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Some Things to Consider About a Rising Rate Environment

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The Federal Reserve increased the federal funds target rate to a range of 50-75 bps at its mid-December meeting.  In its forecast (the “dot plot” shown below), the Fed indicates further tightening in 2017.

010517-dot-plot-buz

While credit unions have certainly lived through rising rate environments in the past, few have managed a credit union through a rising rate environment coming from the lowest interest rates our markets have ever experienced.  Combine this with how dramatically the world has changed since the last time rates went up (setting aside the 25 bps increase in December 2015, the last rising rate environment experienced came during 2004 to 2006) and the future is nearly unprecedented.  Can you believe that Apple’s first iPhone came out in 2007 (Source: Time)?

Now that smartphones are ubiquitous and members have access to every financial services “app” in the known universe right in the palm of their hands, what might a rising rate environment mean for your credit union?  Will your members behave differently now than they did in the past?

Using your asset/liability model proactively will allow you to see a range of potential outcomes before they happen.  This will better prepare management and board for both the risks and the opportunities that are out there.

Some questions to consider and then turn into scenarios to model include:

  • Will we be able to increase loan rates?  Or will competition for loans from FinTechs or traditional competition, or the level of long-term rates, keep loan rates stable?
  • When, and by how much, will deposit rates need to increase?  How might this impact our deposit mix?
  • What things are outside of our control – such as a competitor’s liquidity position and the potential impact to us if they have to raise deposit rates dramatically to attract funds?  Or new competition, possibly from non-traditional sources?
  • If deposit rates increase, but loan rates do not, what additional efficiency can the credit union create to have sustainable earnings with a tighter margin?
  • Given the ease of moving money across institutions, are we at risk of seeing members move funds from our credit union?  Or, what if consumers move funds to our credit union that we may not be able to lend out?
  • There are always opportunities.  What opportunities lie ahead for our credit union in this environment?

This list of questions is not meant to be all inclusive, but answering these questions is a great place to start. There are many more questions to be answered.

 

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Is Now a Good Time to Increase Deposit Rates?

Over the past few weeks there has been some increased discussion in ALCO and board meetings about increasing deposit rates in the near future. Some credit unions have already increased deposit rates, while other decision makers are feeling pressure to do so.

Although short-term Treasury rates, which typically drive deposit rates, have changed very little in the past six months, there are other reasons why some feel compelled to increase deposit rates.

When we ask why they are considering raising deposit rates, the most common response is:

“Loan demand is starting to increase and we want to reward our depositors, who have faced rock-bottom dividend rates for the past five to six years.”

Before a decision is made we highly encourage decision makers to compare their deposit rates to those of money market mutual funds, which are not insured by the full faith of the government. A quick search will show money market mutual fund yields of roughly one to five basis points.

Conventional wisdom should suggest that the extra risk of the money market mutual fund comes with extra return – but, currently that is often not the case with credit unions, as they often pay higher dividend rates without the added risk. Beyond providing additional safety, credit unions also bear the cost of infrastructure (such as branches/call centers) to attract and support deposits.

While it is understandable to want to give back to depositors in the form of higher rates, remember that it could be another few years of short-term rates continuing at historically-low levels. Many are expecting the margin to continue to decline, even with improvement in loan demand. Increasing deposit rates would put even more pressure on the margin.

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To Grow Or Not To Grow—What? Is The Question

For credit unions that are growing deposits faster than they are growing loans, the question often asked is “what do we do with the money?” Perhaps the question should be changed to “should we have the money in the first place?”

While it may seem that no matter how low deposit rates are taken money still flows in, are deposit rates really that low?

Consider a credit union paying 25 basis points (bps) on money markets.  While that may sound low, recent yields on some of the largest uninsured money market mutual funds have been between about 1 to 4 bps, according to Bloomberg.  By comparison, this “low” rate paid by the credit union is about 6 to 25 times greater than what the consumer can get in the market—and it’s insured.

The point isn’t that credit unions should drop their money market rates to the same level as the mutual funds, but to point out that, even at these low rates, 25 bps can still be attractive considering the alternatives.

Some credit unions have instituted relationship pricing, rewarding members who participate in the cooperative and encouraging those who don’t to leave.  Others have identified that the growth is coming from their target market(s) and feel that they have the net worth ratio to “ride it out” for a while.

If your credit union is growing deposits faster than loans, at least two things you should know about the growth is:

  1. Who is bringing in the money?
  2. Why?

Growth that is coming from the target market(s) can provide opportunity, if not now, then in the future.  Growth that is coming from members parking funds may be money that should be discouraged or limited.