VIENNA, Va. - In both a rising and declining mortgage rate environment, pipeline management is a valuable risk management tool. Add to that mix the liquidity crunch credit unions are now dealing with as interest rates rise and pipeline management, say credit union mortgage lending experts, becomes a "critical" tool for CUs.

"Pipeline management is an ongoing involvement, day-to-day in all kinds of rate and market environments," says Navy FCU's Lou Jennings, executive vice president of operations.

"It's crucial that any credit union involved in mortgage lending have strategies in place so they don't have a knee jerk reaction to market changes. They have to be able to anticipate what's going to happen and what they're going to do and not wait to make a decision when the market changes."

To be able to do that, says Jennings, a credit union needs to have a strategy and policy in place, an understanding of what they want to accomplish.

"This can't be a serendipitous thing. If a credit union decides for example that it wants to portfolio mortgage loans as investments it needs to understand that, be able to quantify what it wants to retain and how much, determine what yields it's looking for. If it decides it wants to sell loans on the secondary market then it needs to have strategies in place to accomplish that. And it's important to have the proper people in place with pipeline management expertise and can manage those decisions."

This is where a lot of mortgage lenders-credit unions and banks-get it wrong, says Jennings. They approach risk management as one of the many responsibilities their mortgage people handle.

While pipeline management is important for any type of loan product a credit union offers, it's particularly necessary for mortgages because they're more risky by nature-they tend to be larger than other types of loans, and they have longer terms so there's a larger window of time something could go wrong with the loan.

"Credit unions have enjoyed a very rate friendly environment over the last several years," says Keith Varney, COO, TruHome Solutions, LLC, "but now it's the reverse. Credit unions that sell their mortgages on the secondary market have to deal with the possibility the market may move against them before they can sell. They have to choose between selling the loans right away or holding on to the loans longer hoping to maximize their profitability on the secondary market."

Varney refers to this as "best executive pricing," but "either way, it's a gamble," he says.

Like Jennings, Varney says pipeline management is crucial for credit unions involved in mortgage lending, but based on data collected by TruHome among credit unions, few CUs do it.

"Credit unions as an industry don't do a lot of mortgage lending to begin with. In a lowering interest rate environment like the one the mortgage industry is coming out of, there's no interest rate risk. But it's different in a rising rate environment, and credit unions don't understand the impact if they're not prepared," says Varney.

With interest rates rising, the risk becomes an even more important issue for CUs as their loan-to-share ratio increases.

"Credit unions' liquidity crisis in a rising rate environment should alert them to using the pipeline management tool," says NAFCU Director of Research and Analysis Dr. Tun Wai.

NCUA also recognized this in an article in the April edition of NCUA News "Planning for Liquidity Needs" in which the agency wrote, "Credit unions should review their liquidity policy and contingency plans to ensure that liquidity levels can be maintained at appropriate levels during times of economic stress."

Of course if credit unions don't have enough liquidity to make loans, they're going to have to find other sources for money. A Feb. 2006 NAFCU Flash report shows that more than half of federal credit unions-58.1%-indicated they funded their loan demand by borrowing from corporate credit unions. Selling on the secondary market and liquidating investments came in second at 45.2%.

"Credit unions need to find alternative ways to manage their cash flow so they'll have liquidity to meet their members' needs," says Wai. "Pipeline management helps credit unions determine the inflows and outflows of mortgage loans to project out to the future what's likely to happen."

In Navy FCU's case, Jennings says the credit union uses a system that incorporates historical data that tracks what loans do over time and how they react to market changes. He says the analytical system helps Navy FCU set parameters and decide what to do with certain loan products. The CU's pipeline management system analyzes the attributes of loans in Navy's loan pipeline and determines how likely the loans are to go to closing.

"You have to know the behavior of your pipeline in different rate environments," says Navy FCU Senior Vice President of Lending Mary McDuffe.

Jennings adds that the idea is to constantly be dealing in the secondary market and know what's happening with it.

"A lot of credit unions hold their loans waiting for the next dip in rates to run out and sell. Sometimes that works, but sometimes it doesn't, and then you wind up sitting on loans you didn't intend to."

He stresses that when managing risk, it's crucial for credit unions to optimize their alternatives.

"In a liquidity crunch such as the one credit unions are facing now, if a credit union is just borrowing from corporates that may not be the optimum solution. It's prudent to use alternatives, they will help credit unions manage their margins," says Jennings. -

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