National Credit Union Administration (NCUA)is preparing to ease the reins on the use of financial derivatives and allow more credit unions to deal in a variety of instruments that would help them hedge interest rate risk, including interest rate swaps, caps, floors, options and collars.
Dealing in financial derivatives has been restricted under a ten-year pilot program to a small number of credit unions who must be approved by NCUA. Many of the authorized users did so through dealers that had proven expertise, such as WesCorp Federal Credit Union. But proposed rules would open these commonly used tools to many more credit unions.
“Our intent is to safely allow more credit unions to use derivatives responsibly as a hedge against interest rate risks,” said NCUA Chairman Debbie Matz at a January NCUA Board meeting. “Credit unions that have high interest rate risk exposure on their balance sheet could offset some of those risks if they purchase the right types of derivatives.”
NCUA is looking at a variety of parameters that would guide the broader program, such as minimum standards for financial health and net worth and expertise and limits on specific types of instruments. A final rule, which is not expected until later this year, will restrict the use of derivatives to hedging and prohibit speculative use of derivatives.
Some of the pilot credit unions say limited use of financial derivatives has helped them hedge interest rate risk in times of turmoil. James Moody, president of Chevron Federal Credit Union, told NCUA in a recent comment letter, such hedging helped his $2 billion credit union enhance profitability “while maintaining robust net economic value in interest rate shock scenarios,” even during the credit shock of 2008.
Credit union executives are keen for greater access to such tools. “Now is an especially appropriate time to begin that participation, with the interest risk exposure caused by long-term, fixed-rate mortgages in this artificially low interest rate environment,” said Marvin Elenbaas, chief financial officer for DFCU Financial, in a recent comment letter on NCUA’s proposal.
“Rarely has the need for balance sheet management strategy been greater,” said Kevin Cole, CFO of Oregon’s Maps Credit Union, in another comment letter. “Derivatives are a tool that could help credit unions better serve members in a safe and prudent manner and are a logical extension of the Agency’s focus on interest rate risk in the credit union system. While I advocate for the broadest authority possible for credit unions, some additional authority is preferable to none.”
“The current structure that requires a credit union to seek approval to be part of a pilot program by NCUA has prevented many federally chartered credit unions including OSU Federal from using even simple interest rate swaps,” wrote Bonnie Humphrey-Anderson, CFO for Oregon Federal Credit Union. “Having access to derivatives such as this would have been a huge benefit to our credit union during the last four years, allowing us to offer lower rate consumer loans and swapping that low rate into a variable income stream as rates rise. This would have cut our interest rate risk exposure and help keep us competitive with both state chartered credit unions and banks.”
At least one credit union, California’s SchoolsFirst FCU, recommended that credit unions no longer be required to apply for NCUA approval but that the use of certain derivatives be included in the NCUA regulation 703 covering all permissible investment activity.