Caution Ahead: Two Things Worth Watching

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DALLAS-CUs must pay close attention to "funding cost control" and make sure the assumptions they place into the ALM model are accurate.

That strategy, and words of caution, were shared by Angela Calvert, partner at ALM First, who told Credit Union Journal she is concerned for credit unions regarding two aspects of their business: excess liquidity driving down margins and the potential for the yield curve to flatten and cause even further margin compression.

"Given the steepness of the yield curve, credit unions should have record high margins and they don't. That could be due to internal expenses, but on other side of the coin is funding cost control-deposit pricing. Credit unions have seen a tremendous influx of deposits this past year, and most of those have gone into money market accounts."

Calvert pointed out that the average rate for CU MMA is .90%, above the national average. "When you have this high rate on the MMA deposit, that encourages more liquidity growth, which of course decreases your margins. When you look at what we can invest that money into without creating risk and a duration mismatch, there is not much. It is difficult to increase your margins when you are paying .90% for basically overnight money."

Calvert predicted that in the not too distant future the yield curve will flatten due to the historically high steepness in the curve, and produce margin compression. "And when that flattening happens, it will happen at the long end of the curve, not both ends at the same rate. So now you are funding with an even higher cost."

Because of what lies ahead, credit unions this year must be cautious of their deposit pricing, rather than paying based on the competition. "They need to evaluate borrowing strategies, as well," Calvert said. "The second piece is to make sure the assumptions you are putting into your modeling are appropriate. As I said, the most likely scenario is that we are going to see short-term rates go up much more than long-term rates. And if your assumptions that the entire yield curve is rising at effectively the same pace, I believe your modeling will be short-sighted and not give you the most accurate answers."

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