SEATTLE—Credit unions should brace for a big battle for deposits this year, says one analyst.
“2019 will be a significant, pivotal year for banks and credit unions. Many factors presage an inflection point: the impending end of the economic cycle, gains being achieved by fintech disruptors, challenges of optimizing delivery channels, and many more,” said John Lass, president of Lass Advisory Services. “But one item rises above the rest in terms of urgency and requires immediate attention from credit union leaders: the battle for retail deposits has begun and will intensify dramatically.”
Lass said this issue is important for two reasons.
“First, credit unions have historically enjoyed lower cost of funds (COF) relative to banks,” he explained. “At mid-year 2018, the average credit union COF was 0.62% versus 0.93% for banks. This 30 basis-point differential constitutes a competitive advantage for credit unions, and offsets other cost disadvantages.”
Second, said Lass, the credit union system’s loan-to-share ratio is at a 30-year high.
“2017 was the fourth consecutive year of double-digit loan growth, significantly outpacing deposit growth. Credit unions must now grow deposits in order to sustain overall growth,” he said.
A Different Kind of Rising Rate Environment
Lass explained why this rising rate environment is different from those in the past.
“U.S. interest rates peaked in 1981 and declined steadily until 2016, a 35-year trend. Few credit union leaders have managed in a rising rate environment. Strategies that worked in a falling rate market may no longer be viable,” he suggested.
For example, interest rates have been low for so long many consumers became complacent and paid little attention to deposit rates. Credit unions and banks were able to grow deposits even while offering near-zero savings rates, observed Lass. But that is now likely to change.
John Lass
“Since 1790, the U.S. experienced only two periods of extreme low rates—that is, below 4%—the World War II period from 1940-1955 and the period since the Great Recession, 2008-present,” noted Lass. “Historically speaking, the past decade is an anomaly. Mean reversion suggests higher rates lie ahead, and consumer attention to rates is also likely to intensify.”
Changing Competition
Competition for deposits has also changed radically, Lass said.
“Consumers today have instant online access to product and price discovery information via a variety of websites and apps, such as NerdWallet, Credit Karma, Bankrate.com . . .,” he said. “Digital-first banks use these channels to promote attractive deposit rates reflecting their lower cost of operations.”
Lass detailed steps credit unions should take to address the challenge.
“First, acknowledge that deposit pricing is now a strategic priority. Recognize that any solution is multi-faceted and impacts many areas of your business model,” Lass said. “Train your managers to proactively respond to the rising rate market. Utilize scenario-based planning that anticipates sudden spikes in rates, which has been the norm when rates begin to rise. Analyze the price elasticities of your deposit products as rates change.”
Only 1 CU in Top 100
Lass insisted that CUs must pay close attention to what competitors are doing—and to not define competition too narrowly.
“We searched Bankrate.com in November for ‘best savings account rates.’ Only one credit union, Alaska USA, ranked among the top 100 financial institutions. The Bankrate top ten included CIT, CIBC, State Farm Bank, Barclays, Marcus, Capitol One, and E-Trade. A similar search on NerdWallet yielded only one credit union, Alliant, in their top picks based upon rate and service,” Lass explained.
Lass said Marcus is a particularly important competitor to analyze.
“Founded in 2016 by Goldman Sachs as an online bank, in just two years Marcus has accumulated $26 billion in deposits. Marcus has no physical branches. Marcus’ success is reminiscent of ING Direct which pioneered the low-cost digital-first model, only this time there are many emulators,” he noted.
The New Strategic Question
The COF advantage credit unions have long enjoyed has been attributable to a number of factors, including: aging members, low average deposit balances, and an abnormally low rate environment where few consumers gave attention to rates. It has also been due to the high level of trust in credit unions and the convenience enjoyed by members, coupled with the stickiness of deposit products linked to auto-payment systems, Lass said.
“The strategic question is whether trust, convenience and inertia create enough stickiness to offset the attraction of higher rates from competitors,” Lass said. “Will younger, tech-savvy members demand higher deposit rates?”
That’s not a simple question to answer, and one that requires data and member insight to answer intelligently, Lass said.
A Rethinking is Needed
“It requires a rethinking of the role deposit pricing plays in your overall value proposition,” he said. “Price leadership is often not a winning strategy for credit unions given the constraints of cost structure and scale, but lagging the market in deposit repricing is not a viable option either.”
Sustained growth in a rising rate environment will require credit unions to price deposits competitively—not necessarily as price leaders, but within a competitive range, Lass said.
“The new norm will likely be higher COF, but where COF is supported by increased scale and an improved efficiency ratio,” he said. “Credit unions capable of making this transition will not only deliver greater value to their members but will become financially stronger themselves.”