Filene: Credit Unions Face a Savings Squeeze
Consultant Mike Higgins finds member shares are becoming more scarce as rates and competition increase.
Funding costs are rising at credit unions as core deposits diminish as a percent of assets and are replaced by higher-cost rate-sensitive funds, according to a report released Thursday by the Filene Research Institute in Madison, Wis.
The report, authored by credit union consultant Mike Higgins, found relationship shares —which include draft, regular shares and money market accounts — began falling as a percent of assets in the second half of last year after two years of sharp increases fed by pandemic-era government supports.
Filling the void were certificates, IRAs, non-member deposits and borrowings.
“Growth in Q4 2022 is staggering at an annualized rate of 53.1% as this category of funding is becoming more important to support loan growth and ease strain on liquidity due to unrealized losses on AFS (available-for-sale) securities,” Higgins wrote.
“Hidden in the numbers: There was a $12.8 billion net outflow of credit union deposits. Asset growth was due to non-member deposits and borrowings (rented funds),” he wrote.
Higgins found the cost of funds started to move rapidly late last year. “Recall, deposit costs tend to lag early in upward rate cycles and move more quickly later,” he wrote.
“Expect pressure on cost of funds to continue,” he wrote. “Banks, neo-banks and brokerage houses want deposits because a sizeable investment spread now exists. Tightening liquidity will also play a role in competition for funds.”
Meanwhile, loans grew as a percent of assets last year. Loans ended the year accounting for 69.5% of assets, rising steadily each quarter from 60.9% a year earlier. The ratio was still below the 10-year year-end peak of 71.8% in 2018.
The increase is a good thing, Higgins said, because “a high ratio shows knowledge, skill and ability in lending,” which means the credit union is less dependent on surplus funds.
On the other hand, relationship shares were 66.9% of assets on Dec. 31, down steadily from 71.5% March 31. The ratio was down from a pandemic-era year-end peak of 70.2% in December 2021, but still above levels that ranged from about 60% to 63% from 2013 to 2019.
This is a bad thing, because “a high ratio shows knowledge, skill and ability in funding,” Higgins wrote. “It reduces reliance upon ‘rate shoppers’ for funding. Second, relationship shares have a long average life, thus reducing interest rate risk.”
“Third, because this funding source is transactional in nature, a wealth of data on member spending and saving exists, which can be used to deepen relationships, making it difficult for competitors to steal members away,” he wrote.
Another concerning trend was non-interest income. It was 38% of non-interest expenses in the fourth quarter, falling steadily from 40.5% in the first quarter. For the full 12 months it was 38.9% last year, down from a 10-year peak of 45.8% in 2021, and well below the 2013-to-2020 range of 42% to 43.7%.
This is bad because being able to generate non-interest income is important for sustainability. “Many non-interest income sources are recurring, so each year begins with a pipeline of revenue,” he wrote. “Second, it reduces reliance upon net interest income (and the yield curve).”
And all of the above contributed to a continuing trend of loans growing faster than total reserves (net worth plus the loan loss reserve). Total reserves ended the year at 16.2% of loans, falling steadily from 17.7% a year earlier and above the 2013-to-2020 range of 16.6% to 18.9%.
Higgins compared reserves to loans “to demonstrate how much is present to secure the riskiest asset on the balance sheet.”