C. Myblog

Holding Long-Term Investments And/Or Mortgages?

February 21, 2013

NCUA’s recent Supervisory Focus for 2013 (13-CU-01) stated, “Examiners will evaluate your credit union’s ability to mitigate interest rate and liquidity risk, especially where there are high levels of long-term assets funded by short-term, less stable funds.”

We encourage credit union leaders to make it a habit to continuously review emerging market trends and thoroughly discuss contingencies should the credit union start approaching its risk limits.  Numerous institutions are expecting margins to continue to be squeezed if rates don’t change. Hence, many decision-makers are holding longer-term assets to help mitigate this decline.  We often hear “we are going for the earnings now, and will unload the risk before rates go up.”  Understand that rarely does someone time the market “right” with any degree of consistency.  If rates go up, memories will likely be foggy and questions raised about why the credit union decided to hold long-term assets in the first place. There can be solid business reasons to hold long-term assets, and even in some cases to not take immediate action if a limit is crossed, but clear documentation of rationale and communication among decision makers is key.

With respect to holding long-term assets, consider the following:

  • In the last month the 10-year Treasury has gone up 19 bps, taking the yield north of 2%
  • For the rest of the year, Freddie Mac Chief Economist Frank Nothaft expects mortgage rates to gradually move higher, ending the year at about 3.75% and then moving above 4% sometime next year
  • According to Zillow.com, US home prices increased about 6% in 2012
  • Additionally, although the Fed is indirectly influencing long-term interest rates (which impact mortgage rates) by buying $85B/month in Treasurys and MBS, demand for long-term Treasurys has been declining.  If the reduction in demand continues it could translate into higher long-term rates
The world is very complex and issues are going to get tougher.  There is little downside to continuously discussing, reviewing and reinforcing agreed upon decision drivers, risk-return tradeoffs and risk limits with your management and board.

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