For Credit Union CFOs and ALM (Asset and Liability Management) committees, the past few years have been a masterclass in margin compression. As the Federal Reserve rapidly hiked interest rates, the cost of funds surged. Deposit rates had to rise to prevent liquidity flight, but on the other side of the balance sheet, legacy assets, specifically, the massive volume of mortgages originated between 2018 and 2022, remained locked at historically low yields.

While the industry broadly recognizes this mismatch, there is a silent, underlying metric making the problem exponentially worse: the collapse of mortgage prepayment speeds.

It’s not just that credit unions hold low-yielding assets; it’s that they are going to hold them for much, much longer than their ALM models ever predicted.

The CPR Illusion

When a credit union originates a 30-year fixed-rate mortgage at 3.0%, the ALM model never assumes the institution will hold that loan for the full 30 years. Historically, life events, job relocations, growing families, downsizing, or refinancing, cause borrowers to pay off their mortgages early.

This behavioral reality is modeled using the Conditional Prepayment Rate (CPR). In a normalized environment, ALM models might project a mortgage portfolio’s effective duration to be somewhere around 7 to 10 years.

But today, the traditional CPR models are broken. Because replacing a 3% mortgage with a 7% mortgage results in massive payment shock, borrowers have stopped moving. The lock-in effect has effectively brought prepayments to a grinding halt. Loans that were modeled to turn over in 7 years are now projecting out to 15 or 20 years.

The Cost of Trapped Capital

The financial damage of this duration extension is severe. When prepayment speeds plummet, the credit union faces a dual-threat to its profitability:

1. Severe Margin Compression (Negative Carry): When the cost of retaining deposits climbs to 4% or 5%, but a significant chunk of the asset portfolio is locked into 3% mortgages, the credit union experiences negative carry on those specific assets. They are quite literally losing money every month they hold them.

2. Opportunity Cost: Capital that is trapped in a 15-year, low-yield holding pattern cannot be redeployed. Every dollar stuck in a locked-in 2020 mortgage is a dollar that cannot be used to fund a highly profitable 8% auto loan or a 7% commercial real estate loan today.

The Flawed Traditional Exits

How do institutions typically handle toxic ALM mismatches? The traditional levers are largely ineffective in the current climate:

• Wait it out: Hoping for rates to drop back to 3% or 4% is a gamble, not a strategy. Even if rates drop to 5%, the math shows it won't be enough to overcome the psychological and financial barrier of giving up a sub-3% rate.

• Secondary Market Sales: A credit union could sell these low-yield mortgages on the secondary market to free up capital. However, doing so requires taking a massive, immediate mark-to-market haircut, often 15% to 20% of the loan’s principal value. For most mid-sized institutions, that hit to capital is simply too painful to absorb.

Active Portfolio Management: A Strategic Way Out

To fix the ALM disconnect, credit unions must actively manage their prepayment speeds.

Through frameworks like Takara’s DREAM program, a credit union can proactively offer eligible locked-in borrowers an affordable path forward.

Instead of repaying the full outstanding balance when they move or refinance, borrowers preserve a meaningful portion of the value embedded in their low-rate mortgage, while the institution improves the economics of the loan.

Reclaiming the Balance Sheet

The collapse of prepayment speeds has turned legacy mortgages from safe, predictable assets into structural liabilities.

Credit unions can no longer rely on passive ALM models built for a bygone economic era. By adopting innovative solutions to actively thaw frozen mortgages, CFOs can reclaim control of their duration risk and fundamentally repair their balance sheets, one low-rate mortgage at a time.