Projections See Stronger Economy On The Horizon; Effect Of Rising Rates Is Queried

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Signaling an end to an era of cheap money, the Federal Reserve Board last week hiked its target for the bellweather Fed Funds rate by 25 basis points from its 46-year-low of 1%.

The rate hike, the first in four years, is widely seen as the first in what is expected to be a series of increases over the next 18 months as the Central Bank tries to hamper economic growth and inflation, ending a period of the lowest rates on record. The Fed Funds rate, the rate to which interest on overnight Fed Funds is targeted, is broadly seen as a peg for short-term rates like consumer loans home equity loans and deposits.

Since the Fed cut the target on Fed Funds to 1% last June the rate on overnight funds, which holds the vast depository of credit union cash-as much as $50 billion-has hovered around that mark. The slim returns on investments have brought rates on both loans and dividends to all-time lows. The average rate on regular shares, for instance, dipped below 1% last July, right after the last Fed rate cut and has plunged all the way to an anemic 0.73%, according to DataTrac Corp, which follows rates for 1,000 credit unions. Rates on mortgages, autos and other types of loans have also dropped to the lowest in memory.

The End Of Incredibly Cheap Money

Bill Hampel, chief economist for CUNA, predicted we've seen the end of these record low rates and the Fed will continue to push rates up, hiking the Fed Funds target to as much as 2.25% by year end. CUNA's three economists predict the Fed will add 25 bps to the Fed Funds target in each of the four meetings they hold before the end of the year.

"This is the end of the era of incredibly cheap money," said Hampel. "But we could have fairly cheap money, in historic terms, for some time still."

NAFCU Economist Jeffrey Taylor suggested the target could go even higher, to 3.5% or 4% by the end of 2005.

The Fed's action is expected to put increasing pressure on the bottom line for credit unions, which have already been struggling to maintain profitability, as average Return On Average Assets fell to a five-year low of 90 basis points in the first quarter. That's because many credit unions will be stuck holding lower-yielding loans and investments in a rising-rate environment.

The pressure is expected to result in credit union's resisting an increase in their dividends to keep cost of funds down. Scott Mainwaring, CFO for VyStar CU, said they currently pay the highest dividend interest rates in the Jacksonville, Fla., market-1.25% on regular shares-and will try to hold the line on the attractive rates as long as possible but may eventually have to raise them to retain shares and attract new ones.

But Mainwaring said the $3.7-billion credit union is also well-positioned to cope with the changing interest-rate environment because much of its holdings, both investments and loans, are either short-term or reprice. "We think we're pretty well positioned," he said.

"Brian McVeigh, CFO for State Employees CU, said they have no short-term plans to raise rates-the Lansing, Mich., credit union is paying just 0.40% on regular shares-but may be forced to down the road. "As [market] rates go up we'll be forced to raise rates," he said.

David Colby, chief economist at CUNA Mutual Group, said he expects credit unions to take some time to digest the market conditions and the affects of the Fed's action before moving to raise dividend rates. "I think there's going to be a lag effect," Colby said. "Historically, consumers don't move that quickly. I don't think [credit union] rates are going to be quite as sensitive to national trends.

'Lazy Money'

"It all depends on how lazy that money is. If you have members who are aggressive and trying to squeeze out as much yield as they can, it may force credit unions to act," he continued.

Hampel suggested CUs won't be forced to raise their dividend rates in the short-term because even with the record low rates, they are still higher than those paid by banks, which were paying less than 50 bps on regular savings last week.

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