WASHINGTON—Credit unions in search of higher returns are loosening lending standards and piling into longer-term assets, exposing the firms to potentially significant losses if interest rates rise and worrying regulators in the process.
Such moves are raising concerns at the National Credit Union Administration, the sector’s regulator, which said a rise in interest rates could make loans and investments unprofitable. Some analysts also said credit unions likely are unaware of the risk they are taking on because they largely avoided the housing downturn. That has raised worries that lax underwriting standards could fuel another bubble.
“I am concerned that the message [about rates] is either not getting through, or it’s getting through and they are just choosing not to do anything about it,” said Debbie Matz, chairman of the NCUA, who has long sounded the alarm about the industry’s exposure to interest-rate risk.
Credit unions, which have been expanding steadily for years and now serve more than 97 million members nationwide, collectively held $1.098 trillion in assets at the end of the first quarter of 2014.
For the lenders, taking on more risk can help boost returns in a low-rate environment. A firm that offers a low-rate, long-term loan might win business over a competitor, and a credit union that invests in a mortgage bond with a relatively longer term can often demand a higher return.
But if interest rates rise, the money in those loans or investments will be locked in, generating relatively less revenue than a new loan or investment made in the higher-rate environment. Meanwhile, those banks and credit unions will have to pay depositors higher interest rates, otherwise those customers could move elsewhere.
“It’s a double-edged sword,” said Federal Deposit Insurance Corp. Chairman Martin Gruenberg at a news conference last week.
Credit unions’ net holdings of long-term assets, a measure of exposure to rising interest rates, rose to an all-time high at the end of 2013 to 35.85% of total assets, according to the NCUA. The increase comes as some credit unions are adopting lax standards for mortgage and home-equity loans and lines of credit reminiscent of those leading up to the financial crisis, according to interviews. Credit unions also are extending the duration on investments like mortgage bonds, regulatory data show.
“In periods of declining mortgage volume, people start loosening underwriting to boost business,” said Guy Cecala, chief executive at Inside Mortgage Finance, an industry newsletter. “They seem to be taking on a lot more risk than in the past.”