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May 12 2015

Economic Update – The Billion Prices Project and Inflation

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Written by webmaster

3 min read

Traditionally, inflation is measured by the Consumer Price Index (CPI) which creates a baseline for a basket of goods purchased by a typical household and then measures the increase (or decrease) in the prices of that basket of goods over time.

Weaknesses of the CPI are, of course, the fact that a basket of goods cannot possibly represent all of the goods and services that a consumer will buy and the fact that the basket of goods will change over a 5, 10, or 20 year period. Think cell phone service, once considered a luxury good, now considered a basic utility. There are many examples of these kinds of changes to goods and services included in the basket.

One of my favorite alternative economic studies over the last few years has been the Billion Prices Project started by a group of economists at MITⁱ. The Billion Prices Project uses computer software programs written to “scrape” the internet for the prices of all the goods and services that are offered there. By scraping the internet daily, a new inflation measurement tool was created, referred to as the PriceStats Indexⁱⁱ. We watched this index closely, especially during the years 2012-2013, when PriceStats was telling us that inflation was actually running 2.5-3.0% but CPI was telling us that inflation was running 1.5-2.0%. Ask yourself the question: “Does it feel like I spend more for the goods that I buy, the cars that I drive, and the utilities that I pay now than I did five years ago?” The answer to your question is probably yes. PriceStats may be a help in measuring this.

Although there is no measure of inflation that is perfect (PriceStats has weaknesses too), PriceStats picked up the plunge in inflation when gas prices fell well before it was picked up by the CPI index. Recent PriceStats index data indicates that inflation is firming up, and then going up this summer –faster than economists realize.ⁱⁱⁱ

How might the recent data on inflation affect our credit union clients? There are lots of ways, but here are just a few examples:

One of the main translations of inflation to our credit union clients is the effect on home prices. The Case-Shiller 20 City home price index is up 5.03% in one year and 9.01% in three years!^iv We have mentioned in previous economic commentaries the growth in real estate loans for many of our clients. Some inflation is a good thing in this area. It keeps loan to value ratios healthy.
Another is in mortgage, auto, and other loan rates. Some inflation here is a good thing as well. The net interest margin for so many of our credit union clients has been compressed over the last 3-6 years. Inflation should drive these rates higher over the long term. As long as the rise is gradual, your net interest margin should improve. For providers of financial services and products pricing power is welcome.
High inflation (although economic indicators would tell us this is not a great possibility) is the enemy of any fixed rate asset that the credit union holds. Fixed rate investments and fixed rate loans erode their value in that kind of environment.
With inflation, wages and the cost of labor to the credit union increase.

Next time you shop for something on the internet it is possible that the price of the good or service you purchase has already been recorded by the Billion Prices economists at PriceStats. Utilizing this tool and others that are being created using “big data”, we don’t have to rely just on CPI anymore.

As always, if there are specific questions that you have regarding the interest rate risk at your credit union please don’t hesitate to contact us.

i – The Billion Prices Project @ MIT: http://bpp.mit.edu/
ii – Wall Street Journal, March 13, 2015: http://blogs.wsj.com/economics/2015/03/13/the-billion-prices-project-thinks-inflation-may-have-turned-a-sharp-corner/
iii – PriceStats: http://www.pricestats.com/
iv – S&P Dow Jones Indices, 20 City Index Returns: http://us.spindices.com/additional-reports/all-returns/index.dot?parentIdentifier=6db38316-fd4f-4b21-9db9-61289d88fc9c&sourceIdentifier=index-family-specialization&additionalFilterCondition=

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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.