Credit unions will need to watch expenses to weather latest rate cuts
The Federal Reserve’s decision to slash interest rates is likely to create headaches for credit unions.
Earlier this month the central bank lowered its federal funds rate by a percentage point to between 0% and 0.25% in an effort to spur economic activity during the coronavirus pandemic. But most credit unions are unhappy with the move, especially after enduring low interest rates for years since the financial crisis.
“The majority of [a credit union’s] income is derived from the net interest margin,” said Robert Colvin, president and chief strategist at CU Capital Market Solutions. “So when you have interest rates so low and compressed, then that interest margin gets crushed and there virtually is no margin to speak of.”
“That dampens earnings and reduces opportunities for savers as well,” he added.
The net interest margin measures the difference between the interest income financial institutions make and the amount of interest they pay out on items such as deposits. Earnings will now be squeezed in the wake of the Fed’s decision as borrowers pay less in interest for credit.
The industry’s net interest margin has never fully recovered to pre-crisis levels. The median credit union margin was 3.38% in the fourth quarter, down 2 basis points from the third quarter but up 12 basis points from a year earlier, according to data from the National Credit Union Administration. But that’s still below the median of 3.59% posted in the fourth quarter of 2009, according to the data.
That’s in part because interest rates have never fully rebounded either. The last time the central bank lowered interest rates to zero was during the Great Recession. At that time, rates dropped steadily from 5% until they bottomed out.
Post crisis the federal funds rate peaked at 2.25% to 2.5% after a 25 basis point increase in December 2018. It has steadily declined since then.
Since rates were still relatively low, credit unions don’t have the same momentum right now and won’t feel the same impact as they did when entering the financial crisis, Colvin said.
“But whatever impact it has, it won’t be positive,” he added.
Still there are measures credit unions can embrace to protect their bottom lines. As revenue compresses, credit unions will need to turn to the expense side of their balance sheets to maintain earnings.
Noninterest expenses totaled $48.4 billion for the industry in the fourth quarter, up almost 9% from a year earlier and an increase of more than 60% from the fourth quarter of 2009, according to NCUA data.
“I think credit unions will freeze all open positions as the very first move,” said Steve Williams, president and partner of Cornerstone Advisors.
In tougher times, hiring new employees is one of the first items to be cut since organizations become increasingly mindful of their expenses. Data from the National Credit Union Administration shows that credit unions have increased hiring by 38% since the Great Recession. Banks, excluding thrifts, have reduced their employee headcounts by 1.6%, according to an analysis from Moebs Services.
Williams added that credit unions also will likely pull back in other areas, especially as consumers turn to more remote delivery options. For instance, marketing budgets could be cut, plans to enter new markets may be put on hold and underperforming branches could be permanently shuttered. Vendor contracts will also be reviewed to examine performance measures and determine what, if any, services need to be cut.
Many credit unions have already begun adjusting operations as the coronavirus continues to spread. There were over 44,000 cases in the U.S., as of Tuesday midday, according to data from the Centers for Disease Control. As a result of the virus, some credit unions have started limiting access to branches or shuttering some locations entirely.
“I think the management focus around operational risk as it relates to business continuity, health and safety is overriding the natural earnings challenges that are occurring with the rates falling,” Williams said. “Credit risk concerns will come soon, but luckily, the credit union industry is very well-capitalized.”
Credit unions could turn to fee income as another avenue to address their earnings challenges.
But rather than raising fees, CUs should consider cutting them instead. This will result in larger revenues because it will drive volume and generate goodwill with members, said Mike Moebs, economist and founder of Moebs Services.
“If I was at Navy Federal, I’d cut fees to $5 and say as long as we have this virus that’s going to affect us, we’re going to reduce the overdraft fee,” Moebs said. “People are going to be working from home and they might not work that second job so they might not be able to make as much money.”
Credit unions will also need to determine how much they are willing to chase borrowers by offering lower rates for loans.
“But the question is, just how far can credit unions move those rates down and still generate enough earnings to make things work?” Colvin asked.