The NCUA's sense of urgency on interest rate risk is overblownand many credit unions are feeling pressure to follow the advice oftheir examiners or face consequences.

That's according to George Darling, CEO of asset liabilitymanagement group Darling Consulting Group in Newburyport, Mass.

“I think it's overblown but should they be concerned? Yes. Is itoverblown to the point where you could say in some cases it almostseems hysterical? Probably,” Darling said. “You have a situationwhere to get any kind of income in the environment that's beencreated, the economic environment, people are reaching for yields,so they are putting on longer term investments.”

The NCUA may not have the tools that allow it to trulyunderstand some of the positions of these credit unions, Darlingsuggested. As a result, it's easier for the financial institutionsto be adverse to all long term assets than it is to take the timeto try to develop the expertise and tools they need to truly assessthe real position, he said.

CU Times was informed that some credit unions areselling off long-term assets under pressure from the NCUA toaddress interest rate risk.

“I don't know if they told them they need to specifically selloff certain securities but that they just need to re-calibrate therisk on their books,” NCUA Board Chairman Debbie Matz said after the agency's monthly board meeting inJune.

Matz said the NCUA currently has a rule requiring credit unionsto develop a policy to consider interest rate risk and make sureit's within viable parameters.

“Some credit unions have not done that or have made faultyassumptions and so examiners have been trained. We have not reallyyet implemented the policy of having examiners go out there andtell credit unions they need to take actions to modify their booksbased on interest rate risk,” Matz said. “In some cases whereexaminers have been extremely concerned, I'm sure they have madesuggestions that credit unions take some action before it's toolate.”

Darling said each credit union's situation depends on theindividual examiner involved.

“My sense is sometimes the recommendation from the examiner isviewed as a mandate and it depends on how strong the credit unionfeels about wanting to push that particular issue,” Darlingexplained. That's always the issue–was it really a recommendationor was I told to do that?

Many people believe if the regulators suggest something, theybetter do it before examiners come back in again or they will be introuble, he said.

“Our job is to manage risk, not to eliminate it. Regulators wantto mitigate risk, instead of manage it,” Darling said.

Dan McGowan, CFO at the $180 million Pioneer West Virginia Federal Credit Union in Charleston,W.Va., said the current flat interest rate environment is actuallyworking against his credit union. Pioneer's IRR program hasprimarily consisted of using ALM shock and scenario analysis withthe Profitstar software from Jack Henry & Associates.

“As an anticipatory philosophy, we've been keeping our book ofbusiness pretty short. That even extends to our mortgageportfolio,” McGowan said. “We've been doing brisk business in the10 to 15 year terms, but aren't holding anything beyond that on ourbooks. Our asset sensitive position is positioned to actually takeadvantage of a mildly rising rate environment quite nicely.”

He added, “In fact, we've been hoping to see that happen forsome time. A continuation of this flat rate environment isn't doinganything for us. By the way, one of the downsides of keeping ashort-term loan portfolio is that we have to work double hard togenerate new loans to counteract the rapid rate of pay downs.”

McGowan said he is not personally aware of the details of creditunions apparently being required to sell assets at a loss toreposition themselves.

“As a generalized observation, it's difficult, in my mind, tolock in a loss weighed only against a possibility of loss only ifcertain future events unfold,” he noted. “A credit union with anadequate ALM program shouldn't have a need to ever make radical changesto its balance sheet composition in a short period of time. There'salways a cost to do that.”

For this reason, Pioneer monitors such things on an ongoingbasis, McGowan said. It's much more efficient to make rather minoradjustments with the ebb and flow of the business climate as goodjudgment and sound practice dictate, he explained.

“Probably the worst thing that can happen–not only to creditunions, but to the whole world economic system–is a sharp andsustained rate rise,” McGowan said.

Pete Duffy, managing director at investment banking firm andbroker-dealer Sandler O'Neill & Partners LP based in New York,said an interest rate simulation typically takes into account,somewhat in a vacuum, what is going to happen when rates change andsome key factors are left out.

In particular, Duffy said a credit union's competition should betaken into consideration when deciding the best way to addressinterest rate risk.

“What's the competitive marketplace going to do and what's yourbalance sheet's ability to deal with not only the rate shift butthe competitive environment in your local market,” Duffy asked.“What we did is we lined up all of the banks and credit unions thatthis particular credit union competes with and we looked at 10years of history on all the key ratios of the competitors and thatparticular credit union.”

Duffy's firm also looked at the concentrations of the variousassets and determined that while this particular credit union had alittle more long term asset concentration, it wasn't that differentfrom the average institution in its market. However, the creditunion had a better concentration of core deposits, more liquidityfrom the bond portfolio and a lower operating expense ratio.

Based on these findings, Duffy concluded that in a stressedenvironment his client would be able to withstand upward ratesbetter than the market of competitors.

“A properly constructed investment portfolio typically leansmore heavily on the right kind of mortgage-backed securities thathave reliable cash flow and some good income as opposed to anoverreliance on callables because with callables, the option is inthe hands of the issuer; the agency that issues the callable andtherefore the option, is not in the hands of the investor,” Duffysaid.

He noted that like an auto loan, the right mortgage-backedsecurities pay principle and interest each month.

“The regular cash flows allow the credit union to be alwaysactive with that cash flow into the new rate environment so ifrates go up, the cash flows are coming in and they're reinvested inhigher yielding loans or investments, whereas when rates go up oncallables, the bond doesn't get called and you're getting noprinciple until the end,” Duffy said.