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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.”

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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.

Aug 12 2020

What We Can Learn from the Financial Crisis

With the dramatic changes in the economy due to the Coronavirus, credit unions are wondering what they should expect moving forward. Even though this recession is unlike any other, we can look at data from the financial crisis, or the great recession, to get some clues as to what might happen.

Increased Deposits or “Surge Shares”

Starting in 2008, deposits increased substantially at almost every credit union and were often referred to as “surge shares“. There was much debate as to whether the surge shares would eventually leave, but in the end, deposits did not decline but steadily increased for the next ten years. We have already seen a sizable increase in deposits at credit unions this time around, and we could see even more, especially as talks of another stimulus check are underway. Credit unions should plan for multiple scenarios, but a strategy to maximize profitability with the influx of deposits should remain a top priority. Unless additional deposits are needed for loan funding or the new deposits can be profitably reinvested, credit unions should employ strategies to minimize deposit growth and possibly even shrink deposits. Lowering deposit rates, including certificate rates, should strongly be considered if it has not already been done. Dropping deposit rates below competition rates may not be enough to discourage the inflow of deposits, but it is a critical component to maximizing the profit margin. If deposits leave due to low rates, then we know the money is rate sensitive and the credit union knows how to likely get it back when needed; just raise rates.

Change in Deposit Composition

During the financial crisis we saw deposits move from certificates to regular shares. We also saw members purchasing shorter term CDs as the yield of longer-term CDs was not worth the extended term. The potential changes in deposit mix, both by term and by type, and the impact on the cost of funds should be anticipated.

Share Certfiicate Average Weighted Maturity Graph 7 2020

Increase in Loan Charge Offs

As we get further into this financial crisis and as government intervention fades, we will begin to see loan charge offs increase. The unemployment rate at the end of May was 13.3%. In comparison, the unemployment rate peaked at 10.0% during the financial crisis and the total loan charge off rate for all credit unions went from 0.40% to 1.31%. If we use the historical relationship between the unemployment rate and the charge off rate, at an unemployment of 13.3% we could expect the charge off rate to jump to 1.57% from the current 0.57%. This recession is different, so the relationship between unemployment and charge off rates may also be different. We do not have the data yet to see how unemployment has affected delinquencies or charge offs for almost all types of loans. However, credit card delinquency and charge offs have been steadily increasing over the past few years and are almost to financial crisis levels.

Total Loan Charge Off & Recovery Graph 7 2020

Credit Card Charge Off & Recovery 7 2020

Changes in Loan Composition

The loan composition also saw a dramatic shift during and since the financial crisis. New vehicle loans as a percentage of the loan portfolio rose during the crisis and then fell as we recovered. Used vehicle loans did the opposite. Real estate loan composition shifted and 1^st liens became a much larger portion, but it appears to be offset by the decrease in home equities. It seems many people may have taken advantage of the increase in home values and refinanced or moved the Jr. lien debt into the 1^st lien. This move to longer-term fixed-rate products has caused the average weighted maturity of the loan portfolio to increase, and potential interest rate risk to be greater.

Real Estate Loan Composition Graph 7 2020

Loan Estimated Average Weighted Maturity Graph 7 2020

Lower Net Income

Historically, when rates are lower net income is also lower. Often, loan and investment rates drop farther than deposit rates. At the same time, many credit unions struggle to even make loans, and charge offs typically increase in a declining rate environment. The loans to assets ratio did not return to the pre-financial crisis number, and this recession may halt or erase what progress has been made. Compounding this issue is that investment rates are at or near historic lows, and all of the inflow of new deposits and reinvesting of maturing investments will be in lower-yielding instruments.

Conclusion

It is important to remember these charts and graphs represent the aggregate of the credit union industry, and many credit unions saw much more dramatic shifts in their balance sheet, charge off rates, and earnings than shown. We are presenting this information to help as credit unions explore options, anticipate changes, plan, and prepare to manage through this new crisis. Each credit union should evaluate how they performed during and since the last economic downturn and be ready for the potential for history to repeat itself. If credit unions properly prepare for this and future recessions, they can maintain healthy margins and help their members through their financial difficulties.

If you would like more information on the MHSI Peer Analysis tool and how it can be used to show your credit union and your specified peer’s historical data, please contact us at info@markhsmith.com or call us at 1-800-268-7795.

Jul 17 2020

Managing Risk – Interest Rates, Net Interest Margin, and Capital

Recent Economic Activity

At the end of the first quarter and throughout the second quarter, the U.S. economy experienced one of the largest, if not the largest, economic shocks in history. The Federal Reserve Bank reacted swiftly in lowering the Federal Funds rate to a near-zero target and implemented various additional asset purchase programs. In addition, the federal government initiated numerous fiscal stimulus programs to aide businesses and unemployed workers. Some have proclaimed that given how this was an event-driven economic shock coupled with large and immediate responses, that a quick, “V” shaped recovery could occur. But should you really plan for this when making decisions now and throughout the next 12 to 18 months?

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Apr 21 2020

Net Economic Value (NEV) and The Current Environment

As interest rates increased from 2016 through 2018 so did concerns pertaining to interest rate risk in the up-rate scenarios. Many credit unions saw an increase in the net economic value (NEV) of capital when estimating potential rates up interest rate risk. In the up-rate scenarios, most of the improvement in economic value of capital was a result of the increased benefit received from member shares. In the up-rate scenarios, the increases in the economic value of non-maturity deposits exceeded the decrease in the economic value of assets. In the up-rate scenarios, it is expected that asset values will decline because the yield of the assets will be below-market rates. The increase in the economic value of non-maturity shares in the up-rate scenarios comes from the growing gap between rates paid on shares, including non-interest expenses, and market or wholesale funding rates. The market rates commonly used for non-maturity deposits are the wholesale funding rates or the cost to borrow from a Federal Home Loan Bank or a corporate credit union. One can look at the gap between the all-in cost of funds for deposits and the wholesale funding rates as the economic value of non-maturity shares. (See graph below)

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