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Apr 27 2018

Mary, Mary, Quite Contrary

Article

Written by markadmin

5 min read

“Mary, Mary, quite contrary, how does your garden grow?” is the beginning of a popular nursery rhyme and comes to mind while thinking of how the credit union system has grown and changed over the last 10 years.

As of June 2007, total shares and deposits for all credit unions based on cumulative call report data was $593 billion. The latter part of 2015 shares and deposits surpassed a trillion dollars and are currently above $1.15 trillion. The total number of members has increased, but it is worth noting that average savings/member has also increase during this time from $5,390 to $8,037.

This article is going to focus on some of the changes and shifts noticed in the credit union balance sheet. The statistics referenced are cumulative results for credit unions ranging in size from $10 Million to $500 million in total assets. The time frame for comparison is June 2007 through June 2017.

As shares and deposits grew, there was also a shift in the makeup of the deposits. At the beginning of this comparison, certificates represented 27.1% and declined to 14.1% of total deposits, regular shares were 41.7% and increased to 51.4%, money markets transitioned from at 9.5% to 11.4%, and share drafts climbed from 12.4% to 15.4%.

From cost of funds and an interest rate risk perspective, this shift has been advantageous for credit unions. With interest rates at historical lows, many depositors were still not discouraged, and it appears safety was a priority over yield for these depositors. Moving forward as fed fund rates are expected to rise during 2018, will safety remain a priority, will funds leave the credit unions, or will deposits migrate from lower cost funding to more expensive funding. Each scenario or a combination of these scenarios should not be ignored. This topic will be addressed in another article in this newsletter.

DEPOSIT COMPOSITION 2017

Average annualized loan and investment income hit a high in the 4th quarter of 2007 and then started its decline. Loan and investment rates decreased more than some deposit rates because many of these rates were reduced to almost zero. The compressing net interest margin and impacted net income. The low income combined with the growth caused a deterioration in net worth ratios – although in my opinion, not detrimentally for most credit unions. The average net worth ratio for credit unions was 13.30% in 2007 and comes in at 11.79% as of June 2017.

The credit union garden is growing, and there are more assets to invest than in the past. Where are the resources being invested and are they getting the best harvest or return?

Loan composition to total assets has changed. The biggest shift has been a decrease in new vehicle loans from 12.3% to 7.5% of total assets. Other RE loans also decreased from 9.7% to 5.1%. Used vehicle loans increase slightly to 15.9%. 1st mortgages and the rest of the categories did not change enough to mention. In addition, loan growth did not keep pace with deposit growth and total loans to total assets declined from 62.7% in 2007 to a low of 50% in 2013. Loan growth has since surpassed deposit growth and has climbed slowly to 54.5% in 2017. Loan interest income was at a high of 482 basis points in Q4 of 2007 and continues to decline, though not as rapidly, and is now at 283 basis points.

The decline in total loans to total assets leaves a trend that is worth noting behind the scenes. While fixed rate first mortgages remained relatively constant over time as a percentage of total assets for credit unions in the asset group for this article, 1st mortgages represent a larger portion (almost 26%) of the total loan portfolio. Credit unions over $500 million have consistently held more 1st mortgage fixed rate loans than their smaller counterparts and appear to be more comfortable with this approach.

LOAN COMPOSITION AS OF JUNE 2017

CREDIT UNIONS LESS THAN 500 MILLION

From my experience and considering the percentage of 1st mortgage fixed rate loans to total assets from 2007 to 2017, there has been minimal increase in interest rate risk due to mortgage loans and most credit unions I advised remain in a low interest rate risk range and well within their policy and regulatory limits. The mortgage products appear to still be an earnings opportunity for the smaller credit unions. Pursuing this opportunity should promote discussion around interest rate risk. Reviewing and analyzing regular IRR analysis will help to evaluate and manage interest rate risk and balance potential return against potential risk.

During this growth period when total deposits increased, but loan portfolios did not keep up, the investment part of the balance sheet is where most of the growth landed. Again, we look to answer the question of how did credit unions put the growth to work and are they getting the best harvest or return?

The net long-term assets/total assets ratio increased from 15.1% in 2007 to 23.9% in 2017, leading one to assume the investment portfolio terms increased to improve yield. The average weighted maturity of investments was 1.1 years in 2007, topped out at 1.9 years in the 3rd quarter of 2014, and currently hovers around 1.5 years.

Agencies and mortgage backed security investments as part of the total investment portfolio increased for credit unions in this asset group, but investment CD’s remain the primary investment vehicle. The larger financial institutions have shifted almost completely from investment CD’s to agencies. Investment income in basis points went from 140 in 2007 to a low of 44 basis points in 2013. Investment income has crept up since then to 52 basis points. Cash and overnight deposits remain a sizable percentage of the investment portfolio.

INVESTMENT COMPOSITION (%) BY TERM

What do I see as the take away from all this data? Credit unions’ managers have been able to keep the net interest margin relatively stable since 2013, although there has been little improvement. A large portion of the growth ended up in the investment portfolio, which is less beneficial than lending, and there is still a lot of low earning cash in the system. The garden has crept along but not flourished. Most credit unions’ Interest rate risk profiles remains low and the funding side of the balance sheets contain a significant portion in core deposits. Evaluating and exploring the tradeoff of taking more Interest rate risk, taking on some more mortgages, extending terms on investments, and weighing liquidity needs versus investing overnight deposits, may be opportunities to explore moving forward.

Related/Popular Articles

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.