April 2024: Who offers better rates?
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Welcome to the third edition of The LoanStreet Beat. In addition to our recap of an active economic news cycle and our observations on loan trading trends, this month we take a look at trends in credit union’s rates relative to their main competitor in the space: banks. Enjoy, share and please comment below!
LoanStreet Market Commentary
The current economic narrative that inflation is cooling, although at a slower pace, was highlighted in the latest PCE report. However, while this report showed that inflation was in-line with expectations, other data showed consumer spending was up +0.4% month-over-month when the expectations were for +0.1%. Additionally, (and perhaps because of the high consumer spending growth), the savings rate dropped to 3.6%, the lowest since the end of 2022 and below pre-pandemic rates.
While the consumer remains resilient and continues to spend, that same consumer is dependent on being employed.?This puts additional weight on job data, which posted strong gains in February, although it came with large downward revisions to the December and January reports.?The next report will be released on Friday, April 5th, and will hopefully paint a clearer picture of the jobs landscape.?
To no one’s surprise, the Fed kept rates unchanged in March, though that’s a recent view; it wasn’t so long ago that most had expected several rate cuts by now.?What was a bit more surprising was that the dot-plot remained unchanged despite all the strong economic and jobs data.?Some were expecting the dot-plot to shift towards a two-rate cut scenario in 2024 as compared to the current three cuts.?The stock market reacted positively to the Fed’s commitment to rate cuts in the face of strong economic data, while the bond market is a bit more cautious with the 2-year Treasury up ~20bps month-over-month and up ~40bps YTD.
Loan Trading Trends and Implications
On the LoanStreet Marketplace, we continue to see strong demand for loan participations as organic loan origination lags behind plan.?Auto pools continue to see the most demand, even as yields have tightened considerably. With the lack of supply, expect auto yields to continue to tighten to levels last seen in 2022. That being said, for the time being, we have hit the floor at around a 125-150 bps loss-adjusted spread for autos as buyers have started to push back on yields due to performance concerns. As origination volumes slow, the annual charge-off and delinquency ratios will naturally drift higher, even if the number of charge-offs and DQs stay the same, (see our paper on Static Pool Analysis for its advantage over a pool-level approach to measure performance). For this reason, it’s more important than ever to have static loss data for the products you are planning on selling.?Without static loss data, buyers will rely on annual loss ratios, which rise for many credit unions as origination volume – and often portfolio balance – shrinks, while dollar losses rise as loans age. The demand for other products, such as residential, solar and unsecured has been mixed. As a result, the loss-adjusted spreads on these non-auto asset classes remain attractive relative to auto.
The Interest-ing Case of Credit Unions and Banks: A comparison of rates
In attempting to best serve their members, credit unions often offer the best rates—higher deposit rates and lower loan rates—than banks. Using quarterly data from CUNA, we compare the rates that credit unions offer to those of banks, starting with deposit rates.
The following graphs show 1- and 5-year CD rates since 2018. Bank rates are on the X-axis with credit union rates on the Y-axis. The relationship is surprisingly tight; in both cases, credit unions historically have offered CD rates that are approximately 1.40x the rates offered by banks.
Money market rates show a similar relationship, albeit with a reduced 22% relative premium over bank rates. Savings and interest-bearing checking account rates (not shown) are one place where credit unions have historically offered lower rates than banks; however, because these rates are usually near zero, it’s difficult to discern a clear pattern.
When it comes to loaning money out, credit unions generally continue the pattern of offering better rates than banks. Looking at credit cards and unsecured loans, credit unions have historically offered rates approximately 10% lower than banks.[1]
One place where credit unions do not offer an advantage to the rates offered to their members is mortgages. This makes sense since mortgages are a highly transparent market where the agencies (Freddie, Fannie, Ginnie) post where they are currently buying loans, so long as they meet their buy box, helping to set the market. This is shown by the following graphs for 15- and 30-year mortgage rates.
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When it comes to auto loans, the relationship between the rates that credit unions offer and banks' rates is more complicated. The following graphs show the relationship between credit unions and banks on 48-month used vehicle loans and 60-month new vehicle loans. (While these are not the most common loans out there, this more readily available data is reflective of the broader offerings of loans.)
The somewhat complicated relationship formula says that when auto loan rates are low, credit unions are much lower (in absolute and relative terms), and when they are high, they are still lower, though not so much, at least until rates get up to roughly 7%, at which point credit union rates would exceed those of banks. However, as this is outside the range of observations, extrapolation is not without risk.?
When we look at the data as a time series, we get a little more insight into what happened as rates moved. The graph below shows 48-month used car loan rates for credit unions and banks, as well as the 2-year Treasury and the spread between bank and credit union loan rates.?
As the graph demonstrates, when rates started to decline, credit unions reacted more quickly and more aggressively, reducing their rates sooner and by a greater degree than did banks. This resulted in bank-credit union loan rate spread to widen to 225 bps (not coincidentally, this is also when credit unions were taking market share from banks). However, neither banks nor credit unions reduced their rates hand-in-hand with Treasury rates, eventually hitting a floor, and resulting in wider spreads to the 2-year.?
And the graph shows that when rates began to rise, both banks and credit unions did little at first (it even looks like credit unions, on average, actually lowered rates as the 2-year started to climb). However, both eventually reacted, and once again, credit unions reacted more quickly and aggressively, increasing rates sooner and more sharply than did banks. This resulted in the bank-credit union loan spread dropping to 175 bps before beginning to recover as banks caught up with credit unions.
In summary, the data appears to show that credit unions, compared to banks, offer more favorable time deposit rates and (except for mortgages) better loan rates for their members. At least for auto loans, they react more quickly and more aggressively to changes in interest rates, which is mixed for the members - a positive when rates decline, a negative when rates rise.
[1]As it is not available in the data we are using, we are not controlling for credit quality of the borrower. It’s possible the lower rates being offered to lenders is reflective of more credit-worthy borrowers.
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This article was authored by Eric Marcus, Managing Director and Head of Trading, and Matt Rudzinski, Director of Sales and Trading.
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