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Jan 20 2015

Economic Update

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Written by webmaster

3 min read

For Some Weather Forecasts and Economic Forecasts: About the Same Accuracy

It may be a good place to start our economic update in 2015 by mentioning a study conducted by Deutsche Bank Securities going back to 2003. It measured the accuracy of the survey of professional forecasters’ⁱ ability to correctly predict the interest rate on the 10-Year Treasury one year into the future.

The study indicated that the average 12 month forecast was 60 basis points too high and in some years much higher than thatⁱⁱ (the survey forecasted interest rates to go up and they actually ended down).

So goes the forecast for 2014. Ryan Sweet, Director at Moody’s Analytics, forecasted the 10-Year Treasury yield to be at 3.65% at the end of 2014ⁱⁱⁱ, other forecasts were between 3.25 and 3.50%.^iv Where is the 10-Year treasury yield at the time of this writing? 2.27% as reported by Bloomberg.^v That is 1% lower than the forecast. True to the forecasting study in 2014 when interest rates were forecasted by most to go up, 10-year interest rates fell. We don’t want to be too hard on the survey of professional forecasters. It appears they will be fairly close in predicting other 2014 end of year economic measurements. They got gross domestic product (between 2.5 and 3.0%), consumer price index (between 1.7 and 2.0%), and came close on unemployment (between 6.0 and 6.5%).

Take a guess on the interest rate forecast for 2015… rates are forecasted to go up. The survey of professional forecasters predict the 10-Year treasury to be 3.25% at the end of 2015.^vi That is 1% higher than we are today.

At Mark H. Smith we have noted the significant increase in real estate lending for many of our clients. Some credit union loan portfolios now have more than 50% allocated to real estate loans. This is a significant change from the past. What does this mean for credit unions? Well, for starters, more interest rate risk. Credit union real estate loan portfolios tend to have longer maturities than their historical auto loan portfolios. For credit unions this is not necessarily a bad thing. There are many real estate loan types and structures that we have seen our credit union clients successfully use to limit interest rate risk. Examples include variable rate HELOC’s and ARM’s, dollar cost averaging loans over time, and length of term loan limits.

In addition to increasing real estate lending, we have also noted that several of our credit union clients have extended the maturities on their investment portfolios as well. A popular strategy for some has been to purchase long (7-20 year maturity and longer) callable bonds because of the higher yields available there. Over the last 4-5 years this long maturity callable bond has worked, particularly because interest rates have stayed low and many of the callable bonds have been called early. What does longer maturity investment portfolios mean for credit unions? Similar to the increased real estate lending… it means more interest rate risk. Again, for credit unions this is not necessarily a bad thing. We have seen credit unions successfully limit interest rate risk by dollar cost averaging their bond purchases, spreading investments over several different asset classes (CDs, Treasuries, Agencies, Municipals) and making sure to adhere to their investment policy with maturity limits.

If the interest rate forecasts are more accurate for 2015, then the real estate loans or other longer term loans that you made in 2014 will look a lot less attractive. If the 10-Year Treasury rate were to revert to its historical mean of 4.62%, then your credit union could be holding lower interest rate loans for years to come.

In Conclusion

Although predicting interest rates can be as reliable as predicting the weather, there are some elements that credit union managers should take note of in managing interest rate risk. If there is a take away on the forecast of interest rates (and the forecast for weather patterns), the further out in maturity the more volatile the rate and the more difficult to predict. Interest rates on 2-5 year term auto loans are going to be less volatile than 5-15 year term real estate loans.

As we have for many years now for our clients, we aim to continue to assist you in measuring these risks. Please don’t hesitate to contact us with questions or help that we can provide specific to your portfolio.

References:
^{http://www.philadelphiafed.org/research-and-data/real-time-center/survey-of-professional-forecasters/}
^{http://www.ritholtz.com/blog/wp-content/uploads/2014/12/12-month-forecast-error.png}
^{http://www.philadelphiafed.org/research-and-data/real-time-center/livingston-survey/2013/livdec13.pdf}
^{http://www.forbes.com/sites/kitconews/2013/12/27/what-will-drive-u-s-treasury-yields-in-2014-two-words-the-fed/}
^{10 year treasury rate quoted on Bloomberg.com December 23, 2014}
^{http://www.philadelphiafed.org/research-and-data/real-time-center/livingston-survey/2014/livdec14.pdf}

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Jan 14 2021

Five Top Credit Union Topics For 2021

As we move into 2021, the following topics might be worth discussing and considering with your management team.

Earnings

During the first half of 2020, net interest margins came under substantial pressure as market interest rates were shocked dramatically downward. Net interest margins are expected to remain under downward pressure throughout 2021 as investment portfolios continue to reprice lower and share growth continues.

One of the easiest and quickest responses to declining interest income is to address the cost of funds. Many credit unions still have room to decrease their cost of funds, as shown in the September 2020 ending period graph below.

Source: NCUA

Delinquency

Based on the September 2020 call report data, loan delinquencies and net charge-offs remained low and were below September 2019 delinquencies. Loan forbearance and other assistance programs in place through the entirety of 2020 may have helped delinquencies. Also, certain sectors of the economy are not as impacted as others. The unemployment rate is expected to continue drifting lower in 2021. However, as the assistance programs are lifted, delinquencies and charge-offs are expected to increase as unemployment remains substantially above the years leading up to the pandemic.

