Credit unions are in for a cooling off in 1995 after the red-hot lending and record earnings of previous years, industry observers said.

The tight liquidity situation the industry faced last year is expected to be relieved as lending dips and deposits flow into credit unions. But net income will suffer as the cost of funds increases.

"I'd say it's a return to normal," said Keith Peterson, an economist for the Credit Union National Association, adding "1994 will be the last year of exceptionally high levels of net income, loan growth will be getting back to normal, and savings will be getting back to normal."

Loan portfolios of credit unions larger than $50 million of assets grew 1.5% to $124 billion in the quarter. That's up from 1.1% growth in the first three months of 1994, but it's not expected to last as the economy slows this year.

Loan portfolios grew 16% for the industry in 1994. Mr. Peterson predicts that figure will fall to 12% for 1995, closer to the industry's long-term average yearly loan growth of 7%.

"Consumers have dialed back spending," Mr. Peterson said. "Consumers have slowed down after a spending glut, but we're not going to see a return of 1990-91 when nobody was borrowing."

Another reason for slower loan growth is that since late last year credit unions have been hiking rates, Mr. Peterson said.

By contrast, last year credit unions increased their share of the consumer installment market to 13% from 12.5% because they kept their rates below the competition's. Now credit union rates are gaining on bank rates.

The growth in lending last year caused a short-term liquidity squeeze as credit unions were reluctant to cash in investments devalued by rising rates. As an antidote, the industry jacked up deposit rates late in the year to attract savings.

That trend continued for the largest institutions during the first three months of 1995. The average rate on a one-year certificate of deposit was 5.76%, compared with 3.36% in the first quarter of 1994, according to the Washington-based consulting firm Callahan & Associates.

Deposits increased 2.5% to $182.5 billion during the first three months of 1995, compared with 3.4% growth in the first quarter of 1994.

The industry's deposits should increase between 5% to 6% during the year, versus roughly 3.5% growth in 1994, Mr. Peterson said.

The industry particularly stands to gain if the Federal Reserve lowers interest rates, as is widely expected, said Tun Wai, chief economist for the National Association of Federal Credit Unions. This is because credit unions are slower to lower deposit rates in a falling interest rate environment than the competition, just as they are slower to increase loan rates as interest rates rise.

"When rates pick up, loans grow for credit unions," Mr. Wai said. "When rates go down, shares go up.

"For credit union members this year, savers are the winners and borrowers are losing out."

The growth in deposits, combined with a decrease in loan activity and a move toward shorter-term investments, should alleviate liquidity pressures, said Charles W. Filson, president of Callahan & Associates.

"I would say the liquidity tightening is over," he said.

But more deposits with higher rates means credit union bottom lines are hammered.

According to Callahan, the cost of funds for the largest institutions increased 60 basis points in the first three months of 1995 to 3.87%, compared with 3.26% in the first quarter of 1994.

The largest institutions' return on assets was 1.13% in the first quarter of 1995, versus 1.23% in 1994.

Mr. Peterson said the entire industry's ROA will continue to fall to about 1% at the end of 1995. The industry's ROA peaked at 1.39% in 1993, falling last year to 1.22%.

"A 1% ROA is more normal for credit unions," Mr. Peterson said. "The cost of funds is catching up with the assets."

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