LOMBARD, Ill.—Credit unions have been bracing for hot money in liquid accounts to move since rates started to rise—but are they prepared for longer-term CDs leaving as well?
One analyst does not believe they are, and is emphasizing that a real threat exists to this part of the deposit portfolio.
Bill Handel, VP of research and product development at Raddon Financial Group, said that when rates move up a few more times, “Internet calculators” will appear to encourage consumers to break their low-rate, longer-term CD contracts, with the calculator showing them how much they will make despite incurring the early withdrawal penalty.
As a result, this can be a very risky time for credit unions that have locked in some longer-term money at a low rate, considering those deposits rock solid, said Handel.
“This is exactly what happened in the 1980s with the thrifts,” said Handel. “This was a huge issue with the thrifts and is one of the reasons for the failure of that industry. But they were in a very different environment when (former Federal Reserve Chairman) Paul Volcker raised rates so dramatically in the early ’80s to squeeze inflation out. Consumers then were breaking CD contracts right and left to get the higher rates.”
Internet Is Game Changer
While rates aren’t expected to rise as rapidly today as they did in the 1980s, what will lead to consumers breaking CD agreements is the heavy use of the Internet—by FIs to market CDs nationally and consumers to shop out of their local markets. Handel emphasized how connected consumers are today.
Bill Handel, Raddon
“Out-of-market deposit forays utilizing the Internet will become more commonplace, and deposit competition will intensify dramatically in many markets, especially those where loan demand has been robust. Think about the last time we were in a rising rate environment, around 2007, and we didn’t even have iPhones then. It’s a very different environment ten years later,” said Handel. “Also, those seeking deposits can really target consumers now on the Internet. In the past it was a mass blasting of marketing.”
That can place the credit union’s wealthier members squarely in the crosshairs of those seeking deposits, which will likely include some fintechs needing funding money, observed Handel.
“For the typical credit union, 15% of their members control 85% of the total deposits. So this is a relatively small group. And if they were to undergo some significant change in behavior and start to chase rate, that could create significant liquidity concerns,” said Handel.
Handel thinks a number of credit unions could unwarily be in this tenuous position, having set out as rates started to inch up to lock in longer-term funds.
“Some organizations have said rates are so low let’s pay a little above market to lock in this money longer term,” said Handel. “So they might pay 1.5% to 2% to get some longer-term money, and if rates rise much that turns out to be bargain for them. But that strategy can get destroyed by someone heavily competing for deposits and showing credit union members that if they have a 2% CD now they can trade it for a 3% or 4% CD, pay the penalty, and make more money. They will use the Internet calculators to make their points.”
Steps To Take
Handel emphasized that credit unions need to do two things.
“First, if you have a decent amount of longer-term CD money in your portfolio, recognize that it could be at risk and work that risk into your planning,” said Handel. “Second, take a look at your early withdrawal penalties and make sure they have some teeth in them. At least cover yourself to some extent. The fact of the matter is that this is a contract you have made with your members. In any other case when someone breaks a contract there is a penalty. But credit unions tend not to want to impose too much penalty—and that probably is a mistake in this area by the industry.”
Handel said he does not expect the Internet calculators to appear until the Fed begins consistently raising rates, possibly after two or three more rate increases this year.
“Commensurate with the upward movement in rates, we expect to see the awakening of the slumbering depositor,” he said. “I think consumer awareness of rate will become much more heightened then and this threat becomes more real.”