A Differing View On The Benefit To CUs Of Rising Rates
When it comes to rising interest rates, conventional wisdom has it that credit unions will be hurt by diminishing margins.
The thinking is that as interest rates rise, credit unions will be stuck holding lower-yielding paper-both loans and investments-while their cost of funds rises along with the market, thus squeezing margins.
But one analyst is suggesting that this gloomy scenario need not be so as rates continue to rise, and, in fact, recent history has disproved this theory.
"I think conventional wisdom is a myth," said Frank Santucci, vice president of First Empire Securities, and director of the credit union bond house's asset/liability management services. "Historically, credit unions have made more money when rates go up. It's a matter of repricing.
"The myth comes from the banking industry and the s&l industry, because the huge banks and s&ls are generally hurt by an increase in rates. But it's not true for banks under $100 million in assets, and it's not true about credit unions."
In fact, Santucci, whose firm does business with as many as 3,000 credit unions, cites two recent periods of rising interest rates, 1994 and 1998, to show that CUs can and have benefited.
From October 1998 through June of 2000, for example, rates, as gauged by the two-year Treasury bill, rose by 300 basis points (3%), "and credit unions made more money, not less," he said. During that period, the net interest margin, the spread between what credit unions were earning on their assets and what they were paying on their liabilities, actually increased from 3.93% to 4.02%.
Conversely, as rates came down from July 2000 through December 2001, the net interest margin narrowed, from 4.02% to 3.60%, according to Santucci.
The reason, he explained, is that credit union portfolios, contrary to conventional wisdom, are extremely flexible, allowing credit unions to reprice assets and liabilities on a fairly short-term basis to keep up with changes in interest rates.
There are three major things that affect margins: how quickly loans reprice; how quickly investments reprice; and how quickly cost of funds, dividend rates, is adjusted.
The average credit union loan portfolio still consists of 55% car and other consumer loans, which have a short average maturity. And the average fixed-rate mortgage portfolio now has an average maturity of just 20 months, according to Santucci. As a result, the weighted average life of the entire CU portfolio was just 11 months last year, down from 12.7 months in 1995.
"Half of the credit union loan portfolio reprices every year," he noted. "That means, if rates go up, you're repricing your loans upward, too."
The same is true for investments, he asserted. Half of all credit union investments are in securities that reprice annually. "So how can you get hurt with rising rates?" he asked.
The last piece to the puzzle is being nimble on adjusting dividend rates-cost of funds.
The most important thing is being able to adjust regular share or share draft rates, which amount to half of all credit union liabilities. "Most credit unions have only raised their rates only once or twice in the last 10 years," asserted Santucci. "Now, certificate rates and money market rates are much more rate-sensitive. But regular share and share drafts rates are not so sensitive."
Despite the fact that market rates have risen about 125 basis points (1.25%) since the middle of March, few credit unions have hiked their regular share or share draft rates since then. "I have not talked to a single credit union that has raised dividend rates," insisted Santucci.
In fact, data compiled by rate-tracker DataTrac Corp. shows the average rate for regular shares at credit unions continues to hover near an all-time low of 73 basis points (0.73%) while the average for share drafts remains at a record-low of just 44 BPs (0.44%).
"The result is, when rates go up, you make more money on loans and investments, even if you don't change your cost of funds so much," he said. "Credit unions should be praying for higher rates."