Source: MHSI Online Peer Analysis Module through September 2020

Credit Union Philosophy

Serving the underserved has always been a hallmark of credit unions, and now more than ever, there is an opportunity to do this for many credit union members. As these times have been challenging, credit unions can continue to evaluate and prioritize how to best serve members in the coming year, especially those under financial stress. Exploring how to provide service to those that are underbanked might be an opportunity. One option may include evaluating risk-based lending policies and programs, especially given the robust liquidity on most credit union balance sheets. New and alternative avenues to bolster income should continue to be explored.

Digital and Technology

As the pandemic shifts and prolongs, credit unions should evaluate if their electronic delivery channels meet members and potential members’ needs. Moving to or improving digital delivery channels should be accelerated and prioritized. Digital delivery should include evaluating loan origination and servicing channels to maximize new loan volumes. Online and remote financial services will continue to grow and may be the preferred way members access and manage their financial activities.

Balance Sheet Growth

Before the pandemic, many experts anticipated credit union loan growth to taper off but remain positive. After the first quarter of 2021, loan production became unpredictable, however, by the end of the third quarter, annualized loan growth was 6.34%. Real estate lending, driven by the abruptly lower interest rate environment, helped with the growth. Experts anticipate loan growth to be around 6.0% to 6.5% over the next 12 months as the economy recovers.

The first few months of 2021 may see strong share growth as the second round of government assistance and stimulus takes hold, and households remain reluctant to spend until signs of COVID easing and warmer weather occur. Share growth last year increased at an annualized rate of over 18% and is expected to be approximately 8.0% to 10.0% in the coming year. If double-digit growth continues, earnings sufficient enough to sustain capital will be critical. If economic conditions improve and overall consumer activity increases, loan growth and increasing long-term interest rates could counter some of the anticipated income pressures. Fortunately, the credit union industry is very well capitalized and able to ride out the adverse conditions and absorb some more growth, even if earnings are reduced.

Nov 04 2020

The Bottom of the Frog Market

Several years back, I went to Mexico for a vacation. While there, I found a ceramic hand-painted frog-shaped planter that I wanted. My husband loves the hunt, and his quest began. Every time we saw a frog-planter, he would start negotiating with the vendor to get the lowest possible price. We searched for several days and would stop in different towns and check the markets while enjoying our vacation and exploring. When we found a frog, he would inquire about the price and negotiate for further discounts. After a few days and no success at getting the cost of the frog below a certain point, my husband declared, “we have hit the bottom of the frog market.”

…

The Bottom of the Frog MarketRead More »

Sep 30 2020

Economic Uncertainties and Interest Rate Certainties – Asset Allocation Assessments and Considerations

Future GDP Projections

In September, the Federal Reserve Chairman spoke publicly on several occasions and reiterated that the central bank is committed to helping the economy “for as long as it takes.” He noted continued improvements in the economy, but also acknowledged a highly uncertain path ahead. The September FOMC (Federal Open Market Committee) projections are now projecting a full-year GDP decline of 3.7%. This is substantially better than their previous expectation of a 6.5% decline. However, they lowered their 2021 outlook from 5.0% to 4.0% and their 2022 outlook from 3.5% to 3.0%. Their 2023 outlook is at 2.50%.

Interest Rates and Economic Uncertainties

The FOMC also indicated that they would allow inflation to run above 2.0% on a sustained basis before any federal funds rate increases. As such, most individual members of the Committee indicated that the federal funds rate could remain close to zero through 2023. Some economists and analysts even think that we may not see an increase in the federal funds rate until 2024 or 2025. They believe that it will take up to five years for the global economy to fully recover to pre-pandemic levels.

The risks to the FOMC economic growth projections are high. Even the Chairman of the FOMC acknowledged the economic uncertainty of the path ahead. Following the sharp rebound in many economic data measures and drop in the unemployment rate, some recent measures have disappointed compared to expectations and some are indicating a recovery that is stalling. At the current time of this article, the nature of further fiscal stimulus continues to be negotiated in congress and some are not expecting a resolution until after the presidential election. Of course this only adds to the current economic uncertainty.

What is highly certain over the short to medium term timeframe is that interest rates will not likely be increasing more than just relatively minor fluctuations in the medium to long end of the U.S. Treasury yield curve. It is more likely that potential risks on the horizon could drive medium and longer-term U.S. Treasury yields even lower.

Reassessing Balance Sheet Strategy

Given the above outlook, it would certainly seem that some credit union balance sheet strategies of recent years should be reevaluated for the foreseeable future. Reassessing asset allocation strategies is possibly more relevant at the current time than at any time in the past several years. For example, the credit union may want to ask itself how much should we be redeploying assets into two to three year investment CDs given current interest rates on those maturities. If the answer is less than previous years, then what are the alternatives we can explore.

Priorities Going Forward

In exploring alternatives, the first priority for credit unions is of course serving members. Assessments and considerations could include expanding the types of loans offered, reevaluating risk based lending allocations, increasing real estate concentrations, debt consolidation programs, and loan payment support alternatives to name just a few. Secondary to the first priority are considerations such as allocations to loan participations and alternative investments. For example, should the credit union assess CUSO or similar investment possibilities. What are all of the possibilities for these type of investments that may be available to the credit union? After all, an alternative of earning five basis points at the corporate credit union with too much of assets is not likely to accomplish any priorities or goals for the credit union.

The present time and foreseeable future is a great time for credit unions to really show how they can serve and support members during these challenging times. Being there for your members is for sure the highest purpose for the credit union and always assessing ways to provide service and assistance to them will always be the credit union’s first priority. In addition and secondarily, now more than any time in recent years it may make sense to really take a deep dive into the above asset allocation assessments, considerations, and possibilities. Ideally, the best answers going forward would combine the first priority with the second to optimize balance sheet performance while best serving members.