February 2014 NCUA Report; Interest Rate Risk; NCUA Economic Update
Written by Bernadette Clair, Senior Regulatory Compliance Counsel
Recently, the NCUA released its February 2014 report. Featured articles include:
Interest Rate Risk. Interest rate risk is a top supervisory focus for NCUA in 2014, as noted in Letter to Credit Unions 14-CU-02.Â Along these lines, the article in NCUA's February 2014 report from the Office of the Chief Economist, Long-Term Investments Resulting in Increased Supervisory Actions, notes that supervisory action has been necessary in some Ã¢ÂÂoutlierÃ¢ÂÂ cases, and cautions credit unions in managing their interest rate risk.Â From the report:
Ã¢ÂÂFor credit unions, investments are primarily meant to be safe places to store excess liquid funds. Once liquidity objectives are satisfied, investments also serve as a source of additional income to augment core earnings. The recent shift toward longer-term investments may indicate a trend away from liquidity management toward yield by taking on more risk.
Ã¢ÂÂThe concern is that credit unions are reaching for yield in order to supplement earnings,Ã¢ÂÂ NCUA Chief Economist John Worth said. Ã¢ÂÂIt is an understandable response, given the compression of net-interest margins in the low-rate environment. But the nature of the interest-rate environment, along with credit unions reaching for yield, has the potential to create a perfect storm that could have a substantial drag on future earnings, and make some credit unions insolvent.Ã¢ÂÂ The pace of these portfolio changes has Worth and Cole concerned that credit unions are increasingly ignoring the perils of interest-rate risk in order to meet current earnings objectives. In the past year alone, while total investments have remained at 28 percent of assets, investments with maturities of less than three years dropped 11 percent or $20 billion, while investments with maturities of more than three years rose 33 percent or $30 billion.
The current interest rate environmentÃ¢ÂÂwith short-term rates near zero and long-term rates at historic lowsÃ¢ÂÂis unprecedented. As a regulator, NCUA does not have a specific view on interest rates. Instead, NCUA believes credit unionsÃ¢ÂÂ balance sheets should be resilient in a wide variety of rate environments.
However, given the unusually low current interest rates and the recent improvements in the economy, there is much evidence to suggest that a transition to a rising and more volatile interest rate environment is already underway. Therefore, especially in the near term, credit unions should pay particular attention to their exposure to rising rates.
NCUA strongly urges credit unions not to forsake the role of liquidity in investment-portfolio management or to ignore interest rate-risk implications if they invest in higher-risk instruments to maximize current income.Ã¢ÂÂ
NCUA Economic Update Video. Â Â Last week, NCUA released its latest economic update video. In addition to reiterating interest rate risk concerns, the video discusses the labor market and consumer spending. The video is available on NCUAÃ¢ÂÂs YouTube channel here.