In the past, most credit unions could generate sufficient net interest to cover operating expenses. For most of us, this is no longer true.
During the past few decades, net interest margin (NIM) has been on a steady downward progression. Careful management of NIM, however, is still extremely important to the long-term success of a credit union.
NIM typically is expressed as a ratio: total interest income (from all loans and investments) less total interest expense (cost of funds from all deposits and borrowings) divided by average assets, and annualized if necessary. Historically, credit unions used this calculation as a tool to manage profitability.
With the Federal Reserve Board’s recently stated commitment to maintain low rates until 2013, NIM will continue to face downward pressure.
The reasons are many:
In addition to low Treasury rates pushing down loan rates, fierce competition for loans also is driving rates down further in many markets.
While the Fed plans to spur economic activity by lowering rates, many credit unions face decreased loan demand regardless of rate. Thus, lower demand for loans and increased competition for those loans likely will keep rates low.
To deal with the challenges, here are some strategies to help credit unions improve NIM:
If priced appropriately, however, originating loans with additional credit risk can bolster NIM. Of course, always carefully consider this approach before proceeding. Give careful attention to pricing versus additional risk (credit spread). And develop a full business plan to justify the actions to the credit union’s asset/liability committee and to regulators.
And products like credit cards and personal lines of credit can improve NIM—by growing these loans relative to the overall portfolio. This also might help mitigate concentration risk.
Some credit unions pay a financial price by not taking on enough duration in their investment portfolios. This is especially true today: Loan demand is low and more credit unions have a higher percentage of their assets in investments.
Through liquidity analysis and effective cash flow management, many credit unions can increase investment portfolio yields by buying slightly longer-term investments. Interest rates are expected to stay low, so adding duration to the investment portfolio is very defensible.
It’s an opportune time to review and discuss your credit union’s plan for managing NIM.