By Ray Birch
PLANO, Texas—Say goodbye to paying interest on checking accounts, says one economist, who predicts many financial institutions will either maintain the rock-bottom rates as the country emerges from the pandemic, or do away with the account altogether.
Brian Turner, president and chief economist with Meridan Economics, believes that approach will finally lead to breathing room for net interest margins in the coming years.
“I believe that paying interest on checking accounts may soon be a thing of the past,” said Turner. “Part of that is associated with FOMC monetary policy that should keep overnight rates relatively low for a few years at the least, and—on the high side—may well never exceed the rate of inflation ever again.”
Turner asserted the only interest paid on checking will be associated with rewards or cross-selling packaging, such as KASASA, which have corresponding revenue byproducts.
“By contrast, regular savings accounts will continue to be rate-bearing instruments that will more closely follow federal funds rates but are less vulnerable to spikes in FOMC overnight benchmark rates,” he said.
In terms of the impact on net interest margin, checking and savings collectively account for nearly 75% of credit union funding, pointed out Turner.
“Therefore, cost of funds will mainly be vulnerable to changes in marginal rates and portfolio allocation associated with 25% of their funding—namely term certificates and IRAs,” Turner said. “This should help minimize upward swings in rising rates and downward swings in falling funding rates.”
Expert Allocations Needed
Turner emphasized individual CU results will be based on how each “expertly allocates” the asset-side of the balance sheet and the resulting revenue streams through the same shifts in rates.
“Although the increase in mortgage assets has slightly changed exposure, the dirty little secret in credit union land is that the industry continues to have relatively little adverse interest rate risk despite the millions of dollars invested in measuring and regulating it,” Turner said. “This is because the average life of earning assets is a relatively short two to 2.5 years, compared with commercial banks pace of 5.5 years and nation’s thrifts of six to seven years. This enables credit unions to reset more rapidly with rising rates with less exposure to rising funding rates.”
Brian Turner
But the break on net interest margin, again, will depend on how well CUs manage the balance sheet, and Turner provided some insights.
“As long as they retain an average life of earning assets that can remain between 1.8 to 2.5 years through interest rates cycles, while retaining a non-term funding allocation (checking and savings) between 70% to 78% of total funds, they will see their net interest margins—before provisions expense—become less vulnerable to shifts in marginal market rates,” he said. “Expertly allocating balance sheets requires knowing permissible growth rates, expected loan principal cash flows and how to use surplus liquidity to manage risk-to-earnings.”
Flexibility Needed
Turner added credit unions must understand it is acceptable to experience 20- to 25 basis-point shifts in net interest margins, before provisions.
“Moreover, the balance sheet must be flexible enough to grow and shrink based on economic and market rate environments,” Turner added. “Too many institutions—and regulators—are under the belief that a shrinking balance sheet is an indicator of trouble within the CU, instead of an indicator of properly managing the net-worth profile.”
Turner pointed to what is happening within the industry now, with loan production down at most credit unions, as the larger CUs claim the majority of the loan growth while growth within much of the rest of the industry is down, a situation extensively reported by CUToday.info.
“Many credit unions have been influenced recently to commit the virtual sin in Investment 101—committing to long-term cash flows in an historic low-rate environment,” Turner said. “Agency debentures require longer terms with marginally less return and mortgage pass-through.”
One Example
As an example, Turner cited a $200 million institution with a 10% net worth ratio and $10 million in investable excess funds.
“Reinvesting into a three-year agency debenture might pick up an additional $33,000 in interest revenue,” he said. “But by contrast, diluting $10 million from its higher-cost term CDs might save about $150,000 in annualized cost of funds while enhancing the net worth ratio to 10.6% from improved earnings and levered assets.”