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A Deposit Strategy 5 Years In The Making

Technology Credit Union has repositioned its balance sheet to prepare for today’s rate environment.

By Erik Payne: CreditUnions.com, July 30, 2018

Top-Level Takeaways

  1. Consumers expect deposit rates to raise, but loan rates aren’t as easily budged.
  2. In anticipation of higher deposit rates, Technology Credit Union has repositioned its balance sheet.

For the past decade, the Federal Funds Rate has hovered at or near 0%. This is the lowest rate in the history of the Federal Reserve and is the result of the central bank’s efforts to encourage spending, borrowing, and investment to bring the United States out of the Great Recession. Consequently, borrowers have enjoyed an unprecedented run of low loan rates.

“Consumers have grown accustomed to really low mortgage rates, auto loan rates, and credit card rates,” says Todd Harris, CEO of Technology Credit Union ($2.6B, San Jose, CA).

That’s about to change.

The Fed has been tightening its monetary policy — raising the Federal Funds Rate to 2.00% in a little over two years — and unwinding its quantitative easing program. The result? Decreased market liquidity and increased competition for deposits.

fed-funds

The Federal Funds Rate remained historically low in the aftermath of the Great Recession. A new Fed policy has set a target rate of 3.50% by 2020.

Credit unions typically set loan rates based on the long-end of the U.S. Treasury’s yield curve — for example, basing the rate of a 30-year fixed-rate mortgage on the 10-year Treasury — whereas deposit rates hew closer to the short-end of the curve, generally the three-month (90 day) Treasury.

The rates on the short end of the Treasury’s yield curve have risen with the Fed Funds Rate (see chart below). However, longer-term rates have not risen at the same pace, creating a flatter yield curve.

“It’s easier for financial institutions, whether a bank, credit union, fintech, or leasing company, to make money when there is some slope to the yield curve,” Harris says. “When you have the short-end rising and the long-end staying put, it makes it harder to manage that margin.”

Daily Treasury Yield Curve Rates

Data as of 07.27.18

Date

1 Mo

3 Mo

6 Mo

1 Yr

2 Yr

3 Yr

5 Yr

7 Yr

10 Yr

20 Yr

30 Yr

12/30/2016

0.44

0.51

0.62

0.85

​ 1.20

1.47

1.93

2.25

2.45

2.79

​ 3.06

03/31/2017

0.74

0.76

0.91

1.03

1.27

1.50

1.93

2.22

​ 2.40

2.76

3.02

06/30/2017

0.84

1.30

1.14

1.24

1.38

1.55

​ 1.89

2.14

2.31

2.61

2.84

09/29/2017

0.96

1.06

1.20

1.31

1.​47

1.62

1.92

2.16

2.33

2.63

​ 2.86

12/29/2017

1.28

1.39

1.53

1.76

1.89

1.98

2.20

2.33

​ 2.40

2.58

2.74

03/29/2018

1.63

1.73

1.93

2.09

2.27

2.39

2.​56

2.68

2.74

2.85

2.97

06/29/2018

1.77

1.93

2.11

2.33

2.52<​/td>

2.63

2.73

2.81

2.85

2.91

​ 2.98

07/26/2018

1.89

1.99

2.19

2.41

2.69

2.78

2.86

2.95

2.​98

3.05

3.10

The three-month daily yield curve rate has increased 148 basis points since late December 2016. During the same time, the 10-year has moved 53 basis points.

This presents a challenge, especially when members expect deposit rates to increase in step with Fed rates.

“If you don’t have loan rates going up, it makes it harder to afford deposit rates going up,” Harris says.

What’s more, those institutions that do move loan rates risk losing business to those that don’t.

“It’s a vicious cycle,” Harris says. “Consumers can’t get higher deposit yields because loan rates aren’t going up. And if an institution increases loan rates, it might tank loan demand.”

The Five-Year Engagement

CU QUICK FACTS

Technology Credit Union
Data as of 03.31.18

HQ: San Jose, CA
ASSETS: $2.6B
MEMBERS: 99,313
BRANCHES: 10
12-MO SHARE GROWTH: 7.9%
12-MO LOAN GROWTH: 12.4%
ROA: 1.12%

Technology Credit Union has been prepping for this rising rate environment for the past half-decade.

According to Harris, it has prepared its balance sheet to absorb higher product rates by diversifying its product set and adding more variably priced loans. The goal? To become an attractive financial services provider in a fast-changing landscape.

The Silicon Valley credit union’s balance sheet has changed significantly in the past few years. In first quarter 2014, the credit union held 52.7% of its mortgages in a fixed-rate product. Today, that figure has fallen to 24.2%. Conversely, balloon/hybrid mortgages now comprise 72.6% of its mortgage portfolio.

mortgage-breakdown

In 2014, balloon/hybrid loans were one part of Technology’s mortgage portfolio. Today, they comprise the clear majority.

Over this same period, the credit union has focused on auto loans — a short-term product that re-prices relatively quickly while still generating interest income — and solar loans.

“Solar loans are fixed-rate products, but they’re priced well,” Harris says.

According to the CEO, rates for Technology Credit Union’s solar loans vary between 2.99% and 5.99%, and the yields are typically higher than an auto loan. There’s more credit risk in solar, but the credit union has structured the loans well in the event of an economic downturn.

Repositioning its balance sheet toward more frequent repricing and higher-yielding asset classes allowed the credit union to raise its deposit rates in late 2017 and early 2018. But not before conducting its due diligence.

In late 2017, the credit union survey local competitors to get a sense of the rate environment before raising rates on both maturity and non-maturity accounts.

“Some moved as quickly as we did, but no one has moved further,” Harris says.

To wit, the credit union’s cost of funds has nearly tripled in the past four years, from 0.20% to 0.56%, coinciding with its higher deposit rates. Over the same period, the cost of funds at California credit unions has increased 18 basis points.

draft-dividend

Technology Credit Union’s cost of funds, the interest rate paid on funds deployed, has nearly tripled since 2014, commiserate with an uptick in the credit union’s deposit rates.

Raising its rates and reevaluating its product mix seems to be helping the credit union meet its goal: becoming a more attractive financial services provider in its competitive market.

As of first quarter, Technology Credit Union ranked at No. 7 in member growth and No. 80 in deposit growth among the nation’s 288 credit unions with more than $1 billion in assets. Additionally, the credit union’s net interest margin has trended up from 2.36% in the first quarter of 2014 to 2.89% in the first quarter of 2018.

Small steps taken by the credit union have resulted in big gains.

“In our market, if you aren’t offering some of the better rates, members will move to another institution,” Harris says. “Because we are one a rate leader, we feel comfortable that we’re one of the best deals in the market, and we don’t feel exposed to a lot of exit.”

Rates And Housing Prices: Silicon Valley Edition

Raising rates have an outsize effect on the Silicon Valley housing market.

In a market where supply and demand exist in equilibrium — where there are as many homes for sale are there are people willing to purchase those homes — a raise in mortgage rates corresponds with a raise the monthly payment, which affects the affordability of identically priced houses.

“There’s a slowdown of activity in the housing market where sells must acclimate to the new reality where, even though the house is the same and listed at the same price at which other homes have sold, it’s less affordable to prospective buyers because the monthly payments have gone up.”

It takes several months for the market to then adjust, Harris says, and housing prices move down accordingly.

Silicon Valley is different. Housing demand is much greater than supply; because of this, Harris doesn’t expect raising rates to push down the value of homes in his market.

“The demand here is so great and the supply so much smaller that the forces of supply and demand are going to outweigh the forces that would usually push home prices down as mortgage rates increase.”

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