Credit unions that have a history of holding loans they originate view the Fed’s continual push for lower interest rates as somewhat of a double-edged sword that will have long-term effects on portfolio lenders and credit unions.
Bill Hampel, an economist with the Credit Union National Association, released a report saying low interest rates benefit credit unions in the sense that they encourage refinancing, which produces another income stream.
On the other hand, higher-rate mortgages are likely to be prepaid in this low-interest rate environment, causing credit unions to lose loans that produce larger blocks of revenue.
“They will have assets on the books earning 4% or 5% replaced with loans that may only earn 3%,” said Hampel. “It squeezes their net-interest income immediately.”
The result, Hampel says, is some credit unions will have to sell off a majority of their fixed-rate loans.
The reality is only five-year ARM loans maintained rates that did not hit record lows for the period ending Sept. 27. The 30-year, FRM averaged 3.40% the same week, while the 15-year, FRM hit 2.73%.
The Federal Reserve’s decision to launch QE3 – another round of MBS and Treasury securities purchases – only furthered the monetary policies that have been keeping interest rates low.
In this type of environment, credit unions only have a few ways to hedge against the risks associated with losing higher-paying mortgages to refinancing while new mortgages produce less in returns due to historically low interest rates at origination.
The first counter measure would be to make adjustable-rate loans, rather than fixed, Hampel said. “But with these incredibly low fixed-rates, borrowers don’t want adjustable-rate loans,” he explained.
The other solution is to sell the fixed-rate loans off or hedged them with some form of derivatives, the CUNA economist asserted. Hedging them with interest rate swaps would be one way. Yet, Hampel says “very few credit unions actually hedge that way now.”
Hampel believes the ultimate solution for credit unions is to offload their fixed-rate loans, ensuring they make up a smaller portion of the mortgage portfolio.
“The benefit to financial institutions (in a low interest rate environment) is the revenue to be had from refinancing,” said Hampel. “But it does create the potential for interest-rate risk for lenders going forward.”
