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NORTHVILLE TOWNSHIP, Mich. – In a rising interest rate environment such as the current one credit unions are operating in, what are the best ways for credit unions to maintain the best income position? A study commissioned by the Michigan Credit Union Foundation addressed the risk exposure faced by Michigan credit unions and assessed the best practices and tools they should use to mitigate that risk. Michigan Credit Union League President/CEO David Adams said Interest Rate Exposure Faced by Michigan Financial Institutions is designed “to help credit unions devise appropriate strategies for improving their income position in an increasing interest rate environment.” The study used data collected from various databases to gather interest rate and balance sheet information for banks, thrifts and credit unions. Four asset peer groups were developed for each institution: $0 to $50 million; $50 to $100 million; $100 to $500 million; $500 million and more. The analysis covered five points, and these are the highlights of the findings: * current interest rate risk position: Overall, the study found that credit unions have risk positions that are close to the peer banks and thrifts. “Interest rate risk has been kept at a reasonable level by the credit union managers’ ability to keep expenses low and to provide good loan and deposit rates,” the study states. “Unfortunately, as competition changes, it is becoming more important for every financial institution to provide a robust products menu. It is costing credit unions more every day to keep up or catch up with other financial institutions. This change is happening when interest rates are rising. These two issues result in a difficult environment for credit unions to operate in going forward.” * review regulatory and charter requirements: As the new Michigan Credit Union Act provides more possibilities for state-chartered credit unions, it is apparent that the federal charter provides the most reasonable way to use various financial products to lower interest rate risk. However, even though the federal charter allows the use of financial hedging tools, they limit the use to 50 CUs in a pilot program. In comparison, bank and thrift charters have basically unlimited use of all hedging products. If it is a reasonable, sound banking practice, then it is acceptable as long as the equity position is strong, the study reads. * identify and report on risk hedging tools and best practices: after analysis of an extensive list of risk hedging tools currently offered, the study concluded that there are only a few acceptable products to use – interest rate swaps, caps, floors and collars are among the most widely used. Credit swaps and currency swaps make up the next two largest used products. Credit unions also can use a corporate credit union and the Federal Home Loan Bank to borrow funds to reduce interest rate risk. The main advantage of using borrowing as a hedge, the study states, is that it matches liabilities with assets. The primary disadvantages are extension, prepayment risk and potential lack of need for the liquidity. * research on emerging risk hedging tools: according to the study, the current tools are “remarkably efficient in their ability to reduce interest rate risk, though most products have been priced and packaged only for the largest of financial firms. The future holds the ability for smaller institutions to utilize the complex hedging tools.” * actions to reduce interest rate risk: the study provides various examples of actions that can be taken to mitigate interest rate risk in a rising rate environment. The examples are broken down by the four asset peer groups. -

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