By Ray Birch
WASHINGTON—It’s time credit unions add more risk to—and “reimagine”—the balance sheet so they can survive the pandemic without having to cut jobs, says Evan Clark.
The CEO of the Department of Commerce FCU spoke with CUToday.info about the difficult decision facing many credit unions—where to cut in order to protect jobs as loan losses loom and the pandemic slashes revenue.
It’s an issue being discussed by many credit union leaders, but Clark asserts the answer lies not in cutting, but instead in enhancing revenue and—surprisingly—taking advantage of spreads.
Clark emphasized if credit unions go the cost-cutting route, the only place they will find enough savings to make a true impact on the bottom lines is salary and benefits.
“Most spreads are narrow,” noted Clark. “Look at the spread between the 10-year Treasury and the two-year Treasury. The 10-year is what most mortgages are priced off of and the two-year is the surrogate for everybody's cost of funds—as typically the duration of deposits is around two years. Well, that spread is so narrow it is extraordinary difficult now to make money. So, you have to say what can we do to survive? At most credit unions, 50% of their operating expenses are related to employees and benefits.”
Clark noted the average cost of funds in March for credit unions was about 81 basis points.
“One of the places that credit unions can cut is their cost of funds. In other words they can lower their deposit rates,” explained Clark, who made a p
ledge to staff when the pandemic hit that no jobs would be lost. “But the problem is a lot of credit unions in recent years have never really grown their CD portfolio, so they don't have a lot of room there. OK, so let’s say the average credit union is able to cut their cost of funds by 10 basis points. For a credit union of our size, at $550 million in assets, 10 basis points brings a savings of about $550,000 a year or $45,000 a month. Not a big impact.”
What Must Be Done
What credit unions must do, asserted Clark, is insert more risk into the balance sheet, even though he acknowledges that in periods of rate fluctuation, the exposure is greater. But Clark observed the low-rate environment is expected to remain for years.
“Credit unions are simply going to have to inject more risk into their balance sheet,” said Clark. “The Fed has said they won’t raise rates on the short end until the end of 2022. And as of a few days ago, we could borrow from the Federal Home Loan Bank at 66 basis points for five years and 22 basis points for one month. So, if you know the Fed is not going to raise rates for two-and-a-half years, and your cost of funds is going to be 22 basis points and 66 basis points…I don't know where in time you want to start to lengthen your liabilities, but you should consider it.
“Let’s say you lengthen your liabilities to five years,” continued Clark. “OK, five-year CD borrowing gets rid of about 80% of the interest rate risk on a 30-year fixed-rate mortgage.”
Clark said data show the average life of a 30-year fixed-rate mortgage is five to seven years.
Evan Clark
“Are you kidding me? In other words, if we put on 30-year fixed rate mortgages and they're at 3%, and you can borrow from the Fed for five years of 66 basis points, you’re making a spread of 234 basis points,” explained Clark. “In this time 234 basis points is a ton. So, I think credit unions shouldn't focus on expenses. Instead, they need to be reimagine how their balance sheet can look in this continuing low-rate environment.”
Less Risky
Clark said the approach seems even less risky when considering how the workforce is changing, with many employees moving to working at home and many companies planning to stay with the new arrangement. Clark said his CU plans to make working at home permanent for those who choose the option.
Clark emphasized with workers moving out of various urban cores to their homes, downtown businesses that have relied on office workers will have to change their model and move, as well. That will only slow the economic recovery, Clark asserted, and keep rates low for years.