When Mike Hambrick arrived at Envision Credit Union in April 2011 as senior vice president/CFO, the $260 million Tallahassee, Fla., institution was still struggling under the weight of the previous administration’s mismanagement.
The subsequent steps taken by Hambrick and Darryl Worrell, the new president/CEO hired in 2010, put the credit union on a stable course while setting the stage to better manage interest rate risk in preparation for what will one day be a changing rate environment.
At the time, Envision was burdened with high overhead and had too many 30-year fixed-rate mortgages on its books. Long-term assets topped out at 43% of the overall portfolio with little to balance the risk on the short-term side.
By 2009, losses from real estate loans and other long-term assets had taken a $2.4 million bite out of credit union earnings, Hambrick said.
“We spent two-and-one-half years changing the portfolio, buying $42 million in SBA securities,” said Hambrick. “They are immediately repriceable, but you pay a pretty good premium for them.”
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Envision set out to reduce its long-term debt from 43% to 23%, selling off $12 million in prime loans, a move that cost the credit union $1 million in earnings over two years. Despite the loss, NCUA examiners understood and approved of Envision’s new sensitivity to a better-balanced portfolio that effectively reduced risk.
“I’m not getting busted by examiners for interest rate risk,” said Hambrick. “Examiners are more accepting when you can give them a reason for what you’re doing. It’s the deer-in-headlights look some credit unions have that they don’t much like.”
Envision’s survival strategy created a financial stability that will keep the credit union buoyant amid changing rate scenarios. By all accounts, NCUA is happy with the change, as well as Hambrick’s penchant to work up close and personal with his examiners.
“We don’t take the attitude that examiners are a bad thing,” said Hambrick. “Our attitude is that the sooner you get here and see what we’re doing, the better for all of us.”
Read more: The regulator's point of view ...
From a regulator’s point of view, pending rate increases from the Fed can help credit unions prosper. But certain balance sheet characteristics must be in place in order for an institution to go forward confidently, according to J. Owen Cole, NCUA’s director of capital and credit markets.
“Examiners look for credit unions to have risk measurement metrics in place with prudential limits on how much risk to income and capital each credit union can absorb,” Cole said. “They also look for compliance with those board-established limits as well.”
A conservative strategy with an eye toward maintaining a balanced approach is a good prescription for many credit unions, Cole said. It’s also necessary given future rate changes.
“Credit unions should be evaluating their current and prospective risk positions and determine whether earnings and capital at risk is tolerable for plausible rate scenarios,” he said. “If not, credit unions should be instituting risk mitigation strategies as appropriate.”
David D’Annunzio, CFO and vice president of finance for $845 million South Florida Educational Federal Credit Union in Miami, welcomes a rise in rates. In fact, he sees it as critical to industry survival.
Credit unions that have been cutting costs in an attempt to save their way to profitability may soon be out of low-hanging fruit to pluck, D’Annunzio said.
“The longer we’re at these low interest rates, the harder it will be for credit unions to sustain profitability going forward,” D’Annunzio added. “Credit unions are running out of levers to pull.”
Rising rates, of course, can mean increased interest rate risk for credit unions with unbalanced portfolios or that suffer from inadequate liquidity. D’Annunzio recommended the following steps to help credit unions manage rising-rate risk:
- Maintain a layer of assets such as short-term or variable rate loans and investments that are less sensitive to rising rates and can be tapped for additional liquidity if needed.
- Establish lines of credit that allow you to borrow rather than sell off loans or investments at a loss if you do need more liquidity.
- Proactively managing the mix of the assets duration in anticipation of a rising rate environment.
“One element that gets lost is the value of money over time,” D’Annunzio said. “When managing liquidity and interest rate risk, you’re looking at cash flows and you’re managing the results of the time value of that money.”