Navigating liquidity — also known as the unnerving balancing act of managing deposits, loans, investments and cash reserves — is playing an increasingly challenging role for many of the nation’s 4,900 credit unions as fourth-quarter 2022 transitioned into 2023.
Last quarter, credit unions were lending out more money than they were bringing in through deposits for that three-month period, according to data from the National Credit Union Administration (NCUA) and an analysis of those figures by Washington, D.C.-based Callahan & Associates. This phenomenon amounted to a 10 percent decrease in “net liquidity” from December 2021 to December 2022, or a $192 billion decline.
Why? Credit union loan growth — while predicted to slow down as interest rates surged last year at lightning speed — remained astonishingly red hot in the fourth quarter of 2022 as deposit growth flatlined, according to Callahan & Associates Chief Experience Officer Alix Patterson and Senior Analyst William Hunt. Their national presentation online this past week revealed how breakneck lending growth was being somewhat driven by a huge rebound in indirect-auto lending and organic auto loans late last year, which is good news.
More notable was the increased focus on some important liquidity trends. Excess cash ($132 billion) as a percentage of the industry’s balance sheet, which is one liquidity barometer patrolled by industry number-crunchers, dropped to its lowest level since 2008 (down to 6 percent of total assets).
That means funding loans in future quarters could continue to be difficult and expensive for many in the industry — not because loan demand isn’t there, but because of rapidly depleting deposits over an extremely compressed time period. On top of this, pricing for savings, money market, and certificate-of-deposit account products in today’s rising interest rate environment isn’t helping as the competition heats up.
Hyper-Competitive Deposit Pricing Here to Stay
It’s even more interesting how credit unions and banks arrived at this point.
Because of this volatile period in banking history coming out of the COVID-19 pandemic, financial institutions are now playing in a hyper-competitive sandbox as they work overtime to attract “new” deposits from their members’ outside banking relationships — essentially taking deposit market share from other depository financial institutions or online fintech savings providers. A less popular tool, although still leveraged, is to lure consumers to become members and bring over deposits through their newfound banking connection.
Many credit unions are painstakingly trying to capitalize on both strategies, Patterson and Hunt said. Across the nation, aggressive certificate-of-deposit interest rates for short and medium-term products (6 to 15-months) have been popping up everywhere as financial institutions of all types maneuver today’s liquidity gap with eye-catching offers in their advertisements and marketing.
It begs the question: How do credit unions fund overwhelming loan demand for member purchases of higher-priced inflationary goods and services when the industry’s outstanding deposits are on one of the fastest downtrends in modern history?
In fact, it doesn’t matter if quarterly loan growth slows significantly in 2023 due to higher interest rates or an economic downturn, which is one traditional (yet imperfect) way of alleviating funding pressures to make way for future lending. Today’s deposit-to-loan mismatch could likely — and unfortunately — persist in the coming quarters, although to what degree is unknown.
For now, more credit unions are resorting to costlier borrowing channels to fund loans as excess household cash deposited in all kinds of accounts continues dwindling and the financial services arena exits the pandemic era.
Easing the Pain Through Costlier Funding Channels
Hunt said U.S. households held $2.1 trillion in “excess savings” at one point in 2021 due to easy monetary policy and congressional fiscal stimulus-relief monies dispersed during the pandemic. This has withered to $900 billion today. That’s still a lot of money sloshing around.
However, at the same time, higher-than-average inflation on goods and services has been unrelenting on consumer deposit accounts, with the U.S. household savings rate plunging to a 60-year low of 2.9 percent.
In aggregate, credit union members, like all consumers, are steadily nearing the end of their built-up pandemic cash. They are also paying higher prices for nearly everything and stashing away nearly nothing in savings — all simultaneously and swiftly.
“The sharp drop in savings rates and deposits is alarming,” said Robert Eyler, contract economist for the California and Nevada Credit Union Leagues. “It suggests lower and middle-income credit union members that were provided some financial salvation during the pandemic are now at risk of higher credit costs and less buffer if a large expense hits these households.”
To help ease this credit intermediation conundrum, more than 1,200 U.S. credit unions borrowed from the Federal Home Loan Bank (FHLB) system in late 2022 versus 630 in late 2021 — nearly double. In dollar terms, credit union borrowing spiked 124 percent in fourth-quarter 2022 from one year before.
FHLB has remained one of the most cost-effective borrowing partners for credit unions over the long term, even though these types of funding channels are more expensive than using member deposits.
Whether it’s FHLB or other partners, this credit union-borrowing trend might ramp up further depending on the imbalance of loan-versus-deposit growth each quarter going forward. This could potentially turn a liquidity chasm into a liquidity crunch for some credit unions — namely certain medium and large institutions that will still exhibit relatively healthy loan demand from members.
“Many credit unions are already starting to hit that liquidity barrier and are turning to other borrowing channels to keep things going,” Hunt said. “There’s going to be a wall that some will hit at some point if things keep going at their current pace for the industry.”
