MADISON, Wis. — Credit unions should prepare for a slight rise interest rates this year, say economists.
"We have had a pretty long string of really solid results on the labor market front," said Mike Schenk, VP of economics and statistics at CUNA. "It is the Fed's job to anticipate future inflation, not respond to current inflation, so it seems this is the time for an increase."
CUNA's baseline forecast calls for an increase in the Federal Funds Rate of 25 basis points at each one of the last three meetings of 2015. Schenk said the average for the full year will be 25 basis points.
"The data from the Chicago Mercantile Exchange shows an expectation for the first move being in September," he noted.
NCUA has been ringing the warning bell about interest-rate risk for the last few years. John Worth, chief economist for federal regulator, began his observations by stating the agency's policy is it does not have a "specific view" on rates.
That's because NCUA's supervisory goal is not for credit unions to be prepared for one rate environment, but to be prepared for a wide variety of rate environments, he explained.
"They need to be robust and able to succeed in many conditions," said Worth.
"All that said, the data from the Federal Reserve Board indicates a rate increase is coming. The media estimate of all the members of the board predicts short-term rates will be over 100 basis points by the end of 2015, nearly 250 basis points at the end of 2016 and just over 350 for 2017. All of those number are contingent on the economy being consistent with forecasts — and certainly increases could be faster or slower."
Worth said credit unions should be watching the Fed forecast, as it takes into account the opinions of all the members of the Federal Reserve Board, "but we would not say bet the house on one particular path of interest rates. Rising rates should be one scenario the institution needs to be prepared for in terms of cash flow and earnings."
Jason Peach, SVP and chief financial officer for $160 million West Community CU, O'Fallon, Mo., expects a "very nominal, gradual rise" in interest rates this year.
"We have a 50 basis point rise built into our budget for the end of this year starting about mid-year," he said. "The CUNA economists have noted there seems to be a relationship in recent cycles between a longer term at the low and then a gradual rise — and it has taken longer for the Fed to come back up so we expect a slow rise."
Peach, who also serves as second vice chair of the CUNA CFO Council, foresees an additional 125 basis points rise in 2016.
Schenk said CUNA has "not hammered out" its 2016 forecast, but "we expect it will continue to express optimism in the economy, and in the job market in particular."
"Wage gains, more importantly, will be greater in 2016," Schenk predicted. "This will mean even higher consumer confidence, which translates into people spending money on big-ticket items. From a balance sheet perspective, consumers are in a better place today than they have been in a long, long time. Debt loads have come down significantly."
Sunny Outlook for Economy, Inflation
In addition to the state of the economy and the rate of inflation, the three economists cited a number of factors that will affect how fast/slow rates rise over the next few years.
West Community CU's Peach said the fact there is "little" inflationary pressure and "only a small amount" of wage pressure "limits the need" for a quick rise in interest rates.
"Right now, the Fed wants to get ahead of any inflationary spark so there is some momentum for an increase," he assessed. "It might be mid-year or it might be delayed if the stock market were to plunge for any reason or employment gets worse. The FOMC [Federal Open Market Committee] is communicating that they want to see movement, not that there is a reason to raise rates."
According to Peach, interest-rate risk management means, "you are always anticipating moves up or down." He said CUs need to "immunize" their books while not giving up too much yield.
"We have been managing our long-term rates since rates went very low," he explained. "We have concentration limits in place to make sure we are not stuck with a bunch of long-term low rates such as mortgages. We are prepared for change because there always will be change. We want to protect our net interest margin by managing yield versus risk every month, as do all credit unions over $50 million in assets.
"It will be interesting," Peach added.
NCUA's Worth sees the economy in the U.S. as "really looking fairly strong."
"We are seeing improved household views and labor market growth, which would expect to drive higher rates. But Europe and China are seeing economies that are uncertain or in the doldrums, and there is drama in Greece," he said.
If there is a lower demand for funds, that leads to lower long-term rates, Worth pointed out, noting the federal regulator will be watching all of these factors closely over the next few months.
One option Worth sees: There could be rising short-term rates and low long-term rates, which he said is "tough on credit unions."
"That is why we keep coming back to the Boy Scout mentality — be prepared for a variety of situations," he said. "One issue we have talked a lot about the last couple years is credit unions holding long-term investments. Those grew dramatically for a while, but now have moderated over the last couple quarters. It has helped that there has been healthy growth in auto loans and credit cards. That mitigates having to invest in long-term securities."
CUs should check their balance sheets for the effect of interest rates rising 100, 200 and 300 basis points, Worth advised. This scenario planning should include a look at how high interest rates could rise before the institution becomes insolvent.
"All of that will improve their ability to manage through different rate environments, which is good all the way around," said Worth.
Schenk said he and the other CUNA economists think as the economy continues to improve, the Fed Funds Rate will continue to increase. However, they feel the Fed will be "cautious" because the United States is in the middle of what, historically, has been a "lackluster" recovery.
The good news: inflation pressures not only have been low, there has been a decline due to falling energy prices in recent months. Schenk said these "soft increases" in prices combined with weak underlying data in the labor market argue for a "slow but sure" policy rather than something "dramatic."
"Then there are foreign markets, such as a slower growth in China and what is going on in the Eurodome," he noted. "There are reasons to be optimistic, but the conditions give the Fed wiggle room going forward. The Fed will have to be careful in how it implements a rate increase. There likely will be relatively small increases, unless labor markets improve more rapidly and/or prices increase."
CUs should see this as good news overall, according to Schenk. If the optimistic outlook the CUNA economists hold is correct and the Fed will take a slow go approach, he said that will mean a continuation of "very strong" loan demand and "only the smallest declines" in net interest margin.
"ROA should stay pretty strong, perhaps declining slightly in 2016," he predicted. "There should be healthy bottom lines, improving asset quality, solid membership growth and increasing capital.
"In 2014 we said it was the rosiest forecast we have had in seven years, and the 2015 forecast is even rosier," Schenk added.
