Mixed Trends for CUs as Industry Braces for Next Phase

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Experts from CUNA Mutual Group and Callahan & Associates discussed this past week where U.S. credit unions have been during the first-half of this year, and where they may be going in late 2020 and early 2021.

On one hand, credit unions have weathered February to May’s recession and subsequent economic recovery fairly well for the time being as second quarter results point to some positive trends amid the turmoil and negative numbers. On the other hand, the industry is bracing for major change that’s forecasted for its balance sheet.

A Glimpse of What’s to Come
According to CUNA Mutual Group Chief Economist Steve Rick during the online 2020 Discovery Conference, U.S. credit unions should expect “a doubling or tripling” of loan charge-offs from 2021 – 2022 compared to the past couple of years, which will push up the provision-for-loan-losses category. “We’re going to see record low net interest margins in 2020 and 2021 as they are under extreme pressure,” Rick said.

He predicts NIM will stoop to 2.85 percent in 2020 and 2.5 percent in 2021 (compared to 3.15 percent in 2019) since yield-on-assets will fall much faster than cost-of-funds (deposits) going forward. For comparison, NIM was 2.77 percent in 2013, its lowest point during the last economic recovery immediately after the Great Recession and also due to a much longer-than-expected low interest rate environment.

The downshift in annual loan growth (interest income) is here to stay for at least a year or two, and current loan forbearances, deferrals, and extensions will eventually work through the pipeline — hitting credit unions’ aggregate net worth ratio. “If needed, we can let our capital levels drop a good 2 percentage points over the next couple of years,” Rick said. “It is raining, so it’s time to use some of this capital for our members and let it drop.”

He thinks the nation’s unemployment rate will end 2020 at 10 percent and 2021 at 8 percent due to: 1) “zombie” firms and corporations eventually going bankrupt and those workforces taking time to be redeployed; 2) businesses taking the opportunity to lay off their least productive workers during this post-crisis period and/or not call many of them back from furlough; and 3) would-be entrepreneurs not forming new businesses at the same rate they used to due risk aversion.

“We’re not in a recession anymore, but we have a long way to go as an economy to make it back to where we were before COVID-19 hit us,” Rick added. You can view his slide presentation here.

2Q Trends: Mortgages Carry CUs Forward
Before the COVID-19 pandemic, annual U.S. credit union lending growth was being driven by refinance mortgages. Today, post-crisis and mid-pandemic, that same “refi” storyline has exploded even bigger, and it’s helping bolster the industry during an uncertain economic recovery.

The latest positive and negative trends released this week showed a changing landscape as credit unions came out of the second quarter of 2020 impacted by their members’ response to the Coronavirus. According to Callahan & Associates Chief Collaboration Officer Jay Johnson and CEO Jon Jeffreys (2Q TrendWatch webinar), as of June 30 (second quarter year-over-year trends) the industry experienced the following:

  • Capital rose 9.6 percent to $198.4 billion. Assets hit $1.77 trillion (15.1 percent increase); loans reached $1.15 trillion (6.6 percent increase); deposits hit $1.51 trillion (16.5 percent increase); investments grew to $534 billion (38 percent increase); and membership reached nearly 124 million individuals (3.5 percent increase).

  • Membership grew by 4.1 million consumers. However, annual growth has downshifted from 4.3 percent in both 2017 and 2018 to 3.5 percent this past period. Credit unions now have 124 million members (up 21 percent from 102 million in 2015).

  • Mortgages helped drive total loan originations to post 26.5 percent annual growth — the second-quarter period’s highest volume on record. Total loan originations were $314 billion (26.5 percent growth increase) compared to the usual $200 - $254 billion (-2 to 20 percent increase in growth depending on the year) during the same quarterly periods ending in 2015 – 2019. Additionally, fixed-rate first mortgages accounted for nearly four out of five mortgage originations in the first six months of 2020, driven by record low mortgage rates and large refinance volume.

  • The loan-to-deposit ratio is now 76 percent. This is down from nearly 85 percent in late 2018 and 83.5 percent in late 2019. Most of this is due to deposits at many credit unions skyrocketing during the COVID-19 pandemic, fueled by government relief/stimulus monies, a higher savings rate as consumers were forced to pull back their spending in the pandemic shutdowns, and a delayed tax-period payment season by the IRS from April to July.

