Second Fed Rate Cut May Ease CU Margin Pressure, Boost Lending
TALLAHASSEE, Fla. -- The Federal Open Market Committee cut the federal funds rate another half-point on Jan. 30, which will ease interest rates on consumer credit cards, home equity lines of credit, and auto loans, dropping it to 3.0% from 3.5%. The discount rate, what banks pay to borrow from the Fed, was also cut by a half-point to 3.5%.
Citing "downside risks to growth" that remain, the Fed stated the cuts "should help to promote moderate growth over time and to mitigate the risks to economic activity." The move was seen by credit union economic experts as positive in that it will likely help the yield curve to steepen, thus easing the margin pressure credit unions have been experiencing.
"I think low rates will last for a while," said Greg Wirthman, senior vice president and chief investment officer for Southeast Corporate here, who predicted the half-point drop. "I think we'll see lows near the record lows we had in 2003. The Fed will act aggressively to push the front end of the curve. I think we'll end up with a Fed Funds rate of 2%-2.5%."
Dwight Johnston, vice president of economic and market research for WesCorp in San Dimas, Calif., agreed on the 2% target. "The Fed knows this is the most effective weapon they have to enable financial institutions to earn their way out of things. Getting the yield curve as steep as possible--like they did in the early 90s, when it was flat---allows banks to recover. And it will help credit union earnings quite a bit, as they are dominant in one-year bonds. This will help credit unions to be a better source of loans."
Terrin Mendivil Griffiths, economist and industry analyst for the California and Nevada Credit Union League, told Credit Union Times the size of the cut was no surprise, as the markets made their expectations clear, and concurred that the yield curve would likely end its flat line. "It's been static, and while it takes a while to see the effect, we will see a stepping up in the yield curve and when it does it will alleviate some margin stress and return-on-assets pressure."
Credit union economic experts have been casting CUs in the role of innocent bystander to the cascading problems associated with the subprime mortgage meltdown, which now has the FBI investigating 14 companies for fraudulent practices. As the downturn continues, CUs will inevitably suffer some damage as members with resetting mortgage rates obtained elsewhere slow payments on credit cards and auto loans.
But there is also reason to believe that credit unions are well-positioned to benefit from the excesses of other lenders, said Wirthman. "A lot of the non-bank participants have been taken out of play, creating a void in the market, and credit unions are good at filling a niche for people who need credit. They have a great story to tell, and if they tell it, they'll come out well."
Callahan & Associates determined recently that despite the turmoil, mortgages remain an "area of strength in the CU portfolio." As of September 2007, CUs originated $41.3 billion in mortgage loans, up 8.5% over last year. This brings the industry total mortgage market to 2.4%, the highest level ever, said Callahan's.
While the woes of the overall economy with its credit crunch, debt load, and housing crisis has captured the government's attention and spurred it to action, questions remain about whether the help is enough. The bipartisan stimulus package proposed by the White House and U.S Treasury Department was promptly passed by the House but faces modification in the Senate--which wants to add an extension of unemployment benefits and aid to seniors. Yet even a $150 billion stimulus package isn't expected to halt the slide in the mortgage market. A rebate of up to $1,200 distributed to more than 100 million families won't shore up the millions more homeowners already in foreclosure and those staring at default notices of two and three months. Johnston said that banks are likely to continue to write down more bad loans and take further losses. He also cautioned that that too much government intervention, especially in the form of ARM freezes or trying to force negotiation of refinancing of mortgage contracts would be a bad thing. "That would destroy the securities market; it would be telling foreign investors that our contracts don't mean anything. The government should not manipulate the market."
Asked about the 'moral hazard' of protecting investors who make bad choices by bailing them out, like the S&L legislation, he noted that cutting rates steeply enough to allow a recovery is the better option to taxpayers having to take the hit.
Right now, many homeowners are taking that hit. According to the National Association of Realtors' recent assessment, sales of single family homes in 2007 suffered their worst drop in 25-years, down 13% overall. Home prices are in free fall, too, with analysts having to reach as far back as the Great Depression for a comparison. The median price is down 1.8% to $217,000. An inventory backlog of homes for sale is now at the 10-month mark, and much longer in the worst bubble markets like California and Florida. Coupled with the triple shock of high oil prices, stock market volatility, and lackluster spending, indicators point to a very long recovery arc for real estate. The 2007 foreclosure tsunami in California (481,392 homes) and Florida (279,325 homes) where prices rose fastest and farthest means that they will recover more slowly.
But a bright spot for credit unions is evident in statistics from the NCUA showing that credit unions have been stepping up their mortgage programs in recent years, so that the total CU portfolio of loans is now over 50% real-estate based. The subprime share of that is only 2.1%, said Director of Congressional and Public Affairs John McKechnie.
Given the Federal Reserve's recent inter-meeting three-quarter-point rate cut, banks had already adjusted their home equity line rates, bringing them closer to credit unions' usually lower rates, but as they also had to upgrade lending standards, loan volume isn't likely to bounce back suddenly. One bit of help seems to be that mortgage-backed securities have been trading higher --and as they are the driving force for long-term mortgage rates, those rates are going down. The Fed's surprisingly large cut, ahead of its scheduled meeting, spurred a rally in mortgage-backed securities, which do affect the 15-and-20-year mortgage rate. Conforming loan rates dropped below 5% for a very brief time in sharp reaction, and are now hovering at the 5%-5.5% level. The latest cut may help that movement along.
That's a big opportunity for credit unions to offer refinancing to members who have ARMs and higher-rate fixed loans. Refinancing member loans held by other financial institutions may be more difficult, as it is often impossible to know who actually holds the paper after a loan has been "securitized" multiple times. And many of those loans may already be under water, where the value is less than what is owed.
Help on the jumbo loan front is promising as well, where rates are usually 1% over conforming rates for single-family homes costing more than $417,000. Congress will likely approve an increase in the FHA limit to $417,000 and increase conforming loan limits in California to $625,000 or possibly higher. In other high-cost areas like Alaska and Hawaii, that's already true, and Governor Arnold Schwarzenegger is expected to support the measure.
Clearly, the window for California homeowners to consolidate first and second mortgages into conforming loans--and save at least 1%--may be brief, but it's a port in the storm.