While NCUA constantly monitors all risk, in recent years it has made interest rate risk (IRR) a particular priority.

IRR reflects the concern that an investment’s value will change due to a variance in the absolute level of interest rates. That change affects the value of bonds more than stocks, and depends on the investments’ sensitivity to changes in the market.

Credit unions can reduce overall risk by diversifying the duration of investments it holds at a given time.

While to some degree IRR is inherent in all credit unions, it’s potentially a significant risk in certain organizations, due to mismatches of asset/liability maturity and the types of shares and deposits used to fund loans.

So, it’s critical for the board to adopt safety and soundness practices to address NCUA’s new IRR review procedure—to stay in compliance and protect your credit union.

During the past 10 years, many credit unions have grown significantly, in size and complexity. At the same time, risk management techniques have improved to support these organizations, and the same principles can protect smaller credit unions.

IRR can be prevalent in non-703 investments, which credit unions often use to fund Charitable Donation Accounts, benefits prefunding programs, and funding of 457(f) nonqualified deferred compensation plans.

NCUA doesn’t permit some of these investments outside of this context because of their higher risk profiles, despite their higher earnings potential.

Effective Jan. 1, 2017, after years of analysis, NCUA implemented changes to its IRR review procedures. Key changes to IRR supervision include:

• Developing the Interest Rate Risk Review Procedures Workbook.
• Updating IRR tolerance thresholds in the Net Economic Value Supervisory Test.
• Creating an estimated net economic value tool (for credit unions with total assets of $50 million or less).
• Revising the IRR chapter in the Examiner’s Guide.

These changes aim to support the efficiency and effectiveness of NCUA examinations, and allow examiners to focus on higher-risk credit unions. The changes will address new rule requirements, enhance examiner guidance, reduce inconsistency, and identify outlier risk.

Managing IRR

Credit unions can take actions to minimize risk, but first must understand the risks specific to their organization.

As long as you can determine how your balance sheet will perform in a rising and/or declining interest rate environment, you should be able to plan ahead. IRR depends on how and why rates rise, and whether that occurs consistently across investment vehicles.

You’ll need to determine how your credit union must match market rate increases to maintain deposits, and consider how quickly rates are changing.

New NCUA supervisory rules require examiners to assess a credit union’s risk inherent to interest rate changes by conducting a “shock test,” which assesses the impact of a 300 basis point increase in interest rates.

This shock test uses the credit union’s Call Report data, ensuring accuracy and relevance. The net result is a corresponding decrease in net worth and capital position, showing whether a rapid rise in interest rates could cause insolvency.

Knowing this, a credit union can identify the investments or loans that represent the greatest risk and plan accordingly. Generally, investments and loans that carry the longest durations and highest interest rates will represent the greatest risk to changes in interest rates.

By limiting the credit union’s exposure to long-term investments and loans, and balancing the durations of all assets, you can more easily prepare for interest rate increases.

Diversifying investments into different categories—particularly investments that aren’t interest sensitive—also can help.

Last, the credit union can divest itself of investments and loans that might be more sensitive to interest rates.

JOHN PESH is executive benefits director with CUNA Mutual Group.

This article first appeared in Credit Union Directors Newsletter. which provides strategic insights for policymakers. Subscribe now to the print or PDF version.