WASHINGTON–In the wake of the move by the Federal Open Market to increase the federal funds target rate a quarter-point to a range of 0.75 to 1%, analysts are expecting more increases to come and said the decisions will only work to boost CU ROA.
"As anticipated, the FOMC went forward with the first rate hike of 2017," noted NAFCU Chief Economist and Director of Research Curt Long. "Given that inflation is rising and approaching the Fed's 2% target, Fed officials had little choice but to raise rates. Chair Janet Yellen has indicated that more rate hikes are on the way later this year," Long added.
Long also noted that the FOMC stressed that it "expects that economic conditions will evolve in a manner that will warrant gradual increases in the federal funds rate."
The committee’s revised projections are three quarter-point rate hikes in 2017 (including the one announced Wednesday), three in 2018 and three to four in 2019. The FOMC will meet again May 2-3.
The FOMC last raised the federal funds target rate to a range of 0.5 to 0.75% last December.
Brian Turner, president and chief economist with Meridian Economics in Dallas, said the most immediate impact from the Fed’s moves will be on the return on cash holdings. For example, Turner said for a $300-million credit union with 12% of its assets held in cash, a 25-basis-point increase adds three basis points to their ROA, a six basis point improvement over the past three months.
“To demonstrate the relevancy to these rate hikes, for this same credit union, this would be equivalent to reallocating $7 million from cash to vehicle loans, about a 3% annualized increase in loans. Two more similar rate increases would double that growth rate,” said Turner.
For that reason, he said, he has been placing a high premium on liquidity building by credit unions.
“The relative impact from rate hikes is greater on ROA than investing surplus funds into three- to five-year investments while retaining available funds for potential increases in core loan demand.”
Turner added that most banks took the opportunity following the Fed decision to also increase their prime rates from 3.75% to 4%, which could put upward pressures on revolving credit card rates over the next few months.
“So, as I have been saying for some time, a rising rate environment is a friend to the credit union industry…,” said Turner. “Obviously, industry earnings have been diluted over the past few years by the protractedly low interest rate environment. Now that the treasury curve has returned to a more normal shape and market forces are pushing marginal asset rates upward at a faster pace as funding rates, the results will be positive for most credit union’s net interest margins. The question remains to what extent recent upward trends in loan delinquency might have in offsetting those marginal increases. This makes it even more important for credit unions to limit their loan originations to no lower than B+-paper until the economy achieves a more broad-based growth profile. The potential loss from default could be much greater than the incremental market rate retained by the credit union on those riskier loans.”