Credit union margins continue to come under pressure as increasing liability costs outpace the improvement in loan portfolio yields. This situation is likely to get worse if retail deposit rates start to catch up with the 250 basis point increase in short-term rates in the wholesale market.
Since the Federal Reserve Bank started raising interest rates in June, 2004, the cost of funds for credit unions has increased a mere 30 basis points. In fact, many credit unions have hardly changed the rates on regular share and money market accounts. No wonder the June call report data showed a net decline in regular share and money market accounts and a sharp increase in certificate issuance. This is a clear indication that credit union members are seeking better returns on their savings.
In the second quarter of 2005, overall member balances at credit unions grew around 3.5 percent on an annualized basis, less than half the pace seen during the same period in 2004. During the same period, loans grew more than 14 percent on an annualized basis. Auto loans, particularly indirect originations, were a large piece of this growth and credit unions continue to offer the lowest rates available, sometimes well below secondary market levels.
Pricing on both share and loan products is a key consideration in managing the balance sheet. While competitive factors will no doubt continue to drive the pricing of these products, it is helpful to understand our pricing in relation to each other and to the embedded risks in each product. This can be achieved in several ways and does not have to be a particularly onerous task.
The simplest analysis might simply plot the pricing of each product against an equivalent term wholesale market rate. This would quickly show where products are priced relative to marginal investment and funding rates. At WesCorp we suggest credit unions use the Swap Curve. This is very close to where we price certificates and offer fixed rate advances. The Swap Curve is available on our web site www.wescorp.org.
At the other end of the spectrum, a credit union might decide to implement a comprehensive “Risk Transfer Pricing” (RTP) system. In essence this entails assigning an earnings rate to each liability and a funding rate to each loan based on the risk characteristic of each product. The RTP system helps separate the premiums earned from undertaking interest rate risk, and potentially credit and liquidity risk, from the core profitability of each product. This is very valuable in measuring and comparing product, member and branch profitability. The RTP system can also be used to provide an incentive to staff to focus on the production of preferred products while providing a disincentive for other products.