Who Knew Vanilla Was So Expensive?

by. Henry Meier

Remind me not to pick up the bill if I ever go to an ice cream parlor with Chairwoman Matz.  The vanilla she likes is way too expensive for me and the vast majority of credit unions.

NCUA released its long-awaited and long overdue regulations ostensibly designed to give credit unions expanded authority to engage in limited use of derivative investments as a way of hedging interest rate risk.  I say ostensibly because if the regulation goes through as proposed — assuming one is actually ever promulgated — it is designed to cater to between 75 and 150 credit unions for whom an application fee of between $25,000 and $125,000 and agreeing to policies and procedures that allow NCUA to micromanage their investment activities every step of the way are worth it.  All this in return for what the regulation’s preamble repeatedly refers to as plain vanilla derivative investment authority.  One has to wonder what credit unions would have to do if they wanted to buy Haagen-Dazs.

Under the proposed regulation, credit unions with $250 million or more in assets with CAMEL ratings of 1 or 2 would be eligible to apply for authority to engage in the purchase of interest rate swap and interest rate cap derivatives.  These instruments are basically contracts.  Interest rate swaps would allow a credit union to trade one revenue stream, let’s say a portion of its portfolio of fixed-rate mortgages, for a counter party’s agreement to provide a revenue stream of adjustable rate mortgages, for example.  The interest rate cap derivative is a contract whereby the credit union gets compensated if interest rates increase beyond the level established in the contract.  The downside is that credit unions basically pay a premium in return for this protection so it is possible that they would pay for protection without receiving a benefit.  Credit unions could only utilize this authority to hedge against interest rate risk, meaning they couldn’t be buying these as investments.

How do you get the authority to engage in these transactions?  In addition to the asset threshold and application fee, credit unions would have to be willing to implement a detailed framework for overseeing these investments.  Credit unions seeking level one investment authority would have to hire personnel with at least three years of direct experience with derivatives.  Credit unions seeking level two authority would need to get someone with five years of experience.  Other requirements would mandate that responsibilities for overseeing derivative investments be shared among designated staff so as to ensure  that one person is not the lynchpin of the entire program.  Read between the lines and the cost of hedging your interest rate risk includes having resources to hire personnel primarily responsible for just these investments.

continue reading »