Time To Improve Cost of Funds Management Bottom Line Boosters
LOMBARD, Ill.-It's time CUs improve their ability to manage their cost of funds-getting back to core competencies practiced before overdraft and interchange revenue became big contributors to the bottom line.
Bill Handel made that recommendation, as well as calling for further improving focus on operational efficiency, as necessary steps in the face of looming interchange cuts and further hits to overdraft. The VP of research and development for Raddon Financial Group contended that no matter what the outcome of the Durbin Amendment debate, that credit union interchange revenue will see a marked decline in the next two years and that more legislation will cut into overdraft.
"It's a return to the fundamentals of how you operate a credit union," said Handel. "First, through simple setting of rate-how high or low do I set rate on savings accounts, MMAs, or CDs. The second issue is what we call deposit mix management, the notion that if you can reduce your reliance on generally higher-cost funding sources, you can actually bring your overall costs of funds down without necessarily dropping your rates as dramatically as what you might feel necessary."
The approach, however, does not come without hard choices, noted Handel. For example, if the credit union's loan-to-deposit ratio is 50% to 60%, it should drop CD rates into the bottom half or bottom third of the market. Handel said that discourages CD growth, which is not needed. "We know CDs tend to be hot money. All you are doing is growing a capital adequacy problem, raising your asset base but having no way to lay off those deposits effectively. Earnings and capital come down."
Handel recommended keeping core deposits, basic shares and MMAs at higher levels since these accounts encourage long-term relationships.
"Second, think about creating tranches or tiers in your base savings rates. For low-level relationships you can cut the basic share rate to 10 basis points or less. Most major banks are sitting at one to five basis points on bases savings. We are not suggesting you go that low, but there are still many credit unions at 50 basis points or higher in terms of their most fundamental base rate on savings accounts. For example, for balances from $500 to $1,000, drop those deposits to 10 to 15 BPs, and then pay 25 to 30 basis points on the next tier."