A faster-than-expected labor market recovery makes it likely that the Federal Reserve will increase market interest rates sooner rather than later. And that has regulators raising red flags over credit unions’ long-term asset exposure.
While credit unions’ longer-term asset holdings have increased, the increases have been modest and the levels appear manageable. Furthermore, the growth in interest-rate risk (IRR) exposure has occurred at the same time that exposure to other risks—liquidity and credit risks—have fallen to cyclical lows.
In other words, aggregate credit union risk profiles are low and seem manageable.
Credit unions’ long-term assets finished 2013 at roughly 36% of total assets. To put the exposure in context: Long-term assets at federally insured savings and loan institutions in the early 1980s accounted for roughly 80% of total assets.
Moreover, long-term funding sources (equity and long-term borrowing and deposits) now represent 51% of credit union assets, significantly reducing IRR exposure and liquidity risk.
Among the 340 federally insured credit unions that now report long-term assets greater than 50% of total assets, only 105 report exposures that are more than 10% higher than long-term funding levels. These credit unions represent a mere 1.6% of the total institutions and hold 5.2% of total credit union assets.
Another clue to IRR exposure lies with unrealized losses. Although unrealized losses have increased recently, the current aggregate total ($1.34 billion) is equal to only 0.12% of total assets, 1.2% of total net worth, and 17% of first-quarter annualized earnings ($8 billion).
It’s important to note that liquidity risk exposures have fallen and are low from a historical perspective. Since the beginning of the economic downturn in 2007, credit union aggregate savings balances grew roughly 40% while loans increased only 20%.
As a consequence, credit unions’ aggregate loan-to-savings ratio fell from 84% at year-end 2007 to 69% at the end of March 2014. In the aggregate, credit unions have an abundance of liquidity, can easily meet financial obligations, and would experience little pressure to sell securities with unrealized losses even if market rates increased.
Further, credit union loan delinquencies and net charge-off s are at seven-year lows, and both measures are about equal to long-run averages.
Credit unions— including those with relatively high long-term asset ratios—have soundly managed their assets in the rising interest-rate environments of the past.
At the start of 2004, for example, a comparatively small number of credit unions had both high concentrations in long-term assets and unrealized losses (as is the case today). In June 2004, the Fed began increasing short-term interest rates, and by July 2006 the federal-funds rate rose by 425 basis points to a monthly average of 5.24%.
Despite this substantial market interest-rate shock, no natural-person credit unions failed as a result of IRR. And the National Credit Union Share Insurance Fund ratio increased during this period from $1.27 per $100 in insured shares to $1.31.
Much has changed since 2007. But even though credit unions didn’t contribute to the financial crisis, they’re paying a high price in the form of unprecedented supervisory pressures and an avalanche of new rules and regulations.
Notwithstanding these developments, when modeling the potential effects of rate increases, stressing balance sheets with above-normal rate shocks seems reasonable. It also would be prudent to use higher-than-average assumptions on core deposit run-off and lower than- normal prepayment speeds on longer-term loans, and to use third parties to validate/verify your model mechanics and assumptions.
Credit unions still have an opportunity to make balance-sheet adjustments without too much pain. But that window of opportunity won’t be open indefinitely.
MIKE SCHENK is CUNA’s interim chief economist. Contact him at 608-231-4228 or at email@example.com.