<p>By ELAINE KINGOFF-BARR CU Times Editor-in-Chief WASHINGTON – Low mortgage rates last year were good news for credit unions' loan portfolios, especially when loan growth in other areas was soft. Coupled with a strong growth in savings, credit unions tended to hold onto fixed rate mortgages to build up their asset base. But with economists predicting a rise in mortgage rates in the second half of the year, now might be a good time for credit unions to revisit their asset liability management strategies and consider selling some of the first mortgages they've been holding to the secondary market. Credit unions originated over $2 trillion in mortgage loans in 2001, a record number. Bill Hampel, CUNA chief economist and senior vice president, research & policy analysis said credit unions currently have on average about 12% of their assets in fixed rate first mortgages. While there are probably a few credit unions with more than that, Hampel said he is not too concerned yet though the situation bears watching. "If the number got up to about 15%, I would know some credit unions were skewing the number up, and I would start digging around," he said. The rule of thumb for credit unions, said Hampel, is to have two times their net worth in long term fixed rate assets. "With mortgage interest rates likely to go higher in the second half of the year, credit unions that have locked themselves into having low rate loans as assets could find themselves in danger of taking a loss," said Hampel. NAFCU Economist Jeff Taylor said now's a good time for credit unions involved with making mortgages to keep their ALM policies fluid. He agreed with Hampel's position that credit unions should begin selling off more of their first mortgages on the secondary market, given the forecast for higher mortgage rates in the second half of the year. "You have to look at the retiming issue, that is what the interest rate was on the loan originally, what it is now, and how you're going to make up for the difference in the rate. This is especially crucial in a rising mortgage rate environment," said Taylor. Rather than advise every credit union to sell its fixed rate, long term mortgages, Kevin Haffner, team manager for CUNA Mutual Financial Management Services said, "Credit unions have to test their risk modeling to determine if they should sell or hold. They have to look at all the alternatives and test their assumptions. There are no absolutes." Haffner said credit unions have to "hedge their balance sheet" – try to mitigate the risk on the asset side of their balance sheet with the risk on the liability side. "This is a part of the balance sheet credit unions tend to not look at," he said. "Credit unions should be looking at the risk on the liability side. "Credit unions tend to get stuck looking at risk on the asset side," said Haffner. "There are many instances when credit unions' balance sheets can stand holding on to long term, fixed rate mortgages. Credit unions need to examine the liability side of their balance sheet and test their assumptions." With many members sitting on money deposited in their share account after they withdrew it from mutual funds and other investments when the economy went soft, there's a good chance some of them will consider taking that money out of the credit union when the economy shows signs of reviving. To remain competitive, credit unions will have to raise their rates on certain product lines. "The market will dictate if rates will go up on the loan side, but raising rates on the share deposit side is a way for credit unions to turn off the valve on deposits leaving the credit union even without taking on more mortgage loans and control their balance sheet through pricing," said Haffner. But how much should a CU raise its rates? There are a number of pricing tactics credit unions can use that to segment their membership and learn which members are rate sensitive and which aren't. "Most credit unions base their pricing on products based on the competition down the street," he said. "That's a wrong move. The competition may be deliberately pricing very low to undercut the market and get mortgages." At the very least, Haffner said credit unions should be pricing to cover the risk associated with a particular type of product. To determine that, he said credit unions need to figure out how must it costs them to deliver, originate and service the mortgage, and then compare it to the capital market rate. He gave this example: The capital market is charging 6% on a 30-year mortgage, but a credit union has to charge 6.25% to break even, "The credit union needs to ask itself if the 25 extra basis points are worth giving up their relationship with the member," Haffner said. "That's what credit unions need to continuously ask themselves." Haffner said he's amazed when he holds workshops on ALM strategies at just how many credit unions have ALM policies that are outdated and shortsighted. "I run into situations often where I find many credit unions don't know where to start to set their ALM policy. They usually look to other credit unions to model themselves after rather than evaluating their own tolerance for risk," he said. "Credit unions need to revisit their ALM policies regularly and evaluate where they're at. It's part of due diligence," said Haffner. – [email protected]</p>

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