Issue of Derivatives Goes Beyond 'Significant Value'

In the Dec. 24 issue of Credit Union Journal, I noted your article on the derivative pilot program, which the NCUA Board has approved terminating ("Derivatives Pilot Ends; New Proposal Likely in Early '13").

Currently, ALM First Financial Advisors is the only NCUA-approved entity that can conduct and advise on derivative activity. As the Journal noted, NCUA has "grandfathered" in the credit unions currently participating in the pilot-all 17 of which have derivative lines open through ALM First's program, and some of which are actively hedging their balance sheets.

The pilot program's intent was and continues to be to determine if currently impermissible investments or investment activities are appropriate. NCUA is weighing whether the lessons learned from the program make it worth enhancing, and if CUs with the appropriate strength and expertise should be allowed to participate in the activity.

Great Deal of Controversey

There is a great deal of controversy over derivatives, and the NCUA will need to add to its own knowledge for the industry to use them properly. Because these instruments are perceived as complex, it's important to eliminate some of the mystique and dispel the myths. The fact is, derivatives really aren't all that complicated and they certainly aren't new; there is a lengthy history of safe, plain vanilla, interest rate hedge transactions. But it's critical to use them correctly, or losses will occur.

NCUA's stance has been that derivative transactions can be of significant value to the credit union industry if proper due diligence is conducted first and if they are then properly regulated, controlled, and monitored. At ALM First, our position is that the issue of derivatives goes beyond "significant value." With historically low rates likely to continue for some time, credit unions will accumulate additional low-rate assets.

Our industry has never held as many mortgages as it currently does, and if rates rise rapidly it could result in a catastrophic event. It is vital that CUs have the tools to mitigate this risk.

Emily Moré Hollis, Partner
ALM First, Dallas, Texas