Monday, March 7, 2005

Interest Rates are Rising, but Loan Yields Continue to Drop

Over the past year interest rates have been on the rise, but quarterly loan yields have continued to fall. What should credit unions expect in the coming year?

Over the course of 2004, interest rates have been on the rise. The fourth quarter showed that the quarterly cost of funds marked its largest increase in four years of 14 basis points. In addition, the quarterly yield on investments also rose by 12 basis points. However, quarterly loan yields have continued to fall. During the fourth quarter, new loan originations were booked at a lower rate than the current average yield of the credit union industry portfolio. The declining yield in the loan portfolio can also be attributed to the higher rate loans that were booked a few years ago are maturing. These loans are being replaced by lower rate loans, given the recent historically low rate environment.

Average New Loan Rates
	9/30/2004	12/31/2004	3-month change
New Auto	5.43%	5.46%	0.03%
Used Auto	6.31%	6.34%	0.03%
1st Mortgage	6.01%	6.03%	0.02%
Other Real Estate	5.96%	6.03%	0.07%
Credit Card	11.24%	11.34%	0.10%

Driving the downward movement of the loan yield is the activity in the 1st mortgage and auto markets. These two product groups dominate the landscape of the loan portfolio, accounting for nearly 70 percent of all loan activity in the credit union industry. From September to December, there has been little change in the pricing of 1st mortgages and new and used auto loans.

During the same period, variable products such as credit cards and other real estate loans, which include home equity lines of credit, have seen increases of ten and seven basis points, respectively. Much like the behavior of the cost of funds and investment portfolio, these variable rate products are more sensitive to short-term interest rates movements.

Quarterly Portfolio Yields
	12/31/03	3/31/04	6/30/04	9/30/04	12/31/04
Yield on Loans	6.53%	6.37%	6.24%	6.19%	6.14%
Cost of Funds	1.70%	1.57%	1.56%	1.58%	1.72%
Yield on Investments	2.51%	2.43%	2.49%	2.50%	2.62%

It is most likely that loan yields will reverse course as rates are expected to rise. If the yield curve continues to flatten, credit union pricing for autos and mortgages should remain low. Based from year-end data, it may take anywhere from a 10 to 25 basis point rise in loan rates to push the portfolio yield upward.

Find more information about credit union performanc in the Credit Union Financial Yearbook.

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