After years of waiting, interest rates are finally on the rise. But that good news also raises new questions for credit unions, which tend to keep rates lower than the competition and are more reliant on fee income to generate revenue.
But for an industry that prides itself on low rates and low (or no) fees, recent research from one economist reveals CUs’ overdraft rates are rising faster than those of for-profit banks – even faster, in fact, than inflation – and that could play a big role in how CUs move forward in the new rate environment.
Economist Mike Moebs, of Lake Forest, Ill.-based economic research firm Moebs $ervices, pointed to recent research from his firm that the median overdraft risen by more than 50 percent since the year 2000, climbing from $18 to $30 today for all FIs. According to the Minneapolis Federal Reserve bank’s inflation calculator, the median overdraft rate should only be about $25 today, based on inflation.
According to Moebs’ research, for banks and credit unions, the median overdrafts have jumped from $20 and $15, respectively, to $30 and $29. This means that banks hiked their overdrafts by 50 percent, while credit unions almost doubled them (by 93 percent). Moreover, on an inflation-adjusted basis, these figures should be at $27.82 and $20.86, for banks and credit unions, respectively.
“Credit unions have an image of being more consumer-friendly,” Moebs stated. “[But] when taking a look at the history of overdraft prices, credit unions have been increasing their price at a much quicker rate and [are] now almost on par with banks.”
So should credit unions lower their overdraft prices now that interest rates are back on the rise?
Moebs explained that with overdrafts, the question should be: how far can the price fall to stimulate enough volume to increase revenue? He looks at banks to make his argument.
“Those financial institutions with an overdraft price of $25 or less are producing more volume, which increases revenue over time,” he said.
Moebs thinks that $30 might currently represent a “ceiling” for overdraft prices. “It is time for all depositories to take a long hard look at how they price overdrafts,” he recommended. “They must decide to jump ahead with a high price and have less volume, or take a dive with a low price to drive volume [upwards].“
Moebs added that if overdraft revenue is falling or have not increased in the past several years, then lowering the price is a strategy “worth considering” to reverse the trend.
“Lowering the price is a way to increase overdraft volume and increase overdraft revenue,” he said. “This is basic economics: lower price increases more volume. Credit unions have not changed their volume constraints in 20 years and overdraft revenue is starting to plateau out or decrease. Credit union management needs to protect its ‘friendly’ image while simultaneously lowering [their] overdraft price to get more revenue.”
Cut fees to make more money?
Most observers believe that higher interest rates – at least in the near term – will not have any impact on overdraft fees charged by credit unions.
Dennis Dollar, a former NCUA chairman and Alabama-based credit union consultant, explained that the pricing of overdraft privileges is largely based on risk management as the credit union takes the risk that paying for the overdrafted item will be covered by the member in a “reasonable” period of time.
“That risk is already ‘baked into the cake’ at current pricing, so I would be surprised if there was any significant change in overdraft pricing that would impact the industry average at all,” Dollar added.
Brian Turner, president and chief economist at Meridian Economics LLC in Plano, Texas, sees no correlation between shifts in interest rates and upward pricing trends of overdraft fees.
“The suggestion is that as rates increase, either members’ propensity to overdraft increases or credit unions will feel the need to increase overdraft fee charges to offset some form of loss – neither of which I have observed,” he said. Moreover, Turner cited that in the five years since 2012, fee revenue consistently accounted for 29% of total credit union revenue streams each year. “Some of this can be attributable to the enactment of courtesy pay, which actually reduced the overall members’ cost of overdraft, but increased credit union revenue streams. This also reduced the upward trend in transaction costs – negating incremental shifts in fee pricing,” he noted.
Turner also indicated that, contrary to perceptions, the annual fee schedules at credit unions have already been rising – by 135 bps in 2014, 136 bps in 2015 and 139bps in 2016 -- while interest rates remained near zero.
“In a rising rate environment, a credit union's transaction volume benefits more by trimming market rates competitively rather than [by] playing games with their prevailing fee schedule,” Turner stated. “Therefore, history tells me that a rising rate environment (in its infancy) produces enough volume to enhance fee revenue streams (as we saw from 2003-2007) without having to adjust the fee schedule.”
Staying put – for now
How are individual credit unions tweaking their overdraft fee structures? The biggest credit union of them all is sitting tight for now.
Bill Pearson, public relations specialist-corporate communications at the $80 billion Navy Federal Credit Union of Vienna, Va., said Navy “does not intend to raise overdraft fees as a result of the recent Fed interest rate hike."
Smaller CUs are echoing those sentiments.
Anna Suire, CEO of Section 705 Federal Credit Union, a $33 million institution based in Lafayette, La., cautioned that even if CUs do cut their fees, as a result of rising rates, some institutions could find themselves operating in the red.
“Investments have dropped and credit unions [must] charge some operating fees to cover their own costs,” she said. “It all boils down to what services the consumers want, and what they are willing to pay. Credit unions will be challenged to find a way to afford those programs, even if it means charging a fee.”
Jeffrey K. Conrad, CEO of Pelican State CU, a $296 million institution based in Baton Rouge, La., suggested “Fee reductions will most likely be accompanied by new products or bundled products as credit unions compete with fintech companies. Rising [interest] rates will produce more income for credit unions, so we shouldn't see a rising fee environment.”
Toby Hayes, VP of marketing at the $1 billion SAFE FCU in Sumter, S.C., summed up this new climate. “We’ve lived in a low-rate environment for close to a decade, so rising rates will be a new experience for a whole new generation of members,” he said. “It will take some education, but it’s a good opportunity to tell members how rates are rising for both loans and deposits and that making efforts to save will, literally, pay more dividends.”
Rising interest rates, he added, will have a more detrimental impact on credit unions that have relied heavily on auto loans and other products, as these will be slow to reprice in a changing rate environment.
“As credit unions pay more for deposits, they’ll need adaptable loan products that generate more yield, such as adjustable rate credit cards,” he said. “Those institutions that haven’t planned for a balanced and nimble portfolio will be forced to adjust fees to make up the difference in their balance sheets.”
