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Best rates for deposits? Think again

Recent data is turning a long-standing credit union assumption on its head, and it could result in even tighter margins at some institutions.

Credit unions have long claimed that they pay members more for deposits while also offering better rates on loans. But industry data doesn’t necessarily bear this out, and instead banks have been paying better rates for deposits for several years.

This could eventually force credit unions to pay up for funding, squeezing their net interest margins and their bottom lines.

“The assumption that credit unions pay more for their deposits than banks is a myth with no factual support,” said Jeffrey Marsico, executive vice president at the consulting firm the Kafafian Group. “Sure they can pick a price point where they are paying something higher but … in terms of interest-bearing liabilities, credit unions are currently paying the lowest.”

Commercial banks with between $1 billion in assets and $10 billion in assets have a median cost of interest-bearing liabilities of 1.25% through mid-October while this number was 1.29% for the 10 biggest banks, according to data from Marisco.

In contrast, the median cost of interest-bearing liabilities was 95 basis points for credit unions with $1 billion to $10 billion in assets, according to data from Marsico.

Research from Peter Duffy, a managing director at Sandler O’Neill, showed similar results. He looked at data from 15 major metro areas, such as Tampa, Fla., Seattle and Indianapolis, and found that banks began out paying credit unions for deposits around 2016. For example, banks in Chicago, excluding the money center institutions, were paying 1.12% in interest-bearing deposits in the second quarter. Credit unions paid just 0.35%. The money center banks were paying 0.91% on interest-bearing deposits.

Duffy believes banks started paying more for deposits because of regulatory changes rather than the current interest rate environment. The liquidity coverage ratio, which applies to banks with at least $250 billion in assets, is meant to ensure institutions are liquid enough to meet withdrawal demands of customers. To meet this requirement, banks are going after core deposits rather than other types of funding, like certificates of deposit, Duffy said.

There is also a change to how the Federal Deposit Insurance Corp. calculates funding its insurance fund. Banks pay into the insurance fund based on the CAMEL rating they receive, meaning banks deemed lower risks by regulators pay less. However, a bank’s borrowings are now also part of the formula to calculate their FDIC insurance payments. That makes borrowing funds less attractive and some deposit products cheaper.

Both of these changes were part of the Dodd-Frank Act and were implemented several years ago. But banks were awash with liquidity and loan demand was low for a number of years after the financial crisis. Because of that, they didn’t need to actively attract deposits immediately, meaning the effects weren’t seen until around the second half of 2016, Duffy said.

“The money center banks and the non-money center banks are all focused on bringing in and retaining more core deposits than ever before,” Duffy added.

Alliant Credit Union in Chicago has seen stiffer competition from banks in terms of attracting and retaining deposits, said Chris Moore, the institution’s director of deposit products and payments strategy. The $11.8 billion-asset credit union is an online-only institution so faces its greatest competition from online banks, such as Ally Financial and Marcus by Goldman Sachs.

These other institutions are significantly larger than Alliant with much bigger marketing budgets. The credit union tries to counteract that by offering a variety of products to meet members’ needs in terms of safety, security and flexibility, Moore said. Alliant then works to cross sell additional products to existing members.

Alliant’s bank competitors are primarily focused on offering higher annual percentage yield to consumers, Moore added. Though the credit union tracks what other institutions are offering, it doesn’t necessarily match it, Moore said.

“We certainly track the competition, and they are paying more. I can’t dispute that,” Moore said. “We are not matching them by any stretch. We are disciplined to our approach, and it’s not causing us to raise our prices.”

However, there is a risk in banks continuing to out pay credit unions for deposits, experts said. For one, if credit unions are eventually forced to offer higher interest rates for funding, this could squeeze their net interest margins and their earnings, though that doesn’t seem to be happening yet.

The median net interest margin for commercial banks with $1 billion to $10 billion in assets stands at 3.64% through mid-October, down 6 basis points from 2018, according to data from Marsico. In contrast, credit unions in the same asset class expanded their median net interest margin by 13 basis points, to 3.50%, through mid-October from 2018, according to that same report.

In general, credit unions need better margins to help offset higher expenses in other areas, Marsico added.

“The impact isn’t just on growing shares,” Duffy said. “It is also on the cost to retain what [CUs] have relative to [their] yields on earning assets.” Even though rates are down, he added, the cost to retain those earnings is on the rise.

Credit unions also already struggle with being sophisticated in the rates they offer on products, said Bob Doby, partner at DJ Consulting. Banks, especially the money center banks, have the resources to ensure they are paying the right price for funding and charging the correct interest on loans to turn a profit. Credit unions may not realize they are losing money on certain types of loans, especially smaller credits, if they don’t take into account all their expenses, such as back office management.

“Every credit union needs to have a pricing methodology,” Doby said. “I can assure you [the big banks] know exactly where they can fund themselves and what rate they should be offering depending on their needs.”

Regardless of what’s driving the current desire for core funding from banks, it doesn’t seem like the competition will let up anytime soon. Wheelhouse Credit Union in San Diego has seen banks providing one-time special offers and special introductory rates to draw in customers, said President and CEO Lisa Paul-Hill. The $283 million-asset credit union is also having to battle fintechs for funding.

“We are also seeing new developing players entering the market as well, particularly in the fintech area, which also ramps up the competition for deposits,” Paul-Hill said. “And, across all segments, we are seeing a much stronger marketing push, with increased advertising, direct mail, social outreach, and promotions to get the word out in a cluttered market.”

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