In our last column, we touched on the logic of credit unions implementing non-interest product offerings such as discretionary overdraft payment services to compensate for the decline in net interest margins. The gap between the higher interest rates charged for money loaned out and the lower rates paid for deposits that fund those loans is compressing. This economic condition has made it a challenge for some credit unions to maintain economic viability. What’s more, with the many alternative investment and savings vehicles available to members, core deposits from credit unions have been shrinking. In this column we’d like to take a closer look at recent developments that have been driving this phenomenon.
Online or Out of the Picture
Consumers, more specifically credit union members, utilize the Internet more and more each year. In fact, the Internet has been the conduit for consumers to investigate alternatives, to compare rates, and to transfer funds between competing institutions. Core deposits as a percentage of assets are declining and likely to continue to decline. As more consumers investigate and have access to competitive sources, margins tend to compress even further. Change may be a necessity. Many credit union executives are questioning whether their current business model will stand up in today’s competitive environment.
Alternative on-line banking entities such as ING and HSBC have gone from Internet experiments to large-scale organizations housing billions in deposits. At the time of this writing, HSBC was promoting a 6% yield on deposits. E-Loan and Countrywide are just two examples of on-line options that boast low interest rates on loans. These are all products that have cut deeply into traditional credit union reserves.
Surviving In Today’s Economy
The challenges facing the traditional credit union are clear. What is not so clear is how to deal with them. Should credit unions wait it out? Should they expand? Should they change their charter to allow for more operating flexibility?
Let’s investigate option one: ‘waiting it out.’ If no action is taken, perhaps things will get better. In fact, there are some economists that believe recovery from depressed income streams is just around the corner. Other economists predict that flat yield curves may be around for a long time. They point out that over the last 15 years the volatility of inflation, which impacts long term interest rates, has been lower than real rates – or inflation-adjusted short term interest rates. This camp of economists believes this will continue to influence the curve for the foreseeable future.
There are other factors that impact the yield curve. How will the Federal Reserve handle inflation or recession in terms of interest rate adjustments? Will highly competitive market conditions continue to exert more downward pressure on the yield curve? And for credit unions that choose to wait it out, will they be able to survive if things remain unchanged? Cutting operating costs could become imperative but reducing costs alone may not be an effective strategy. The bottom line is ‘waiting it out’ does not come without risk, especially if loan demand falters.
Expansion may be another approach. In theory, it increases core member numbers along with deposits. But for credit unions, it may mean altering their charter to allow for a larger member audience. And expansion can be expensive, requiring more facilities and staff. Plus, it’s a long term strategy often taking three to four years to reach economic viability.
Economics 101 – Adapting To Difficult Times
Let’s go back to the basics. Sometimes obtaining success in difficult times is not as complicated as it might seem. Clear vision in terms of meeting member needs is priority one. Focus on products and activities that:
- Stabilize and diversify income streams.
- Control interest rate risk.
- Reduce dependence on this more volatile loan market.
- Create sources of non-interest income.
- Differentiate and shift member preference to their own credit union.
In 1984, the net interest income earned by financial institutions roughly outweighed non-interest income by a three to one margin. Over the years, that ratio began to shift heavily toward non-interest income until statistics tell us that by 2001, non-interest income accounted for 43% of net operating income, up from 25% in 1984. What does that tell us? Create sources of non-interest income to reduce your reliance on net interest income.
There are a number of sources of non-interest income. They range from service charges on deposit accounts to brokerage services to financial planning services, as well as various fees on loans, mortgages, and ACH transactions. The latest and perhaps most popular member service available is a discretionary overdraft payment service. If you don’t have one, consider the Strunk & Associates’ Overdraft Privilege™ Service Program. For more information, call us at 1-800-728-3116 or go to our web site at www.strunklp.com.