The Risks Of Holding Mortgages

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NCUA's Director of Examination & Insurance, Dave Marquis, is expressing concern over how credit unions are managing rate risk, especially the short-term attractiveness of holding mortgages. Below is a look at the update Marquis gave federal credit unions during NAFCU's recent meting.

* Bank Secrecy Act. "This is a big deal. On the risk-based exam program, which [is] very flexible, this is mandatory for all credit unions. It's become a big deal in the Senate and with bankers. We're spending a fair amount of time on it, and have seen some fines on BSA. When we see a violation of BSA, it's not just about identifying that the policy was there, but making sure the credit union has put into place the procedures to ensure the controls are working. In all likelihood, it's a one-strike issue. Most credit unions have been pretty fast at correcting this."

* Record keeping and audits. As reported on page 1, Marquis stressed, "Record keeping and audits are becoming a big issue for us. Contracts with auditors must be monitored very closely for language." And Marquis acknowledged, "We encourage credit unions to potentially use third-party vendors as a way to learn the business. So on one hand we're are saying use it, on the other, we are saying you have to do more than just turn it on."

* Security breaches: "We've had some warnings come across our way over the past few months where something was wrong with member information. This is touchy. If there is a breach of member information, at what point do you contact the member? At what point do you trigger notification? You have to develop a policy or procedure on this. It's hard for us to wrestle with."

* Safety and soundness and fixed-rate mortgages. "Fixed-rate mortgage programs deserve some attention; the potential here is that credit unions have increased their mortgage outstandings 16%, and fixed-rate loans account for 29% of member mortgages. Meanwhile, nonmaturity shares are now at 89% as a source of funds. So that creates a potential liquidity issue. "

Marquis said there are approximately 600 credit unions with mortgages in excess of 25% of assets. But he also stressed that that threshold is not a cap; rather, it's the trigger point for the agency to watch the credit union more carefully. Four percent of credit unions have more than 25% of their loan portfolios in fixed-rate mortgages that they are not selling, he said, adding, "This is the first time in five years credit unions now hold more fixed-rate mortgages on their books than banks, by quite a bit.

"I understand it's hard to sell a mortgage at 5.5% on the books and trade it off for a Treasury at 1%," said Marquis. "Yet you have to be careful about being a rate hog. ROA is secondary to good balance sheet management right now, as rates are so low."

Marquis acknowledged NCUA's own regulations create a conflict. "There is an incentive to stay out of NCUA oversight due to PCA. So there's a tendency to hang on to the mortgage loans to generate more ROA."

* Three rules to follow: Marquis offered three other rules: 1) You will not be faster than the market when it comes to selling loans. 2) When the math models predict what will happen, the math turns out to be wrong because of the emotions of the market and supply and demand. 3) Some credit unions that postpone and wait-and-see will run out of liquidity;

* Modeling. Marquis told credit unions the agency advocates using several models, including the income simulation model, and the NEV (net economic value) model. "Net income will not protect you later on when you find out you're locked into the balance sheet. More modeling is better than just one model. Don't be na?ve about it."

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