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Fed ELEP policy affects CUs 2 ways--CUNA economist
WASHINGTON (12/17/09)--Federal Reserve policymakers' decision Wednesday to continue the policy of "Exceptionally Low interest rates for an Extended Period" (ELEP) will affect credit unions in two ways, said a Credit Union National Association (CUNA) economist. Those with strong loan demand will see an increase in net interest margins. Those with weak loan demand will see investments putting "significant downward pressure" on assets, said CUNA Senior Economist Steve Rick. Noting that economic activity has continued picking up and labor market deterioration is abating, the Federal Open Market Committee (FOMC) Wednesday kept the target range for federal funds at 0%-0.25%. That "is considered to be an emergency interest rate due to the financial crisis," said Rick. "The stance of monetary policy remains extraordinarily accommodative," Rick said about the decision to continue the ELEP policy. "This will maintain a steep yield curve for a while longer. Longer-term interest rates could rise further if financial market participants see short-term political pressure impairing the Federal Reserve's independence. This could push up inflation expectations and therefore longer term interest rates," he told News Now. "For those credit unions with strong loan demand, the steep yield curve should increase net interest margins as low-rate short-term deposits are used to fund longer-term higher-rate loans," he said. "Credit union average net interest margins rose to 3.23% in third quarter, up from 3.13% in the second quarter. The higher net interest margins should help credit unions cover loan chargeoffs and NCUA (National Credit Union Administration) assessments, and therefore earn their way out of the current financial crisis," Rick said. "Unfortunately, credit union loan growth has declined significantly since the beginning of the financial crisis in the fall of 2008. Credit union loan balances are up only 2.4% in the 12 months ending in October, the slowest pace since 1992 and below the last five-year average of 8.5%.," he added. The FOM noted in its statement that household spending remains constrained and faces many headwinds (weak labor market, modest income growth, lower housing wealth, and tight credit), Rick said, adding, "Until those headwinds become tailwinds, credit union loan portfolios will post small gains, with forecasts of only 3%-5% in 2010. "In the third quarter, credit unions responded to the ELEP policy by lowering their deposit interest rates enough to lower their cost of funds 14 basis points (1.63% in the third quarter versus 1.76% in the second quarter)," Rick said. "Low interest rates on savings, however, have not discouraged credit union members from increasing their deposit balances. During the first 10 months of 2009, credit union savings balances rose 10.3%, faster than the 6.2% reported for the similar period last year. "This has increased credit union liquidity and credit union investment portfolios," Rick noted. "Investment portfolios rose 30% over the last year, pushing up credit union investment-to-asset ratios from 26.3% in October 2008 to 31.3% in October 2009. This change in the distribution of assets from loans to investments is putting significant downward pressure on asset yields for those credit unions with weak loan demand." In addition to keeping the target range steady, the FOMC Wednesday said the Fed would ease the pace of purchasing securities and set dates for scaling back or terminating a number of temporary liquidity swap arrangements. To support mortgage lending and housing markets and to improve private credit market conditions, the Fed will purchase $1.25 trillion of agency mortgage-backed securities and about $175 billion of agency debt, as well as gradually slow the pace of these purchases. It anticipates the transactions will be executed by the end of first quarter 2010. The Fed expects that most of its special liquidity facilities will expire on Feb. 1, "consistent with the Federal Reserve's announcement of June 25," the FOMC said in a statement after Wednesday's meeting. The facilities include the Asset-Backed Commercial Paper Money Market Mutual Fund Liquidity Facility, the Commercial Paper Funding Facility, the Primary Dealer Credit Facility, and the Term Securities Lending Facility. The Fed will also work with its central banks to close its temporary liquidity swap arrangements by Feb. 1. "The Federal Reserve expects that amounts provided under the Term Auction Facility will continue to be scaled back in early 2010. The anticipated expiration dates for the Term Asset-Backed Securities Loan Facility remain set at June 30, 2010, for loans backed by new-issue commercial mortgage-backed securities and March 31, 2010, for loans backed by all other types of collateral," the committee said. "The Federal Reserve is prepared to modify these plans if necessary to support financial stability and economic growth," it added.


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