By Ray Birch
LOMBARD, Ill.—Competition for deposits, and even loans, may spell trouble for net interest margins when rates rise, as several analysts are predicting the bottom line will get squeezed even tighter before things get better.
A number of factors will likely spur aggressive competition in a rising-rate environment, including non-traditional financial services providers fighting for their share of the market and the Internet widening the playing field. Moreover, the economy has been in “uncharted waters” with rates so low for so long, likely making consumer and FI behavior unpredictable.
All these factors make it imperative that credit unions look for ways today to further streamline operating costs and pay close attention to costs of funds management. The bottom line, experts say, is that credit unions can’t be holding on and hoping for rising rates to be the solution to tight margins.
How well a credit union fares when rates rise, which experts predict will occur at the end of the year, will depend on how effective the organization manages its cost of funds, explained Bill Handel, vice president of research for Raddon Financial Group here.
“That will determine if they will be able to reap benefits in the next rising-rate period,” he said.
ALM Models
Handel said that while many ALM models suggest a lot of credit unions will benefit from rising rates, in reality, many may not, as costs of funds could rise faster than loan rates.
Bill Handel, Raddon
“Our biggest concern is that there may be liquidity issues. If rates move up in a systemic fashion you may see heightened volatility on the deposit side, causing more money to move,” said Handel. “And that competition for deposits may more than offset an increase in loan yields.”
David D'Annunzio, CFO at the $1.9-billion Truliant FCU in Winston-Salem, N.C., has margin concerns, but for slightly different reasons. He thinks loan competition may keep asset yields from rising to keep pace with deposit pricing.
“We’ve got all these large financial institutions sitting on the sideline with liquidity to put at work. We could see a situation where competition for loans keeps loan rates down as deposits rates rise and pinch margins more,” he said. “I am not saying that is expected. But we have to consider the possibility this may come to pass.”
Don't Refer To Past
Overall, D'Annunzio observed, trying to predict what will occur in the next rising-rate period based on what has happened in previous rising-rate cycles is difficult due to the fact rates have been low for an extraordinarily long period.
Sarina Freedland, senior investment officer for Catalyst Corporate, Plano, Texas, said that when the Fed eventually moves to push short-term rates higher it will change the mindset of Americans who have felt “stuck in a rut” on investments for years. And that will put a lot of pressure on deposit rates, something that will pinch margins for a period of time as loan rates won’t keep pace.
Sarina Freedland, Catalyst
Freedland predicts that credit unions and banks will have to address consumer expectations on their investments, and ratchet up deposit rates when the Fed moves.
“As soon the headlines go out that the Fed has raised short-term rates, consumers will go into their banks and credit unions and expect to see higher deposit rates,” said Freedland. “It is different with this rate cycle. Eight years ago most consumers did not even know about the Fed.”
A New Environment
David Mooney’s key point to credit unions is they should brace for a rising-rate period that could be much different than those experienced in the last 20 years.
In addition to heightened rate sensitivity from borrowers held to rock-bottom rates for a long period, new players are now in the FI space—online banks are much stronger today than in 2004 and Silicon Valley lenders have emerged, said the CEO of the $8.5-billion Alliant CU in Chicago. And consumers are much more aware of the national rate market thanks to much greater use of the Internet.
“I think margins are likely to improve, but not by as much as many expect or hope,” said Mooney.
Mooney expects two “phenomenon” will occur.
David Mooney
“First, there will be more rate competition and credit unions that otherwise would lag on increasing deposit rates may be forced to compete quickly or risk losing liquidity,” said Mooney.
Easy Money Movement
Second, Mooney said, the Internet now allows consumers to easily shop for the best rates nationally and easily move money.
“There will be an effect from the high-rate direct providers,” said Mooney. “Now you have perfect transparency and easy price discovery among providers across the country. I can find out who offers the best rate and relatively easily move my money. This increases pressure on rates and may permanently constrain margins. I am not saying margins will stay as low as they are today, but I do think it means, overall, lower margins going forward. So lower loan yields than one might be expecting based on history and higher deposit rates, as well.”
Mooney added that he thinks many credit unions are waiting for what traditionally happens in a period of rising rates—deposit rate increases lagging behind loan rate hikes, widening margins.
“They can’t be holding on for that,” insisted Mooney, saying a sign of what’s coming can be seen in the banking quarterly earnings reports. “Qua
Curt Long, NAFCU
rter after quarter their net interest margins have been rolling down.”
Look At Costs
Instead of hoping for markedly better times, Mooney recommended that CUs take hard looks at their operating costs.
“This is very important, because if these competitive marketplace changes are permanent, then the economic set needs to be addressed,” said Mooney. “Because there will only be so much you can do on the revenue side.”
Mooney said credit unions could keep trying to grow and finding higher-margin products.
“But the fact is revenue continues to be under pressure, including fees,” he said. “The revenue side will be tough, so I think you have to address the cost side.”
Alliant leverages remote delivery and has limited branches.
“We are fortunate because we have an extremely low-cost model. We look a lot like a direct bank. Our costs historically have been about one-third of our peers on an expense-to-asset basis.”
Curt Long, NAFCU’s chief economist and director of research, sees margin pressure coming from inside the CU, as well.
“I think every credit union will see movement of funds out of core deposits into higher-yielding vehicles within the credit union,” said Long. “That will impact cost of funds.”