What Credit Unions Should Know About the Uncertain Economic Environment

There is a lot of uncertainty – and even panic – behind the current inverted yield curve, because an inverted yield curve has preceded every recession over the past 50 years (source: Financial Times). But this time our nation may not even be headed for a recession at all.

An inverted curve comes when interest rates for long-term bonds trade at a lower yield than short-term bonds. In March, the curve inverted for the first time since 2007, according to Forbes. Since then, the curve has been flat or dipped slightly back into the negative.

Yet an inversion is no guarantee of a recession. There is no doubt that a flat or inverted yield curve puts pressure on financial institutions. As credit unions, however, we are fortunate to function within a model that can weather the storm.

Credit unions operate at thinner margins because our earnings are not paid back to stockholders, as with banks. Thus credit unions can continue to deliver great rates to members, even in an economic slowdown.

Banks often pass economic risks onto consumers. With a flat yield curve, many banks have no choice but to raise fees and find new ways to charge consumers, because of the obligation banks have to their shareholders to keep equity up and maintain sufficient quarterly earnings.

Credit unions, on the other hand, can play the long game. As not-for-profits, our only obligation is to our members.

Credit unions that go into a flat yield curve well-capitalized can even come out ahead in an economic slowdown. Maintaining capital allows financial institutions to grow during any economic cycle, positioning them to invest in new branches, technology or equipment for future growth.

But with the current economic landscape uncertain, most credit unions should be focusing primarily on earnings and capital, as opposed to growth. If a financial institution outgrows its earnings, it depletes capital. So organic growth should be slowed in this environment.

What about our members? First, we should dissuade panic. Since 2009, we have experienced the longest credit expansion in modern history. Some inversion was bound to occur. But the economy responds to optimism. If credit unions regard the ups and downs of the markets with responsible optimism, members will too. We should be encouraging our members to diversify their portfolios based on their personal goals, keeping a healthy balance of bonds, stocks and cash to meet their long-term needs.

Additionally, it’s important to note that all financial institutions should be wary of chasing lower credit scores for higher yields. In periods of economic downturn, there is pressure to stretch deeper into the credit pool, extending loans to borrowers with lower and lower scores. Boards need to be aware of the long-term consequences of this, should we actually go into a recession. If borrowers lose their jobs, many will default on their loans, jeopardizing funds in securitized loan pools and putting many other Americans’ investments at risk.

Financial institutions should also be advocating for smart fiscal policy that can counteract any negative market changes. Most notably, prioritization of a bipartisan infrastructure bill would act as a fiscal stimulus that can extend the bull market economy we’ve been enjoying for so long. Over the past several decades, government investment in infrastructure as a percentage of GDP has declined, as stated in a January 2018 Congressional Research Service report, “Economic Impact of Infrastructure Investment.” But historically, infrastructure investments have positively impacted employment rates, stimulated demand in the short term and increased productivity in the long term.

While an inverted yield curve is an important factor to be watched, it is not necessarily a cause for alarm. What it can do, however, is spur credit unions to make smart financial and management decisions, by focusing on earnings and capital while continuing to offer best-in-class service. This strategy will position credit unions well in any economic environment.

James R. Schenck is president/CEO of PenFed Credit Union and CEO of the PenFed Foundation.