Small increase; big impact?

Kristen D’Andrea, The Daily Record Newswire

Last month, when the Federal Reserve raised the federal funds target rate a much-anticipated and long-speculated-about move many questions emerged about the impact it will have on banks and credit unions, as well as businesses and consumers, in 2016.

The Fed had kept the interest rate at which banks lend funds to each other within the Federal Reserve System at an unprecedented range of 0 percent to 0.25 percent since December 2008. The rise will bring the target range to 0.25 percent to 0.50 percent.

In announcing its decision, the Federal Open Market Committee explained that the economy has been expanding moderately and is expected to continue expanding at a similar pace, according to Daniel Spagnolo, principal of Dynamic Financial Services, Ltd. in Syosset, who noted in an e-newsletter that the committee also "expects labor market conditions will continue to strengthen and that inflation will rise to 2 percent over the medium term."

While the increase is minor and is the result of an improving economy it does have an effect on interest rates in general. For instance, when interest rates rise, bond prices generally fall, according to Spagnolo. If bond investors anticipate higher future yields, they may be reluctant to tie up their money for longer periods of time; and, the longer a bond's term, the greater the risk that its yield may eventually be surpassed by that of newer bonds, he said.

Additionally, rising rates can affect equities. Companies that have been taking advantage of low rates and borrowing heavily in recent years could see a rise in their borrowing costs, affecting their bottom lines, Spagnolo said.

Since the federal fund rate determines what banks pay to borrow money, it is also a benchmark in how they set their own short-term rates including savings accounts, money market accounts and short-term bonds. Rising interest rates could help savers, as savings accounts, CDs and money market funds are likely to produce higher yields, he said.

However, small business loans, adjustable-rate mortgages, home equity lines of credit, credit cards and new auto loans are often linked to the prime rate, which is typically tied to the federal funds rate, Spagnolo said, noting "That means when the federal funds rate increases, the rates on these types of loans tend to go up, as well." New fixed home mortgage rates may begin to creep up as well.

Still, Doug Manditch, CEO of Islandia-based Empire National Bank, said the rate increase had been discussed and speculated about for so long, "it was probably almost a non-event."

"Ultimately, there are loans that adjust to prime," he said. "Because prime has been so low for so long, a lot of loans have floors on them. So, some won't go up until the rates go higher, depending on their formula."

Most people expect more increases, about 25 basis points, over the next four quarters, Manditch said.

Rates will likely rise on term loans and commercial mortgages, which might have a slight effect on debt services on non-owner and owner-occupied real estate, Manditch said. However, those loans are probably fixed for about five years before they will go up, he said.

"Depending on your portfolio, a certain amount of loans will re-price every year," he said.

Another potential side effect of rising rates: "If rates go up high enough and I don't anticipate they will the value of real estate comes down," Manditch said. "People get discouraged from borrowing.

"But, even if the rates go up another 100 basis points from where we are by this time next year, I don't think it will have a major effect," Manditch said.

Edward Paternostro, CEO of NEFCU, a Westbury-based credit union, agreed. "Though we don't feel the rise in interest rates will have an immediate, earth-shattering effect, it may present some financial challenges for small businesses on Long Island," he said.

"NEFCU has aggressive commercial loan programs to meet the needs of these businesses and we stand ready to assist with aggressive pricing," he said. "Even beyond that, the regulatory environment will be a challenging one for small businesses, especially in terms of healthcare investments and payroll costs."

Another factor: The rise in rates gives the Fed room to move should the country go into another recession.

"It gives the Fed the ability to adjust rates on a turndown," Manditch said. "Bringing rates back up and making them more regulatory-driven would help."

Published: Mon, Jan 18, 2016


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