The highest rate in more than 15 years could have a big impact on cost of funds and ROA.
The Federal Reserve’s latest 25 bps increase in the fed funds rate presents opportunities and challenges for credit unions. With the grand total of rate increases since early 2022 now at 5%, this puts continued upward pressure on credit unions’ cost of funds and potential downward pressure on net interest margin and return on assets as more credit union members seek higher rates on deposits.
For perspective, the last time the fed funds rate exceeded 5%, it climbed to 5.25% in July 2006 and stayed at that level through July 2007. Such rate levels attract the attention of consumers and businesses, as they demand better rates or will move to get more return on their deposits. The result was a cost of funds for the credit union industry that increased to 3% by March 2007 and stayed above 3% through March 2008.
Actions Items for Credit Unions in Light of the Rate Hike
What actions should credit union leaders consider?
- Do not assume the increase in your cost of funds is finished; this mindset is important for decisions you will be facing.
- Learn from history; study 2006-2008 to see the deposit migration for your credit union and the industry, along with the resulting cost of funds.
- Review your budgets, forecasts and other ALM information to see how the cost of funds in your modeling compares to history. If it is materially less, consider modeling a larger increase to see the potential impact on your earnings, net worth and risk profile.
- Assume a faster speed of change. Ask yourself if you think there is more competition than 2007. Do you think it is easier to move money than it was in 2007? As you consider your answers, are you incorporating them in your modeling?
- Gather your team to work through different scenarios that may occur. Test drive potential situations and how you may respond.
- Rates could continue to increase; rates could drop quickly; deposits could leave select institutions faster; a recession could lead to increased credit risk; there could be a flight to safety.
- Brainstorm and innovate. Many leaders have not paid a material amount of attention to deposit acquisition over the last decade. It is time to apply critical thinking to the subject to find potential opportunities. This should include thinking about the longer-term implications of your current deposit pricing strategies on member behavior.
At first, having so much to think through can be overwhelming, but discussing and modeling potential actions for each path can provide clarity. That clarity can lead to a shift from a reactive to a proactive mindset.
Liquidity pressure has been building for banks and credit unions. Most institutions are struggling to retain deposits without significant increases in offering rates, and this all comes at a time when it has never been easier for members to move funds elsewhere. Some credit unions are turning to borrowings or non-member deposits as a funding source.
This upward pressure on cost of funds is likely to continue for some time. However, if the Fed’s latest actions help to drive inflation down quickly to their 2% desired long-term target level, this could lead to rates moving back downward at a sooner point in time. A potential concern is that the total 5% increase in fed funds rates could drive the U.S. economy into recession. This could also serve to drive rates downward, as well as materially increase credit loss concerns for credit unions.
With the magnitude of the inflation problem, the fed certainly has a tough balancing act. The good news for credit unions is that their reinvestment opportunities, in the form of future investments and loans, also come at higher rates, which will, to a certain degree, help to counterbalance and help prop NIM and ROA back up. Credit unions with shorter duration assets will benefit the most from this reinvestment opportunity. So, while the fed has a tricky juggling act, credit unions also have their own challenging balancing act being fueled by the Fed’s actions.
Sean Zimmermann is senior vice president at c. myers. C. myers helps financial institution decision-makers uncover opportunities and continuously optimize their business models. Their depth and range of experience in linking strategy, talent, desired financial performance and successful execution enables them to work with their clients as strategic collaborators. They have the experience of working with over 600 financial institutions, including 200+ of those over $1 billion in assets. C. myers helps financial institutions think to differentiate and drive better decisions through strategic planning & business model optimization, strategic solutions and implementation, strategic leadership development, real-time ALM and financial forecasting, education, and thought leadership.