The Federal Reserve continued to exert enough downward pressure on interest rates last week that credit unions' rates were poised to submerge into uncharted waters.
The Fed's Open Market Committee voted to slash short-term rates by another 25 basis points, cutting the overnight Fed Funds rate to a 45-year low of just 1%.
The Fed's action was expected to be just enough to push the benchmark credit union rate, the average dividend paid on regular shares, or savings accounts, under 1% for the first time ever, as credit unions struggle to maintain profitability.
"Nobody wants to drop rates below 1%, but they really don't have much choice," said Brian Turner, senior advisor for Southwest Corporate (FCU) Investment Services, of the probability that the 1% floor will be pierced in the coming weeks.
Since January 2001 when the Fed enacted the first of 13 short-term rate cuts credit unions' rates have steadily declined. Data compiled by DataTrac Corp shows that average rates on regular share accounts has halved to an all-time low of just 1.03% during that time; while rates for share draft accounts (checking) have plummeted all the way to 0.61%; and money market rates to a meager 1.19%.
Bank rates have fallen even further, to just 0.62% for regular savings; 0.43% for checking accounts; and 0.69% for money market accounts.
The latest Fed action is going to pressure credit unions in several ways to cut their rates even further, according to Turner.
First, because CUs still have as much as $40 billion tied up in short-term funds, most of it in the overnight market, credit unions will have to make up for lost yield on those funds. Lower yields on longer-term investments are going to add additional pressure. And finally, the downward pressure on rates on the loan side is going to force further adjustments in cost of funds. "The only thing left in their arsenal is share rates," said Turner, who predicted the 1% floor is right around the corner.
"Definately," said CUNA Mutual Group economist David Colby, of the likelihood of the 1% mark. "Credit unions have to maintain their pricing of deposits in line with the markets. Otherwise, they'll see a lot of unintended inflows of new deposits and they'll see a negative spread situation."
While loan rates are also expected to follow the Fed lower, it's deposit rates that will move quicker, he said. "Deposit rates reprice faster than loans," he noted.
Brian McVeigh, chief financial officer for State Employees CU, Lansing, Mich., said his credit union has already pierced the 1% mark, moving its dividend rate on regular shares down to just 0.75% and on share drafts to 0.25% for the first quarter. This helped the $600-million credit union maintain a 0.83% return-on-average assets (ROA) for the quarter.
He predicted the Fed's action last week will pressure other credit unions to pierce the new rate threshold. "If it doesn't, I'd like to know what they're doing to be able to pay those rates," said McVeigh.
The additional rate pressure will make it more difficult, but not impossible, for credit unions to maintain ROA. Turner suggested they continue to pare expenses and slash cost of funds, and to hold on to more mortgage loans.
"They'll want to hold as much mortgage paper as possible," said Colby. "They'll want to hold on to 6% or 6.5% mortgages. This will benefit credit union ROAs by increasing their gross spreads. In this rate environment those mortgage loans have really dampened the economic impact on credit unions. That's a big positive."
The record-low rates have yet to drive off depositors, as credit unions continue to report massive inflows of new savings, But, sooner or later, when the stock market rebounds and other alternatives resurface for savings, members could finally revolt. "How much lower," asked NAFCU economist Jeff Taylor, "can you drop your rates before they start burning down your credit union."
