Credit Unions Should Consider the ‘Upside Down’ for the 2020s

With the teens past and the ’20s upon us, CUNA Mutual Group Chief Economist Steven Rick spent a half hour sharing his thoughts on the landscape credit unions are entering.

In short, Rick said credit unions can expect loan growth to continue to slow and savings to accelerate. Meanwhile, banks will be breathing down their necks. That should sound familiar.

But he also said interest rates are likely to fall further, squeezing margins and sending the U.S. economy into a “growth recession.” Those trends will force credit union boards and managers to consider the financial equivalent of the “Upside Down” realm depicted in the “Stranger Things” Netflix series: Negative interest rates, when members get paid to borrow and pay to save.

Rick started his career as an economist at CUNA in Madison, Wis., in 1992, and was appointed chief economist of CUNA Mutual Group in Madison in 2014. He’s also been a board member at University of Wisconsin Credit Union since 2004 and senior lecturer at the University of Wisconsin in Madison since 1999.

CU Times: Loan portfolio growth has been slowing. What do you expect for 2020?

Rick: We’re forecasting 5.5% growth, which is below the 7% five-year average, so I would define it as a weak year. In 2019, we saw growth of 6.5%, which is also a weak year. Both of those years follow way-above-trend growth of 11% to 12%.

You see the natural credit cycle playing out. We have three or four years of very strong borrowing and spending, followed by the next three or four years of weaker growth.

CU Times: What direction do you see the economy going in 2020? Is it going to continue growing or turn down?

Rick: Right now we’re growing at a 2% pace. We may actually drop below 1.5% in the fourth quarter, a big dip, maybe 1.3%. We may see a little bit of a bump in the first quarter, but then slowing down through the rest of the year from the 2% long-term trend growth to 1.4% to 1.5%. So maybe it’s not a full-blown recession, but kind of a growth recession, where growth is not as fast as normal.

CU Times: What role will interest rates play?

Rick: We had been forecasting interest rates to keep rising through 2019 and into 2020, but we’ve had this Powell pivot. [Federal Reserve Chairman Jerome] Powell has lowered interest rates three times over the last four or five months.

A lot of credit unions are worried about their margin compression, and that their earnings will be under pressure because of that.

You have a lot of headwinds blowing right now: Slower loan growth, lower interest rates. Both of those will combine to really push down earnings in 2020.

CU Times: Can’t credit unions just change their rates?

Rick: With interest rates falling, credit unions haven’t really pushed down their deposit rates yet. They’re worried about runoff. If they’re not matching the bank down the street, their members will pull out their bank deposits or CDs or money markets and move across the street to the bank or another credit union.

CU Times: What’s behind the slowdown in auto lending?

Rick: A lot of businesses have pulled back on their capital spending because of the trade war and all the uncertainty. The decline in business lending has led banks to pursue consumer loans more aggressively, including auto loans. They’re really pushed hard, and that’s stealing some business away from credit unions.

CU Times: The real estate market was a surprise in 2019. Where do you see that going?

Rick: The real estate market is holding up pretty well, especially with the big drop in interest rates. You see a lot of new home construction. The existing housing market is holding up because of the lower rates.

We expect in 2020 that the housing market will do well. We still have jobs being created. You will have the demographic effect of a lot of millennials in their prime home-buying age buying homes in the next year or so.

CU Times: You and other economists have been saying consumer spending is holding up the economy. Your latest report mentions “consumer fatigue.” What is that?

Rick: People have been spending above average on durable goods like cars, so in the future we’ll see less. We’re seeing a big increase in the savings rate in this country. You always want people to save, but it’s a little bit of a drag on the economy if people are saving and not spending.

CU Times: How can credit unions respond to margin compression? What will become more important, or less important?

Rick: With margin compression you will see a more watchful eye on how fast they want to expand their branch activity and buy new equipment. They may not open as many branches, and they might not invest as much to modernize and upgrade their computer systems for online and mobile banking technology.

CU Times: How much effect will this have on ROA? It’s been very high the last few years.

Rick: CUNA Mutual’s forecast for 2019 is 0.95% and 0.85% for 2020. It was 0.91% in 2018, and 0.80% is the previous five-year average. The rule of thumb in the banking world was 100 basis points is what you’d shoot for, so 85 basis points is below the long-run average you would shoot for. Since the Great Recession, we’ve been below that 1%, mainly due to margin compression. The interest rates have been so low, thanks to the Federal Reserve, that we’ve lost a lot of margins.

CU Times: You can’t go below zero.

Rick: There’s a bank in the Netherlands that has a negative interest rate on their mortgages now. The bank actually pays you to borrow money. I think it’s a negative 0.5% on their mortgage. It turns the whole world of banking upside down. Traditionally a borrower funds a bank or credit union by paying interest. But in the world of negative interest rates, savers would be the ones who fund the credit union. The negative rate on savings would be greater than the negative rate on loans.

CU Times: That sounds like the Upside Down in the “Stranger Things” series.

Rick: There are actually six countries in the world now with negative interest rates. There are a couple Federal Reserve Boards of Governors who say we could be next.

If rates keep falling in the United States, that’s something credit union boards will have to discuss. It may not go negative, but how low could it go in the United States? Lower than we’ve ever seen, which means margins will be tighter than we’ve ever seen.

CU Times: Would consumers accept that?

Rick: If it’s not too negative, like a negative 0.5%, that’s just kind of like charging you a fee to keep your money there. If you have to go to minus 1% or minus 2%, so that you put $100 in your account and only get $98 back, how many members will say, ‘I’ll just keep my money in a coffee can.’?

CU Times: Powell is still talking about a 2% inflation rate target. Is that realistic?

Rick: They’ll have a hard time hitting that target.

CU Times: What are you predicting for the inflation rate in 2020?

Rick: Below 2%. The value of the dollar is still rising, and as the dollar goes up, import prices fall. And as import prices fall, that drags down overall inflation in this country. You go into a Walmart and half the items are imported. Right now import prices are falling about 1.5%. We are importing deflation when we are importing goods from around the world. That means American prices can’t rise because they have to compete against all those imports. Also, oil prices are falling and are expected to fall in 2020.

CU Times: So that’s going to keep inflation below the Fed’s target?

Rick: The Fed keeps thinking that if they lower interest rates it will stimulate the economy, and push inflation up to the 2% target. But just like Japan the last 30 years, they’ve had a hard time getting their inflation up. They’ve been living through deflation these last 30 years. It’s called the Japanification of the world.