In 2012, credit unions originated more than $300 billion in total loans, $123 billion of which was in first mortgages. In the first quarter of 2013, first mortgage originations reached $31.2 billion. That’s up 19.3% versus the first quarter of 2012. Despite the accelerating origination volume, first mortgage balances — which credit unions hold in their portfolios — are up only 5.2% over the same period last year. This is largely the result of sales to the secondary market.
During the first quarter, credit unions sold $18.1 billion in first mortgages to the secondary market. That’s a new high for the quarter and is nearly 60% of the quarter’s originations. The sales held the ratio of fixed rate first mortgages to total industry assets at 14.5, which is unchanged from one year ago.
Record numbers of credit unions are selling mortgages as part of an asset liability management strategy; however, Star One Credit Union ($6.4B, Sunnyvale, CA) is bucking that trend. Despite the institution’s 12-month loan growth of 6.72% — which is stronger than credit unions with more than $1 billion in assets, 5.76%, credit unions in California, 1.38%, and all credit unions nationally, 5.35% — Star One holds the majority of its mortgages in-house.
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Here, Brian Ross, senior vice president and treasurer of Star One, discusses the credit union’s ALM strategy.
Does Star One hold all of its 30-year-fixed mortgages in portfolio?
Brian Ross: On occasion we sell a few loans to test our ability to sell to Fannie Mae so we know that option is available. Apart from that, we hold almost all our mortgages in our own portfolio. We offer other mortgages in addition to the 30-year-fixed, but the 30-year-fixed is the majority as that is what our members want.
Has the credit union always kept mortgages in its portfolio or is this a newer strategy?
BR: I’ve been at Star One for approximately eight-and-a-half years, and the credit union has kept mortgages in its portfolio as long as I’ve been here. I believe the credit union did sell some of its loans prior to that, but the portfolio strategy has been in use for nearly a decade at least.
CU QUICK FACTS
Star One Credit Union
data as of 6.30.14
HQ: Sunnyvale, CA
12-MO SHARE GROWTH: 5.86%
12-MO LOAN GROWTH: 3.74%
How do you hedge against the interest rate risk?
BR: We borrow from the Federal Home Loan Bank at a fixed rate. Through the borrowings, we match funds — not dollar for dollar but pretty close — to offset the interest rate risk. We also test our borrowing strategy every six months to see how it compares against our other options, specifically, if we had sold the loans or not hedged versus hedging with the borrowings.
Do you conduct the testing internally or do you use an outside firm?
BR: We model it ourselves, but we use an outside source to calculate our current average life estimate every six months so we can put that in our modeling. We have policy ranges regarding how much we’re going to borrow and for how long. ALCO (asset liability committee) reviews the ranges each month along with an estimated amount that’s in the pipeline. We try to borrow before we fund. We have a large pipeline and want to avoid borrowing after the fact.
Is there an ongoing education process to help the board understand the hedging strategy?
BR: Yes, absolutely. We share all of our reports with the board every six months. I also put together an annual department summary and incorporate more information on the hedging strategy.
How many people are in the finance department?
I’m the senior vice president and treasurer. I have an asset liability manager that works for me. And that’s the finance department. I report to the CFO and there is a separate accounting department that is made up of six employees, a manager, and a controller.
Do you think credit unions need to have a certain asset size to employ a similar strategy?
BR: No, not at all. Risk is risk. Whether you are a $100 million institution or a $5 billion institution, you’re going to face the same challenges when rates change. The beauty of using the FHLB is it will do any size borrowing and customize it to what you need, so there are no real economies of scale. As this has ramped up and mortgages have become a larger part of our portfolio, we haven’t had to add staff at all.
What advice would you have for another credit union considering this strategy?
BR: In 2009 we started adding a call option to all of our borrowings. Basically, this gives us the right to give the funds back to the home loan bank after a year and then quarterly thereafter. Since 2010, when our first call option came up, we have called more than $600 million of our borrowings, which has saved millions in interest expense. It all depends on how you’ve structured your mortgage products, though. At Star One, refinancing is easy for members, which is why we added the call option to our borrowings. If rates dropped substantially and we had a lot of modifications or refinances, borrowing a ladder just wouldn’t have worked. Adding a few extra basis points for the call option was a no-brainer.
My other piece of advice is to track how your borrowing program is performing versus the amount of refinancing and modifications you’re doing. We know the exact cost versus the benefit of the program because we are always tracking it.
Are there other benefits to keeping the mortgages as part of Star One’s portfolio?
BR: One of the main benefits is you’re able to provide service. You still have control of the loans so you can make refinancing easier. If you sell the loan and retain the servicing, you no longer have the ability to do easy modifications or refinances; you have to do a completely new mortgage. At Star One, we allow members to lower their interest rate for a fee (read Star One Builds Loyalty With Streamlined Modifications). We don’t extend the term of their loan, but they don’t have to go through the appraisal process or re-qualify their income for a lower rate. This has been popular with members as it makes their existing mortgage with us more affordable and the credit union gains member loyalty. From June 2011 through March 2013, we’ve modified more than $2 billion in mortgages at an average savings to members of 56 basis points.
Do you have other lessons learned or advice to share?
BR: It’s critical to make sure you can prove your hedging strategy is working — run your reports, educate your board, track your average life, and stay on top of the net economic value. It has been hard for credit unions flush with liquidity to borrow, but it’s an insurance policy. You might not need it, but if you do, it can protect you.
Taking your investment portfolio into consideration is important as well — we use it to hedge our real estate exposure by keeping our investment duration short. Our effective duration in our investment portfolio only goes out two years. Even if rates were to go up by 400 basis points, it would only extend to two-and-a-half years. You need to be disciplined on the investment side if you’re going to portfolio your real estate loans. Another item to note is that the FHLB accepts securities as collateral.