CHICAGO—With loan growth continuing to outpace savings growth in what is for now a rising rate environment, credit unions will need to pay even closer attention to their interest rate risk exposure, advises the Federal Home Loan Bank of Chicago.
“Credit unions are expanding their footprints in consumer, real estate and member business lending activities—loan balances rose more than 10% in the 12-month period ending November 2015,” noted Brian Frame, director, institutional sales for the Federal Home Loan Bank of Chicago, in citing CUNA Mutual data.
Almost half of this loan growth is attributable to longer-term real estate loans, explained Frame. That has come at the same time the savings growth rate at credit unions has not kept pace with the robust loan growth rate, which has increased loan-to-share ratios.
“Why is this important? Last year in December the Federal Open Market Committee raised the target range for the federal funds rate to 0.25% to 0.50% with a projected outlook of additional rate increases over the next couple of years,” said Frame. “Just a month later, the NCUA released Letter No. 16-CU-01, highlighting the agency’s supervisory priorities for 2016, which includes a focus on interest rate risk management.”
Join FHLB
The NCUA has stated that rising rates may provide a challenge for those credit unions that hold high concentrations of longer-term assets funded with short-term liabilities.
Frame said credit unions can get an assist in managing their interest rate risk exposure by joining a Federal Home Loan Bank.
“Membership in an FHL Bank provides credit unions with access to liquidity as well as solutions, tools, and products to support their interest rate risk management policies and goals in all interest rate environments,” he said.
Frame explained that several solutions are available to Federal Home Loan Bank members that are effective for on- and off-balance-sheet strategies in managing interest rate risk.
“For example, for longer-term assets already held in portfolio, a credit union can access low-cost, long-term advances from the FHL Bank to assist in lengthening the duration of its liabilities and hedging the risk against rising interest rates, as well as improve their net economic value ratios. Credit unions can effectively reduce their interest rate risk by building a ladder of advances, match funding a loan or group of loans with an amortizing advance, or blend funding loans with a mix of credit union shares and FHL Bank advances.”
Secondary Market Relationship
Frame said credit unions with strong or seasonal loan growth and a need to lower cost of funds may access low-cost and flexible short-term and floating rate advances as a Federal Home Loan Bank member to fund loan growth and improve net interest margin.
“Another solution for credit unions is to establish a secondary market relationship with the FHL Banks’ Mortgage Partnership Finance (MPF) Program or the Mortgage Purchase Program (MPP),” said Frame. “By establishing this relationship, members are able to sell flow mortgage loan production under a variety of sell options. Also, credit unions holding long-term first mortgage loans in portfolio would also be able to sell a pool of seasoned first mortgage loans to reduce their exposure to increasing interest rates.”
A secondary market strategy would minimize the mark-to-market impact of below-market rate loans being held in their portfolio, as well as reduce the impact of increased prepayments in a falling rate environment, said Frame, adding that the sale of the seasoned first mortgage pool may also generate fee income to the credit union while reducing their interest rate risk.
“There are 11 Federal Home Loan Banks serving the 50 states, the District of Columbia, and four U.S. territories,” explained Frame. “Membership is determined by the state in which members are chartered. Each FHL Bank operates as a separate entity with its own board of directors, management, culture and views reflecting the regional differences of its members. It is important to contact the regional FHL Bank serving your area. Program and product availability can vary.”
For more information, or to determine which Federal Home Loan Bank serves a particular area, visit www.fhlbanks.com. For more information about MPF products visit www.fhlbmpf.com