DALLAS—Credit unions that priced loan and deposit rates appropriately over the past two years are in the best position to capture more business if rates decline, ALM First says.
“As we think about any transitionary timeframe, whether it's back in 2022 when rates were rising, or now in what may be a declining-rate environment, understanding how the flow of funds occurs in those transitionary periods is really critical,” said Travis Goodman, ALM principal who oversees the advisory services group and loan transaction network at the organization.
Goodman pointed out that in 2022, financial institutions had an immediate need to raise loan rates.
Margin Compression
“Market rates were increasing very quickly and the kind of downstream impact of that transition meant loan rates needed to rise first, because eventually deposit rates were going to rise and that would cause margin compression,” he explained. “We see the opposite occurring right now. As we move from one transitionary period to another, the first thing credit unions need to do is adjust their deposit rates down if rates are falling. If you don't move the deposits down, you'll end up with margin compression.”
Thomas Griswold, managing director of advisory services at ALM First, emphasized the basics of balance sheet management don’t change.
“As we're going into a new economic environment, the core fundamentals don't change,” Griswold said. “It's still pricing risk appropriately and making sure that we're staying diligent. We saw it a lot last year, even if rates come down that doesn't mean they won’t move back up. Therefore, we’ve got to keep pricing loan spreads appropriately.”
Goodman sees a big advantage now for CUs that have priced correctly in the last two years.
“I think some credit unions might be able to take advantage of this. If you moved your loan rates to the appropriate levels when rates were higher, when term rates fall, institutions have the ability to also lower loan rates and still be in the market with appropriate returns,” Goodman said. “Now, if you have your rates high enough, you can be first to try and capture market share and still be appropriately priced.”
Didn't Raise Rates Fast Enough
Goodman believes many credit unions are struggling from an income perspective because they didn't raise rates fast enough when rates were increasing in 2022.
Travis Goodman
“And then, along the way, never got their rates high enough to be where the markets demanded they should have been,” he said. “As rates were increasing, the real time to raise rates was early on, when there was a lot of loan demand and volume. But many credit unions were concerned that would cause loan demand to fall, and most of them were wrong about that. They raised rates eventually and loan demand has remained robust. But those assets that were put on in that timeframe when loan demand was strong are at too low of a rate. Credit unions are now paying for that because they just never had the ability to make up more margin.”
Goodman said his first concern is with commercial loans, saying many credit unions continue to misprice this asset class, given the fact it's being driven by alternative options. He cautioned against pricing based on what the lender across the street is doing as opposed to a true return, based on a per-unit-risk analysis.
“That’s paying too much attention to what the other guy is doing and not what's really working for the credit union,” he said. “I think a lot of credit unions do that.”
What should CUs be doing to keep funds from leaving?
“We see the liquidity threats credit unions faced over the last couple of years appear to be ending,” Goodman said. “Over the last two years, the hot money depositors got blended into the checking and savings and money market accounts and many have reidentified themselves.”
Not Rate Sensitive
Goodman explained the hot money consumers who haven't moved over the last two years are clearly not rate sensitive.
“Because they've had tremendous amounts of opportunities to move money and haven't done so. Therefore we would consider those depositors now core,” he said. “The other funding people, the hot money people, may end up going back into money markets again if rates continue to decline.”
What’s going to drive the overall liquidity of CUs, according to Goodman, is solvency of the consumer.
“A lot of that is driven by concerns around economic activity and the savings rate,” he said. “If depositors begin to save more, we're going to see deposits actually grow, especially if we see a downturn in the economy. If we see a continued robust economy, where people can continue to pay and everybody can pay, there's still probably some pressure on the hot money moving around. But, overall, in the next economic cycle, we don't see the impending issue being as much liquidity risk as potentially credit risk.”
Griswold said institutions need to do their best to quickly lower their cost of funds.
“That's probably going to come in fewer CD specials, if rates are coming down,” he said. “The overall market is not more liquid. There's not tons of dollars coming back into the depository space now.”
With it being budgeting season, Griswold advised credit unions to be conservative on their deposit growth expectations.
“Overall, the liquidity environment has improved for institutions because we've seen those hot money individuals leave already and everyone that's left is core,” Griswold reminded. “But all this does not mean that if rates fall a bunch of savings accounts are going to start growing magically.”
Goodman stressed that credit unions should have a disciplined and defined decision-making process.
“That is really important for all of these scenarios,” he said. “It's kind of a cliché, but, ultimately, the thing that survives through all of this—whether it's a rising-rate environment, a static-rate environment or a declining-rate environment—is when you have good disciplined decision making practices you're able to weather all of those storms much more easily than the one who is trying to figure out which way the winds are going to blow and make decisions based upon those expectations.”