WASHINGTON - It was inevitable that in lifting some of the weight off of consumers last week the Federal Reserve would squeeze credit unions and banks even more with its unexpected 75 basis-point cut in short-term interest rates.
Credit unions are already having trouble earning a spread in the low-rate environment and are expected to have an even tougher time as they are forced to lower rates on home equity lines of credit, car loans, adjustable-rate mortgages and other short-term loan products–adding stress to their bottom lines, even as the Fed action reduces stress on their members.
“This is obviously going to squeeze our margins even more,” said Maria LaVelle, president of Westmoreland Community FCU, in Greensburg, Pa., who said her $32 million credit union will be forced to lower rates on its HELOCs and money market funds. To make up for the lost loan revenue, she said she planned cut rates for regular shares from 1% to 0.50%.
Feeling The Squeeze
“This is going to squeeze us some more,” said Jeffrey Albert, chief operating officer at People First FCU, in Allentown, Pa. “It’s going to make it a lot more difficult to earn that interest margin and to get that margin in other areas, on loans and deposits.”
Last week’s reduction in the target rate for overnight Fed Funds was the biggest single cut by the Fed in the benchmark rate since a 1% reduction on August 16, 1982. As a result, the key Fed Funds rate is now 3.5%.
As one effect, credit unions are expected to be inundated with cash because Freddie Mac, Fannie Mae and other government agencies are expected to call bonds, leaving credit unions with vast new pools of liquidity in the lower-rate environment.
“We’ll have to think about repricing (deposits). Seventy-five basis points is a big drop,” said Debra Connors, president of Money One FCU, in Largo, Md., who said she expects some of her agency bonds to be called.
Gail Cook, president of Erie (Pa.) General Electric FCU, summed up the ensuing dilemma for credit unions: “We’ll have to lend it out in CDs,” she said, meaning lower returns in a lower-rate environment.
In a more direct way, the rate cut means credit unions will also earn millions of dollars less in the billions of dollars in overnight funds they keep with their corporates or other intermediaries, and on short-term investments.
The surprise move by the Fed, aimed at stemming a broad sell-off in the stock markets, came a week before the Fed was scheduled to meet to discuss rates, leading some to believe more cuts are coming, perhaps as soon as this week.
Increased Pressure
The increased pressure on credit unions and other intermediaries comes as rates make it increasingly difficult to earn a spread on loans. Data released by NCUA last week shows that credit unions now earn a larger spread on fees (non-interest income) than they do on assets, like loans and investments. At the end of the third quarter in 2007, credit unions earned 86 basis points on fees, compared to just 75 bps on their assets, and the Fed’s action is expected to exacerbate that trend.
Westmoreland Community’s LaVelle said her credit union earned a strong 0.94% return on average assets last year, but she expects the rate cut to push them into the red for at least the first quarter.
