The credit union significance of latest rate cut

WASHINGTON - Not as rate sensitive as banks, credit unions still have a large stake in the Fed's actions these days as the dreaded "r" word is bandied about regarding the state of the U.S. economy. Most would agree that a recession is good for no one, whether it's a bank, credit union or consumer. The Fed and its chairman Alan Greenspan continue to try and head off a recession with the greatest weapon in its arsenal - interest rate adjustments. On March 20 the Fed cut its target for the fed funds rate - the interest banks charge each other on overnight loans - by 50 basis points, dropping the rate to 5.0%, the lowest it's been since the summer of 1999. The Fed also cut the discount rate by 50 basis points, dropping it to 4.5%. "The big question is whether or not the Fed is guessing correctly about the future course of the economy in order to steer us out of a deep recession. Just six months ago the economy was booming at break neck speed, and almost on a dime it stopped in November and December. Consumer confidence and the stock market has been down," said CUNA Chief Economist Bill Hampel. It all sounds pretty bad, but it's not if you look at key economic indicators, he said. For one, unemployment is still hovering around 4%, nowhere near the levels during a recession. Also, inflation has been held in check. A Fed rate cut takes about six to nine months to show any major economic effects. Hampel said this latest cut is the Fed believing that tanking consumer confidence will cause the economy to slow enough that unemployment would rise in that time without the cut. "If they guess right they can keep the low unemployment rate. One of the risks they face is if the economy isn't slowing down enough the 150 basis points cut so far this year could increase inflation," said Hampel. The rate cut is good news for credit union bottomlines, said Hampel. "It gets us closer to an upward slope on the yield curve again," he said. The cut helps because it reduces the cost of funds faster than a credit union's return-on-assets falls. Investment yields at CUs will obviously drop but at most CUs assets are longer term than sources of funds and liabilities, producing a positive net effect for the bottomline. With the industry flush with liquidity, credit unions may be looking at different investment options in a falling rate environment, but credit unions that didn't move short-term money prior to the cut shouldn't beat themselves up, said Hampel. "Playing the market, timing the market, thinking you know what's going to happen in markets can get you in trouble. Credit unions shouldn't be changing investment portfolio practices based on what's happening with short-term interest rates. Credit unions are not in business to manage the bottomline based on short-term rates," said Hampel. Dwight Johnston, managing principal of WesCorp Investment Services, said credit unions should continue to fill in their investment ladders and not count on another rate cut when the Fed meets May 20. "Conventional wisdom anticipates another rate cut in addition to one during the summer, bringing the funds rate down to 4%. However, this wisdom is not without risk. If the economic statistics start taking on a surprisingly stronger tone, and the stock market stages a serious recovery ... conventional wisdom will start to look shaky," said Johnston. He said the best thing for CUs to do is keep track of the upcoming economic data releases The rate cut is a mixed-bag for consumers. "The results are ambiguous for consumers, especially if you pull out mortgages. Consumers have more deposited in the household savings market in short-term than they have in consumer loans. Falling interest rates takes more out of a consumer's bottomline." Hampel said with consumers having $4.5 trillion in short-term savings and $1.5 trillion in consumer loans, the rate stings because they are earning less on the bigger slice of the pie - the $4.5 trillion. One interesting outgrowth of that fact is that credit union faithful are constantly throwing around the term "flight to safety" for consumers to take their money out of risky Wall Street investments and park them in safer credit union accounts. Members may still do that, but they'll now be earning less. Fixed mortgage rates won't necessarily drop by 50 basis points or at all in some cases said Hampel. He said if the Fed had cut rates by 75 BPs there would have been a drop in most mortgage rates, but bond investors, which play a big role in dictating mortgage rates, had accounted for this drop already. Adjustable-rate mortgages, however, will likely drop, and all the talk of falling rates could spur the public to think refinance, he said. (See related mortgage story on page 8.) Hampel is sticking to his early year prediction that loans will slow down and shares will rise in credit union land this year. He said loans are already slowing. Auto loans grew by just 0.06% in January, the weakest one-month growth in over a year. Jeff Taylor, staff economist for NAFCU, said there has been a "disconnect" of consumer economic behavior. "Everyone is saying they're not confident in the economy and the stock market is dropping, but people are still buying homes and cars. There's disconnect there," said Taylor. Taylor said one factor that could off-set members possibly pulling money out of their credit union because of falling yield on short-term investments, is the unstable stock market. "I think shares are still going to increase. The stock market continues to be volatile," said Taylor. There is one crystal clear difference between banks and credit unions when it comes to rate adjustments. Anyone looking for proof need only monitor a financial wire service on the day of a rate adjustment. It took Bank of America all of a few hours to slash its prime lending rate from 8.5% to 8.0% once the Fed announced the cut. Other large banks moved just as fast. Credit unions, not as rate sensitive, take much longer to make rate adjustments, sometimes waiting weeks before changing rates. -pgentile@cutimes.com