Cost of funds is the king ofretail banking acronyms. Yet, it only tells us half the story.Granted, without a sharp eye on COF, credit unions can exposethemselves to devastating interest rate risk. As recent years haveshown us, net interest margins can compress very quickly — and staycompressed much longer than anyone previously expected — revealinghow little control we have over our mixed asset yield. Fortunately,we can still influence overall deposit cost and take backa large portion of our margin control.

COF falls incredibly short, though, when assessing the true costfor the core component of any member's relationship with theircredit union — their checking account. To illustrate, high-yieldchecking accounts average $5.90 in monthly interest expense, or aCOF of 0.79%. But a more holistic measurement of those sameaccounts reveals they actually generate an average of $6.20 netprofit. That's nearly $75 in annual profit per account, before evenconsidering the interest income generated by redeploying thedeposits.

Clearly, basing strategic funding decisions on COF alone is likedriving with blinders on, leaving you in danger of making a costlymistake.

A New Acronym — And A New Revenue Stream

Cost of funds works well for many deposit products like savings,money markets, CDs. But not transaction accounts. COF capturesinterest expense. But transaction accounts also have noninterestexpenses and income, which can easily get buried in the balancesheet and not properly associated with these deposits.

Consider free checking. While it has a 0% COF, there are anumber of marginal expenses — processing checks, sendingstatements, core fees and more. But there's also debit cardinterchange and overdraft revenue. When you look at this wholepicture — interest expense, noninterest expense and noninterestincome — you're now looking beyond COF, and seeing the holisticview of the cost of deposit, or COD.

A lot of revenue and expense flows through free checking thatnever impacts the 0% COF. Unfortunately, many credit unions havelittle visibility to these numbers as a function of the individualaccount type, because they're tracked en masse across the entiredeposit suite. This makes it virtually impossible to assignmarginal expenses and revenue to individual product types.

Now is the time to make accurately measuring the full story —the cost of deposit — a priority. Mired in continuing margincompression at historic levels, there are only so many optionsavailable for responding:

• Increase interest revenue. Regrettably, there simply isn'tenough loan demand to go around.
• Decrease interest expense. Financial institutions are reportingtheir lowest COF in recent history, suggesting there's little roomfor more cuts.
• Decrease noninterest expense. Most financial institutions havesqueezed just about every drop available here too.
• Increase noninterest revenue: Traditionally, this has meanthigher fees or other strategies that draw intense consumer ire.But, it doesn't have to be that way.

Next Page: Cost of Deposit

Using COD to Position Your CU for Growth

Through the holistic cost of deposit lens, we accuratelyallocate noninterest expenses and revenues to the accountsgenerating them. As a result, the true value of transactionaccounts as a lower cost/higher margin source of funding becomesapparent. We then see the liabilities of certain deposit accountsare actually valuable revenue streams.

An increasingly popular method to maximize that revenue hasemerged over the past decade: qualification-based, high-yieldchecking accounts. They're attractive to consumers by addingpotentially high dividends on top of free checking. The attractionfor credit unions has also been validated. These reward accountsattract desirable consumers who are twice as likely to take out aloan in their first year, and who utilize 33% more of your productsper household.

As for COD, reward accounts have been proven to both increaserevenue while decreasing expenses. A nationally branded high-yieldreward checking account that is offered by well over 200 communityfinancial institutions provides a lot of performance metrics. Onaverage, those high-yield accounts have the following impacts oncommunity financial institutions nationwide:

• Generate a 45% increase in non-interest income^.
• Lead to nearly 80% e-statement adoption, reducing overallstatement expense by 69%
• More than 2X debit card swipes per account and interchangerevenue

Most telling, what appeared as 0.79% COF is actually revealed as-2.04% COD, meaning these deposits generated a 2.04% profit margin,before they were invested or loaned. The bottom line … is yourbottom line. No matter your particular situation or opinion onmarket compression, accurate tracking to obtain the lowest possiblecost of deposits will always be in the best interest of your creditunion.

Of course, the lowest COD will typically be free checking. Butthe extraordinarily high attrition rate and extraordinarily lowlife expectancy of free checking begin to cancel out any CODadvantage it has. Reward checking accounts, however, retain theexceptional benefit of a low-cost deposit source — along with keyadvantages like more loans, more wallet share and more noninterestincome.

Greg Wempe isexecutive vice president and general manager for client profitsolutions at BancVue inAustin, Texas.