NCUA's Interest Rate Concerns and Possible Impact to Savers

The NCUA is worried about what will happen to credit unions when interest rates finally start to rise. In January the NCUA Board announced rules to ensure certain credit unions have written policies addressing interest rate risk. The primary concern is that mortgages now make up a larger percentage of credit union loans, and those tend to be long-term loans. On the deposit side, the percentage of deposits in money market accounts have grown while the percentage in regular share accounts have fallen. The NCUA considers money market accounts to be more sensitive to interest rates. In other words, members will be more likely to move their money to other institutions for higher rates. Should interest rates rise, credit unions may have to aggressively increase their money market rates to retain those deposits. However, the credit unions will be stuck with long-term mortgages with low fixed rates. This could result in what they call net interest margin compression which will negatively affect their financial health.

The NCUA chief economist discusses this interest rate risk issue in the second half of this NCUA video (7:30 into the video).

One thing I found interesting is a pie chart showing the composition of deposits (10:47 into the video). It shows how the composition has changed from 2001 to 2011. The percentage of money market accounts has grown from 16% to 23%. Regular shares (savings accounts) percentage has fallen from 34% to 30%, and share drafts (checking) percentage has remained the same at 12%. The percentage of deposits held in share certificates (certificates of deposit) has fallen from 27% to 25%.

Many of us savers who invest in CDs have been worried about how credit unions and banks may treat CD holders when interest rates eventually rise. With the recent cases of credit unions increasing early withdrawal penalties on existing CDs, it seems likely we'll see more credit unions try this when interest rates start going up. Even more worrisome is if the institutions refuse to honor early withdrawal requests. As I described in this blog post, some institutions give themselves the right to refuse withdrawal requests before maturity.

It doesn't appear that the NCUA is overly worried about CDs since their percentage is only a quarter of total deposits. One thing not described in the NCUA pie chart is the term composition of the CDs. How much of the deposits are in long-term CDs vs. short-term CDs? Early withdrawals are more of a concern on long-term CDs.

Based on what I've seen in credit union call reports, most deposits are in short-term CDs. I just checked the NCUA call reports for Navy Federal Credit Union, the largest credit union in the nation. The call report showed total deposits of $33.6 million. Only 8% of those deposits were in CDs with terms over 3 years. For terms from 1 to 3 years, the percentage of deposits was 11%. It should be noted that Navy Federal has a long history of very competitive long-term CD rates. So these percentages will probably be less for the average credit union.

Since long-term CDs don't make up a large portion of deposits, long-term CDs may not be a major concern for credit unions and banks when interest rates rise. So we may not see a lot of unfair restrictions being imposed on CD holders (like early withdrawal refusals and larger penalties).

One concern that I get from the NCUA video is that it may be a slow process for banks and credit unions to increase deposit rates when interest rates finally start to rise. Due to all the low-rate mortgages, institutions will be under pressure to delay increasing their deposit rates.