Income Planning for Credit Unions in a Falling-Rate Environment

Despite underwhelming loan growth, so far this year we have seen net interest income and profitability expand at most credit unions as cost of funds pressures have eased and more assets have rolled over into a higher rate environment. This sets up what could be a “bumper” year for net interest income in 2025. But what can we expect as we look forward to 2026?

The market increasingly expects the Federal Reserve to cut short-term interest rates by 100 basis points over the coming year. But unlike past cycles, this won’t necessarily unleash a wave of mortgage refinancing.

Why? Because long-term rates, like 10- and 30-year Treasury and mortgage rates, remain relatively elevated, holding steady near 7% for most conforming mortgages. That leaves most existing mortgage borrowers “out of the money” to refinance.

But that doesn’t mean balance sheets are immune from income pressure. In fact, the next rate environment could quietly compress margin and create reinvestment challenges for credit unions that aren’t prepared.

Here’s what you should be watching, and doing, now.

What’s Actually at Risk?

1. You May See Runoff—Even Without a Refi Wave

While we don’t expect heavy mortgage refinancing, moderate prepayments could still pick up in:

• Consumer loans, especially unsecured personal loans and used auto loans originated in 2023-2024 with rates above 8–10%. Even a modest rate drop could lead to refinancing, payoffs, or refinancing through external providers.
• Housing turnover activity—especially if falling short-term rates support the economy and stimulate mobility.
• Callable bonds and recent Agency MBS pools, where investors or issuers may act on optionality (calls or early paydowns) even without a sharp drop in long-term rates.

📌 Why it matters: The result is earlier-than-expected principal return on both loans and investments. That forces you to reinvest in a lower-yielding environment, even if you don't face a classic refinance surge.

2. Your Cost of Funds Will Drop—But Only So Far

While falling short-term rates may ease your funding costs, the impact is limited:

• Non-maturity deposit rates (e.g., checking, savings) are already near internal or competitive floors. Most won’t fall much further.
• Certificate (CD) balances, especially those maturing in the next 6–12 months, offer more flexibility to reprice downward, but also risk deposit migration if not managed carefully.

📌 Why it matters: Your cost of funds may only come down modestly, while asset yields slowly decline due to early paydowns and reinvestment at lower rates—compressing margin over time.

What Credit Unions Should Do Now (On-Balance Sheet Strategies)

1. Anticipate Moderate Runoff and Reinvestment Needs

• Review consumer loan books (auto, unsecured, HELOC) for segments most likely to pay off early.
• Evaluate MBS and CMOs for structures with exposure to even modest prepayment changes.
• Use ALM modeling to project cash flow acceleration scenarios, not just from refis, but from behavioral turnover or callable structures.

📌 Action: Build a reinvestment strategy that prioritizes yield preservation and predictable cash flow, even if modest runoff occurs.

2. Rebalance the Investment Portfolio Thoughtfully

Rather than shortening or extending duration outright, restructure it to protect yield and retain flexibility:

• Reduce callable exposure that may disappear if short rates fall further.
• Limit over-reliance on floaters or overnight investments, which will quickly lose income as rates decline.
• Increase allocation to intermediate fixed-rate bullet securities and well-structured MBS/CMO product (e.g., 3–5 years) that preserve yield and provide a stable income base. Seasoned MBS with out-of-the-money coupons offer predictable payment structures and deep discounts that are attractive even if prepays pick up modestly.
• Avoid rushing into long-duration assets unless the steepening curve becomes clearly attractive. Preserving some of your interest rate risk capacity gives you flexibility to support future long-term loan growth, particularly in mortgages or member business lending

📌 Action: Shift toward assets with less optionality and more consistent income in a falling-rate, while slowing rate of reinvestment.

3. Manage Member CDs Proactively

• Map out all maturing member CDs in the next 12 months.
• Build promotional and tiered pricing strategies that retain member relationships while allowing cost-of-funds to come down in line with policy rates.

📌 Action: Use CD repricing as a tactical lever to defend margin without triggering deposit runoff. Remember, it is significantly more expensive to bring in a new deposit relationship than it is to maintain a deposit relationship.

4. Revisit Deposit Assumptions in ALM Models

• Adjust your non-maturity deposit models to reflect realistic rate floors.
• Model how shifts from CDs to liquid savings or money markets may impact your liquidity profile and beta sensitivity.

📌 Action: Ensure income-at-risk simulations reflect the real behavior of your members and products, not just what the model assumes.

Final Thought

This isn't a classic falling-rate environment. We're not expecting a flood of mortgage refinances or an immediate earnings shock.

But we are entering a phase where moderate loan runoff, embedded option risk, and limited relief on funding costs will gradually pressure margins—especially for credit unions with large prepayable loan and investment portfolios, and CD funding from new (or non-) members who are rate sensitive.

The best-positioned institutions will act now, before rates move, by rebalancing investments, refining their funding strategy, and building income resilience from the inside out.