  • Only two loan categories experienced 12-month growth from 2019 - 2020: first mortgages and used autos. First mortgages rose 12.9 percent (compared to 6.8 percent in the year-ago period), and used autos increased 3.9 percent (5.4 percent prior). Otherwise, HELOCs/second mortgages dropped 2.3 percent (versus growing 7.7 percent prior); new autos fell 3.2 percent (versus growing 5.2 percent prior); and credit cards dropped 2.4 percent (versus growing 7.7 percent prior). Additionally, credit union lending market share increased in mortgages (now 8.6 percent of the entire mortgage market) and in credit cards (now 6.4 percent), but fell in autos (now 17.8 percent).

  • Asset quality remained strong as credit unions extended loan and payment forgiveness programs. The asset quality ratio dropped to 1.1 percent; the delinquency ratio dropped to 0.58 percent; and the industry’s net charge-off ratio fell to 0.52 percent. Propping up this picture is the fact that some loans are in forbearance or deferral, and it remains to be seen how they will be categorized by early 2021 as the economy continues recovering. Meanwhile, the industry is reserving earnings for a financial pinch down the road.

  • Deposit growth rose at nearly three times the pace it increased in 2019. Approximately $174 billion in deposits (13 percent growth increase) was added in the first six months of 2020 (due to a second-quarter spike) compared to the usual $36 – $61 billion (3 – 5 percent growth increase) during the same periods in 2015 – 2019.

  • Total outstanding deposits rose from about $1.3 trillion to $1.51 trillion. This is a nearly 17 percent jump, and it is driving total outstanding assets higher. Deposits usually tick up during the first quarter of any given year (not the second quarter) from worker bonuses, tax refunds, and a post-holiday savings effort by consumers. Also, there was a delay in tax payments to the Treasury Department by some households due to the IRS’s extension from April to July, which kept more funds in people’s accounts.

  • While all five deposit categories experienced 12-month growth from 2019 – 2020, the most liquid short-term accounts (checking and savings) topped the chart. In fact, checking, savings, and money markets accounted for 98 percent of total deposit growth during the first six months of this year. Certificates of deposit rose 9 percent (compared to 21 percent in the year-ago period); IRAs/Keogh accounts increased 4.3 percent (2.5 percent prior); money market accounts rose 15 percent (0.6 percent prior); checking accounts rose 27 percent (6 percent prior); and savings accounts rose 19 percent (2.6 percent prior).

  • Checking account penetration with members has reached a new high of 60 percent. It means 74 million credit union members (6 out of every 10 members) have checking accounts compared to 56 million during the same quarter in 2015. Also, the average member relationship was still rising ($20,676): $12,081 in deposits per member, and $8,594 in loans per member (was a total of $16,681 per member in 2015).

  • Although the credit union employee growth rate downshifted from 3.8 percent last year to 1.9 percent this year, the outstanding number hit a historical high. There are now a record 305,100 credit union employees serving members nationwide (up from 251,500 in 2015).

  • Income from various sources is a mixed picture. “Other” operating income and loan-interest income are both up, but investment interest income and fee income are both down. However, topline revenue is up about $1 billion. Additionally, yields on income generators fell across the board as interest rates hit record lows: for loans — 4.83 percent (fell slightly); for investments — 1.48 percent (down dramatically).

  • Net interest margin (NIM) fell 31 basis points to 2.87 percent. Last year during the same quarter, the industry’s NIM and its operating expense ratio were both about the same (3.17 percent) — but not anymore. Today’s 17 basis-point spread between the two (OpEx is about 3.04 percent today) resembles a margin environment not experienced since 2017. OpEx is declining as expenses are growing.

  • Provision for loan and lease losses are now the highest on record — $2.7 billion. Credit unions are planning for a worse-case scenario in the near future. This compares to $1.6 billion during the same quarter last year (up 69 percent). The coverage ratio is also at the highest level it’s ever been (allowance for loan losses/delinquent loans) — at 172.2 percent compared to 138.7 percent one year ago. It means credit unions have set aside $1.72 for every $1 in delinquent loans, not knowing how many will actually go into default going forward.

  • Return on Assets (ROA) fell 41 basis points over the year. Industry ROA was 0.97 percent this time last year, but as of June 30 it had fallen to 0.56 percent. It is expected to drop further before it starts rising again.

  • The industry’s net worth ratio declined as deposits skyrocketed. It dropped from 11.3 percent to 10.5 percent (not seen since before 2015). Credit unions are setting aside capital for challenges to come. Total net worth stands at $185.3 billion.

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