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How Will Higher Interest Rates Impact Credit Unions?

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WASHINGTON — The Federal Reserve's decision to raise interest rates for the first time in nearly a decade is raising questions about the move will impact loan and deposit rates at credit unions.

Already reports have surfaced that at least one large bank, JPMorgan Chase, will boost the rates it pays to its depositors.

Perc Pineda, senior economist at CUNA said that, for the moment, the recent 25 basis point hike announced by the Fed in December is unlikely to cause most credit unions to boost the rates they charge on loans and deposits by any significant degree.

But longer-term — if the central bank keeps tightening — CUs will have to raise rates to attract savings. "Customers and borrowers are all seeking higher yield, even if it's only a marginal increase," Pineda said. "As such, banks and credit unions will be competing with each other to provide that higher yield."

David A. Sayers, SVP of finance, accounting & operations at Maine Savings FCU, a $301 million institution based in Hampden, said the most immediate impact from higher interest rates will be on CUs' adjustable-rate loan products such as home equity and overdraft lines of credit as well as credit cards — products where rates contractually re-price when rates change.

"Beyond that I don't expect fixed rates to change quickly although loan rates should inch up before deposit rates move," he said.

Rising rates pose an unusual scenario for most consumers used to historically low and stable numbers. That's because borrowing money (to pay for homes, autos, etc.) becomes more costly; but also receive higher interest payments on their deposits.

Other financial products, like home equity lines of credit, adjustable rate mortgages and credit cards, could also become more expensive — but only by meager amounts. Indeed, as Pineda points out, the U.S. economy is still hovering at near-zero interest rates, meaning a small hike will have an inconsequential impact on CUs borrowers and members in the near-term.

Sayers noted the interest rate landscape between credit unions and banks is extremely competitive, especially when rates are compressed, but CUs have a tendency to lead the way on both savings and loan rates. "This scenario is amplified in higher-rate environments as banks typically move loan rates faster and deposit rates slower than credit unions tend to do," he added.

Jill Gonzalez, an analyst at WalletHub, said the Fed's hike will "mostly affect" credit unions' loans, but not deposits. "This kind of rate increase generally affects savings accounts in a positive matter," Gonzalez said. "But, most banks and credit unions will try to moderate this [increase], since they have been losing money on savings accounts during the [nearly decade-long] zero% interest rate period."

CUs, she said, will try to keep interest rates on savings accounts low, while slowly raising loan rates in an attempt to recover.

Generally, CUs tend to offer higher savings rates and lower loan rates than banks, according to Gonzalez, adding, "the hike in interest rates shouldn't change this scenario."

For example, according to recent NCUA data the average 36-month CU used car loan interest rate was 2.64%, vs. 5.09% at banks. Also, the average interest rate for credit card loans at credit unions was 11.67% compared to 12.65% for banks.

With respect to deposits, the average credit union offered 1.47% interest on 5-year CDs, compared with 1.22% for banks.

Michael Moebs, CEO of Moebs Services, projects the Fed's increase in short-term interest rates will have about a $2 per monthly payment effect on vehicle loans, as well as $2 per month impact on credit card payments. But there will be no effect on mortgage rates, according to Moebs, adding, "the average credit union member saves $34 a month in lower gas prices at the fuel pump, so the average member will see no effect."

Future Rate Hikes?

Even if the recent rate hike leads to little or almost no impact on credit unions, most analysts predict the central bank will continue to raise rates.

As for this year, WalletHub predicts the Fed will raise interest rates just once in 2016, either in March or June, bringing its median target rate to 0.625%. "Most financial institutions will hold a "[we are] all in this together' mentality," Gonzalez said. "Credit unions specifically will have to try to find a steady balance between savings and loan rates."

CUNA's Pineda said that, depending on how strong the economy stays for the duration of 2016 and how pervasive inflationary and wage pressures remain, the Federal Reserve will likely raise short-term interest rates very gradually, "perhaps by a 25-basis-point [hike] at every other FOMC meeting."

Pineda projects that the Fed Funds Rate will reach 1.25% at the end of 2016.

Curt Long, the chief economist and director of research at NAFCU, expects the Fed will be "cautious" when considering future rate increases. "The driving factor will be inflation, which has been muted for nearly the entire duration of the financial crisis and recovery," Long said. "Assuming inflation remains relatively low, I would expect a very gradual pace to future rate hikes. The Fed will also be wary of slowing growth abroad and the potential impact that has on domestic growth and inflation."

Sayers of Maine Savings agreed: "as with December, rates will likely increase in increments of 25 basis points, and I expect rates to increase 50 to 75 basis points this year."

Moebs expects the Fed will raise rates twice this year — each time by 25 basis points. "The increase in rates is a function of the price of oil and the risks associated with the oil price," he explained. "As long as the gas price at the pump stays low, [Fed Chairperson Janet] Yellen will be able to raise rates. However, there is a [presidential] election this year, which poses a risk that [hikes in] interest rates can be curtailed."

Regardless, it would be a while before short-term interest rates put a dent in CU finances. "If Yellen increases rates every quarter by 0.25% it will be the end of 2017 [when] a potential interest rate level will be achieved that will present a challenge to credit unions," Moebs noted. "This assumes the consumer comes back, oil stays below $40 a barrel, China has hit bottom, costs for credit unions go down, and compliance stays [under control]. Will this happen? No, so [we] expect a normalized interest rate [not until] 2018."

So, how should CUs respond to a potentially different interest rate environment?

Deborah L. Rightmire, VP of asset/liability management for the Cornerstone Credit Union League, suggests using market indicators to develop pricing structures. "Due to the recent increase [in rates], this should result in rising market indicators and the need for credit unions to make small adjustments to pricing of both loans and deposits," she said.

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