Big deposits become a big problem for lenders

A credit union has cut one of its interest rates to zero.

What next -- you get a toaster to go away?

A small Bloomington-based lender has, in effect, started turning away money. Star Choice Credit Union recently mailed a short letter to about 20 customers informing them that it will no longer pay interest on the amounts they have above $100,000 in their money-market accounts.

"With the recent inflow of money, we have found that we can no longer pay market or above market rates on these accounts," President Daniel Christiansen said in the letter.

In an interview, Christiansen summed up the situation: "We're just pretty well loaned out."

The move illustrates the pressure on lenders of all stripes, including prosperous ones like Star Choice, as they struggle to invest cash that wary customers have parked with them for safekeeping.

With interest rates scraping bottom and loan demand tepid, there aren't many options for small lenders to wring profits from their customers' savings. Credit unions face an extra complication, in that they have special limits on the volume of business loans they can make.

Star Choice, with assets of just $46 million, was losing money on its mounting deposits because the short-term investments where it places the money pay it less than what it has to pay customers.

The credit union's move is unusual, but not unique. Many lenders have, in fact, been subtly turning down the deposit spigot for some time via super-low interest rates. A one-year CD, for instance, is paying an national average of 0.33 percent, according to Bankrate.com. Money-market accounts pay even less.

As for shifting to flat-out zero, 17 of the 3,267 credit unions offering money-market accounts dropped rates on all or parts of the balances to zero last year, according to the Credit Union National Association.

Last August, the Bank of New York Mellon threatened to impose a 0.13 percentage point fee on mountains of cash that institutional clients were dumping in banks for safety. The announcement was enough to moderate the deposits, and the bank never actually had to charge anyone.

The Minnesota Department of Commerce, which regulates banks and credit unions, said Star Choice's zero-interest move was the first of which its financial examiners had heard.

'Unprecedented low rates'

"As Minnesota works its way out of the recession, we are seeing unprecedented low interest rates and unusually high liquidity in our financial institutions -- banks and credit unions alike," Commerce Commissioner Mike Rothman said. "This is a unique set of circumstances that our experts have not seen in recent memory."

The Minnesota Bankers Association also said it hasn't heard of any local banks going so far. "That's something I'm sure no business wants to do," said general counsel Tess Rice. "There's a good chance you could lose a customer like that. It is pretty drastic."

Christiansen said his credit union hasn't lost any members over the decision. The letter he mailed out informs customers "the situation is temporary and we will keep you updated."

Dave Murdock, a financial adviser who is working with Star Choice, said he is helping another local credit union with a similar strategy, and helped a third earlier this year.

In the earlier case, Murdock said, the credit union hoped customers would shift the extra money over to its financial planning department. Instead, "the assets are just moving to other financial institutions."

Murdock, who works for New Brighton-based CU Companies, a special credit union organization jointly owned by 75 Minnesota credit unions, described the moves as "more of a proactive measure by the credit unions to manage their ratios than an act of desperation.

"They're all very conscious of their capital ratios," he said.

Those ratios are an important measure of a lender's financial health, and regulators watch them like hawks. For credit unions, the ratio is essentially reserves and undistributed earnings, as a percent of assets. Mounting deposits inflate a lender's assets, which lowers its capital ratio. A credit union needs a minimum of 7 percent to be considered well capitalized, a requirement that Star Choice meets.

Backlash drew members

While nearly all financial institutions are wrestling with excess liquidity, the issue has been exacerbated for some credit unions given the surge many have seen from new members in the backlash against big banks.

"They've got what's called the winner's curse. They got the deposits but they're now, 'What do I do with them?'" said Keith Leggett, senior economist at the American Bankers Association.

Star Choice grew 7 percent last year -- a record for the credit union -- as people moved over from large banks, according to Christiansen. The credit union, established in 1931 for employees of the Minneapolis Star, has grown to nearly 6,000 members.

"It was unbelievable the number of people we were getting," Christensen said.

Smaller banks and credit unions probably are more adversely affected by the influx of deposits, Leggett said, because larger institutions have a bigger menu of investment options. For instance, larger lenders can engage in trade finance, helping companies export their goods abroad.

Plus, credit unions can't shore up capital ratios by issuing more stock. Credit unions can only add to capital with profits.

Despite all the money coming in, Star Choice doesn't have a plethora of profitable options to put it to work. About 87 percent of Star Choice's savings dollars are loaned out. That's high. Nationally, the average for credit unions of similar size is about 57 percent, Christiansen said.

Short-term investment vehicles, such as U.S. Treasuries, have extremely low yields. Star Choice has been losing money on deposits because the "corporate credit unions" -- the credit union version of a banker's bank -- where it keeps money pay it less than it must pay its depositors.

"These are very unusual times," Christiansen said.

Jennifer Bjorhus • 612-673-4683

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