagle Community falls were less comfortable than the credit union with the losses.
“The NCUA comes at this from a very different perspective,” Rains said. “They’re all about safety and soundness, but we have to make money.”
Cultivating earnings potential while staying within NCUA’s prescribed regulatory guidelines can be a risky business, admit examiners and credit union executives alike. Managing interest rate risk is a challenge faced by all credit unions, and one that’s likely to be compounded when rates eventually begin to rise.
When that day finally comes, credit unions whose cash flow streams fail to balance with their funding streams may find themselves very uncomfortable.
“We get concerned in a situation when a change in interest rates stresses income or creates very large changes in asset valuation,” said John Worth, NCUA’s chief economist.
A changing rate environment can weaken the value of fixed-rate assets at a time when depositors may demand higher rates just to keep money in their member accounts, he said.
The result, Worth explained, can be a compressed net margin that can wind up threatening a credit union’s financial strength and stability.
“That’s really the crux of it,” Worth said. “A stress to earnings, a stress on asset values and a reduction in liquidity can create a significantly stressful environment for the credit union. That’s where we have concerns about interest rate risk.”
Read more about interest rate risk and credit unions in the Feb. 5 issue of Credit Union Times.