On September 18th the Federal Reserve lowered the Federal Funds Rate by 50 basis points to 4.75%. This change represented not only the first time the Fed had adjusted the rate in over a year, but also the first time that rates have been cut since 2003. As the Fed Funds rate is cut, credit unions are feeling downward pressure on the rates of some of their higher yield savings accounts. Credit unions are now faced with a decision where they must determine whether they will follow the Fed and lower rates as well, or whether they will hold their rates at current levels a little longer in an attempt to drive share growth.
From May 2000 to June 2003 the Fed Funds rate was cut 13 consecutive times. By the end of that period, the rate fell from 6.5% all the way down to 1.00%, it’s lowest value since 1958. During that time period many credit unions chose to lag their rates behind the movement in the Fed Funds rate. These higher interest rates, coupled with a flight to safety, drove share growth for the June 2001- June 2002 period to 13.2%, one of the strongest numbers credit unions have ever seen. The downside however comes in the form of cost of funds. As credit union rates begin to exceed that of the target rate, cost of funds is driven up and credit unions are faced with tightening margins.
Going forward in 2007 many analysts are predicting that the Fed will have another rate cut in store before the end of the year. If a second rate cut does come to pass and credit unions are once again faced with a falling interest rate environment, a similar decision will need to be made. Credit unions will once again have to attempt to find a comfortable balance between offering competitive rates and managing their cost of funds. One factor that will begin to play a role in this balance is the yield curve. Over the last few years, the yield curve has flattened out, however changes in rates have allowed for the yield curve to pick up some of its lost slope. This will allow credit unions the increased flexibility that comes with a greater yield on their loans.
As interest rates fall, credit unions may have to re-evaluate their current strategies. The key to this strategy is managing net interest margin. The balance between net interest margin and growth comes at tighter margins for credit unions. This means that credit unions will have to work to find the balance between keeping costs at a reasonable level and offering competitive rates to their members.
To hear credit unions discuss how current market changes will affect their pricing strategies please join us October 24th at 2pm for our webinar “Core Deposit Pricing Strategies in a Falling Rate Environment”