Other Avenues Offer Limited Relief
Others — notably many smaller credit unions across the industry — probably won’t experience these risks as harshly since their loan demand has been more tempered over the past several years, Hunt said. In general, many smaller credit unions have remained far from loaned-out while their medium and larger counterparts hit or surpassed the 90, 95, or 100-percent mark (loan-to-deposit ratio) several times over the past 5 – 7 years.
Another avenue credit unions have is selling investments and redeploying those funds into lending. But when it comes to freeing up “term” investments, many credit unions aren’t selling them into the financial markets since they would incur “realized” losses.
Because of this, many within the industry will probably continue resorting to enticing new deposits or new depositors, as well as utilizing the most advantageous borrowing-partner channels at their disposal within the bank-to-bank lending market, such as the FHLB system.
Looking beyond investments, a small number of credit unions have been selling loans to fellow financial-institution buyers to immediately free up capacity for new lending. After loan sales by credit unions dipped to a trough over the past couple of years, they are ticking up again.
“These are all valid points” regarding liquidity, stated Chip Filson in his daily blog commentary — former NCUA director of the Office of Programs, which included the Central Liquidity Fund (CLF), National Credit Union Share Insurance Fund (NCUSIF) management, and supervision and examination policy (and co-founder of Callahan & Associates in 1985). “However, liquidity constraints are rarely fatal. It most often just means slower-than-normal balance sheet growth. That is the intent of the Federal Reserve’s policy of raising rates.”
He noted how credit unions’ local consumer-based funding strategy is the industry’s most important strategic advantage compared to larger financial institutions. “Those (larger) firms rely on wholesale funds, large commercial or municipal deposits, and regularly move between funding options to maintain net-interest margins,” Filson stated. “Those firms are at the mercy of market rates because they lack local franchises.”
As interest rates most likely continue to rise, there will be “competition at the margin for large balances, especially as money market mutual funds are now paying 4.5 percent or more,” Filson noted. “If credit unions take care of their core members, they will take care of the credit union.”
‘We Haven’t Seen This Since the Great Recession’
While liquidity concerns are at the forefront of balance-sheet aficionados, others are keeping an eye on the U.S. credit union industry’s asset quality ratio and their individual credit union’s delinquency ratio. These ratios have been trending up for three consecutive quarters for the entire industry combined, although they are lifting off from historic super-lows.
Fourth-quarter 2022 data published by the NCUA shows the industry’s asset quality ratio (net charge-off ratio plus delinquency ratio) rose from 0.75 percent in late 2021 to 0.95 percent by late 2022, with the much-watched delinquency ratio increasing from 0.5 percent to 0.61 percent.
Historically, these two metrics were 1.4 percent and 0.81 percent (respectively) in late 2017. By these standards, credit unions remain in a very good position today.
Credit cards and auto loans are driving today’s uptrend in delinquency, with residential first mortgages and “other” residential lending (home equity products) playing a much lesser role. In comparison to prior economic periods over the past 10 – 15 years, many experts consider these rising ratios as a “return to normal,” Patterson said.
“How can we help members who will be behind on payments soon,” she noted, suggesting credit union leaders ask this question to prepare for 2023 and 2024. “We haven’t seen an uptick like this since the Great Recession of 2007 – 2009.”
Overextended Household Debt ‘Now Coming to Pass’
Indeed, credit unions are stocking up their provision for loan losses. The industry’s quarterly provision was $2.1 billion in fourth-quarter 2022 and has been steadily increasing from a reversal (provision money shifted back to the industry’s bottom line) in second-quarter 2021 of just under $100 million.
That’s because so much money was set aside during the pandemic crisis in 2020 relative to the industry’s perplexingly falling delinquency ratio. At the time, members’ personal household balance sheets remained more than healthy from monetary easing and federal stimulus checks. The economy was eventually bolstered when spending shifted from services to goods — immensely.
Credit unions reversed course throughout all of 2021 as they rested on their previous-year loan loss provision set-asides, happily taking back capital for net worth and other purposes.
However, all eyes have now concentrated on the industry’s 2022 uptick in loan loss provisions. These provisions are dual sided. First, it’s to prepare for rising delinquencies in an economy that may be on the precipice of recession; and second, to comply with the Current Expected Credit Loss (CECL) rule that many credit unions have been beta-testing and simulating over the past few years from a balance sheet and federal regulatory perspective.
At the end of the day, credit union leaders — and those throughout the entire banking industry — can probably expect consumer delinquencies to continue rising off their recent historic lows. Some members are running into financial issues at home, a trend that’s poised to rise throughout the year ahead.
“We had to expect delinquencies to pick up due to rising rates and adjustable-rate loans that some members have taken,” Eyler said. “Also, many of these members have exposure to credit card debt as a way to bridge cash shortfalls at home. For some who got overextended during the pandemic, this is now coming to pass.”
Fourth-Quarter 2022 Industry Update
From Dec. 31, 2021 – Dec. 31, 2022 (year-over-year unless otherwise noted), U.S. credit unions experienced these industry trends according to recent quarterly data made public by the NCUA.
All trends were obtained from the Fourth Quarter 2022 Trendwatch webinar hosted this past week (view the slide presentation here) by Washington, D.C.-based Callahan & Associates.