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Beware Of Interest Rate Risk

DALLAS-Credit unions have shown in recent months that mortgage lending is a potential area for growth, but Angela Calvert warns CUs to tread carefully.

Calvert is a partner at ALM First Financial Advisors, which she described as a consultancy that takes a "holistic approach" to balance sheet management, ranging from policies to the board. When asked where the best opportunities for CUs to grow are in 2011, she said it seems as if it should be an easy answer, but instead it is a complicated one.

"In this economic environment we need to look at where growth is happening naturally, and that is in long-term mortgages," she assessed. "This comes with somewhat of a concern to us as financial advisors-to have a long-term asset on the books that is growing at a time when absolute yield levels are at their lowest. So when interest rates inevitably change-and they have nowhere to go but up-that is a tremendous amount of interest-rate risk."

Because of this risk, ALM First is not encouraging "tremendous growth strategies" in long-term mortgages. But for those that want to do mortgage lending, Calvert said the company works to help reduce risk, such as borrowing from a home loan bank. In another alternative, some credit unions are looking at derivatives as a hedge to offset interest-rate risk. "In 2011, credit unions must understand the impact on the balance sheet of these decisions."

Too Long On Investments

Another growth area that is happening organically is deposits, Calvert continued. She said the money coming in that is not being put into long-term mortgages is naturally going to flow into investments. With yields remaining at low levels, it is natural to look longer to realize a better return, but she said ALM First sees institutions investing too long or making investments that are inappropriate.

"Long-term investments also carry interest-rate risk. Again, there is not one answer we are providing to all credit unions. Credit unions are all different from each other, so there is not one strategy for deposits. The best thing is to make them aware of the impact each strategy would have on their balance sheet. It is okay to add long-term mortgages to your books if you understand that risk and have a risk-reduction strategy to go along with that."

ALM First provides its CU clients with a "tool set" to let them examine every "what if?" before they make a decision, Calvert said. "We don't have a crystal ball, but we can tell a credit union what the course of action will entail, and then they can decide if the risk is acceptable."