BY CYNTHIA R. WALKER, CEO
Fed fund rates have increased 100 basis points since December of 2015 and yet credit unions, or for that matter, other financial institutions have not increased their deposit rates much over the same time frame. The last 12 months defies many of the regulatory expectations and concerns as they have warned and worried, and even forced some institutions to reposition their balance sheets, that a interest rate increase would be crushing to many financial institutions and a threat to insurance funds.
There was a headline in October in a trade publication that read “unnamed bank triples rates on money market accounts in Q3”. It cited that the bank had reported some run-off in deposits in its investment management business, but the rate increase put a stop to the run-off and the pricing pressure appeared limited for now. The catch was the rate increased from .07% to .21%.
While many credit unions would comment that their current money market rates are at or above the bank money market rate, the intent of the article cannot be ignored. Fed funds are expected to increase 25 basis points in December 2017 and it is anticipated there will be three more increases of 25 basis points in 2018 resulting in another 100-bps increase over the next 12 months.
Consumer rates are driven by prime or the shorter end of the yield curve and mortgage rates are driven by the 10-year treasury. On November 30th, 2016 the fed fund rate was .31% and the 10-year T-bill was 2.37%. November 30th, 2017, the fed fund rate was 1.16% and the 10 T-bill rate was 2.37%. No, this is not a typo. It is the same. When we look at loan rates since December 2015, depending on the source, new and used auto loans did not increase or moved up 11 basis points. Either way the move is inconsequential. 30-year fixed rate mortgages and 10-year HELOC rate movement stayed within 5 basis points—again, negligible.
I think the next 100 basis point increase will not be the same as the last equivalent increase. Credit unions have been able to stabilize net interest margins since 2013. As the fed fund rate continues to increase and at possibly a faster rate than the last 100 basis points, net interest margins may be impacted temporarily, not at all, or more long-term, depending on a variety of factors.
Most interest rate risk analyses assume loan and investment rates will move up to the shocked rate, but the timing of the move will be controlled by the repricing speeds or terms of the instrument. Most also assume deposit rates will go up pretty quickly, but will be limited by the rate sensitivity or beta that correlates to the deposit type. Regular shares and share drafts historically have low rate sensitivity or beta (between .10 and .25) and play a significant role in controlling cost of funds in an interest rate risk analysis. Deposits have shifted out of CDs, which have a much higher rate sensitivity as well as a higher overall cost, into regular share and share draft balances over the last 10 years. As a result, the funding side of the balance sheet has become an even more significant factor in controlling and mitigating interest rate risk. A shift in the funding mix as rates continue to increase should be anticipated. The percentage of member deposits in CD’s before the last rates up cycle may be a good starting point in evaluating how deposits may change. The potential impact of a deposit shift is not trivial, and we will be dedicating a full article on funding mix and deposit trends as interest rates change in the next quarterly newsletter.
It is worth exploring the possibility we could experience scenarios where credit unions will increase deposit rates to keep their funding or funding will shift within the credit union, but they will not be able to increase loan rates due to competitive pressures. Raising deposit rates without increasing loan rates will cause your interest rate risk to increase and is a scenario worth considering. Another scenario for credit unions with excess liquidity and lower loan to asset ratios might be to hold deposit rates and accept that some of the deposits may leave the credit union.
On the loan side, the reality of being able to raise loan rates and not slow lending should be evaluated. Preparing for the possibility products such as unsecured and used auto loans may tolerate a rate increase, while other products, such as mortgages, may not tolerate an increase due to very little change in the long end of the yield curve. Seeking to understand deposit mix and the stability of core deposits that help control cost of funds and offset the possible lack of rate increase in the mortgage products become increasingly important in this scenario.
The investment portfolios yield increases will most likely be closer to market rates and will only be limited by the maturity or repricing terms. Many credit unions are holding quite a bit of cash and have shortened the terms on part of their investments, which helps manage interest rate risk.
One other area to consider during the budget season is the anticipated impact of likely rate changes and balance sheets shifts on forecasted interest income and expenses. The projected interest income and expenses for budgeting purposes is quite different than the projections in an interest rate risk analysis.
As we continue in an increasing rate environment, a myriad of questions arises. Some of them may have easy answers, but many of the answers are unknown. The ability to track and observe changing deposit and lending trends will become an important part of the credit union’s strategies. Multiple scenarios should be discussed, and alternative strategies developed by credit union management, ALCO, and boards. It can be expected deposit rates will eventually be pressured to increase.