An Inflection Point: Will a Fed tightening cycle relieve income pressure?

If the market's expectation is for rates to rise how will credit unions income be effected? Like any good discussion on economics there is a good scenario and one not so good.

 
 

First, the good news: In the short run, yes, a tightening will relieve income pressure – particularly if credit unions are able to hold the line on non-maturing-deposit dividend rates, like those paid on regular shares and share draft accounts. I agree with most CFOs who believe they will be able to keep those rates “sticky” on the way back up.

However, those who do not have a money market liability account may discover that the premium they are currently paying on the regular share account vs. market substitutes (money market mutual funds) will go away quickly, and so may the deposits. Here, liquidity may become an issue. Credit unions experienced this most recently in the summer of 2000, just four short years ago. For those who do have a money market account, most have 25 basis points (b.p.) to75 b.p. of protection in the form of premium vs. the money market mutual fund counterparts (in which rates currently average .50 percent to 1.00 percent). After that, they’ll be forced to join the party and raise rates along with the competition or begin funding outflows.

Now for the bad news: In the long run, it’s doubtful that tightening will help. A lot of folks are fighting a powerful foe – themselves. The years 2001 through mid-2003 will likely prove to be a “once in a generation” period, in which assets flowed in to safe haven depository institutions (thank you, NASDAQ collapse), the yield curve steepened severely (thank you, Fed), and equity skyrocketed through budget-busting income gains (thank you, CFOs).

But beginning in mid-2003, the evil effect of margin compression took hold. Fixed rate auto loans and investments made during the golden year of 2000 were maturing into dismal short-term yields and deposit costs became floored somewhere between 0-1.00 percent.

At the end of first-quarter 2004, everyone sighed, threw in the collective towel, and firmly believed the Fed was on hold for the balance of the year. The way to fight this margin compression was to reload with interest-rate risk, all in the name of protecting this year’s budget.

Unfortunately, markets have a way of distributing the most amount of pain to the most amount of people and the March (and April and May) jobs report brought the Fed back into play. This left fixed-rate assets gasping for air, sinking in the quicksand of a 100 b.p. increase in market yields in April.
Here’s the best-case scenario: We all may able to scrape through with patience and a Luke Skywalker-like performance from Chairman Greenspan. He is keenly aware of market reactions to well-placed comments. His oracle offerings often cause traders to do his bidding, moving short and long market yields like a master puppeteer. However, as prudent managers, we must prepare for a flatter yield curve, which most are calling for in 2005-06. But remember the wise words of a Wall Street sage, “Hope is not a viable strategy.”

In an environment with a flatter yield curve, we can lean on the abnormal capital built during 2001-2003. Most credit unions wildly exceeded their budget expectations during those glory days.

 

 

 

Aug. 2, 2004


Comments

 
 
 
  • I'm dissappointed that there is no mention of "BIG PICTURE" issues ALCOs should alert CU operations staff to: A probably rise in delinquency as borrowers with variable rate & variable payment loans find it harder to pay their bills on time, a need to review non-interest sensetive income like behavior modification fees, to recover overhead expended; something that may not have been a priority during the go-go capital buling years. Carolyn M. Warden, CCUE, President Shared Resources Consulting
    Anonymous
     
     
     
  • Correction to the first paragraph. First, the good news: In the short run, yes, a tightening will relieve income pressure – ONLY if credit unions are WILLING to hold the line on non-maturing-deposit dividend rates, like those paid on regular shares and share draft accounts. I agree with most CFOs who believe they will be able to keep those rates “sticky” on the way back up. HOWEVER ONLY BOARD MEMBERS HAVE THE AUTHORITY TO SET DIVIDEND RATES, SO EDUCATING DIRECTORS ON THE ABCs of ALM is ESSENTIAL.
    Anonymous
     
     
     
  • Correction to the first paragraph. First, the good news: In the short run, yes, a tightening will relieve income pressure – ONLY if credit unions are WILLING to hold the line on non-maturing-deposit dividend rates, like those paid on regular shares and share draft accounts. I agree with most CFOs who believe they will be able to keep those rates “sticky” on the way back up. HOWEVER ONLY BOARD MEMBERS HAVE THE AUTHORITY TO SET DIVIDEND RATES, SO EDUCATING DIRECTORS ON THE ABCs of ALM is ESSENTIAL.
    Anonymous