Expectation of Slow Jobs Recovery Behind CUNA Forecast

CUNA Chief Economist Mike Schenk holds two seemingly divergent beliefs: The economy will grow robustly this year and credit unions will wind up with lower net income margins than in 2020.

The first assertion is shared by most economists. However, Schenk is among those who believe we are experiencing a K-shaped economic recovery with the haves benefitting most, and the have-nots lagging way behind.

In part, the conservative outlook on credit union earnings is shaped by the expectation of that uneven recovery, because Schenk said the labor market is the underlying premise for many of the numbers in the joint forecasts by CUNA and CUNA Mutual Group, both of Madison, Wis.

The April forecast showed credit unions generating net income in the first quarter at an annualized rate of 0.60% of average assets. They also forecast 0.60% ROA for the full 12 months of 2021 and 2022.

Actual ROA last year was 0.71%, down from 0.94% in 2019.

First-quarter results are already in for the Top 10 credit unions, which account for more than 15% of credit union assets, and they showed much higher results. ROA rose from 0.51% in 2020’s first quarter to 1.48% in this year’s first quarter. Most of the gain was from receding loan loss provisions, but ROA was also helped by cost-cutting that overcame a drop in income.

In an interview last Thursday, May 6, Schenk said there will be many bright jobs reports ahead, noting the consensus estimate that the May 7 job report would show a robust gain of one million jobs. (The Labor Department reported a seasonally adjusted gain of only about 260,000 jobs.)

But even with April’s jobs gains, Americans still have more than eight million fewer jobs than they had before the pandemic. Or, as Schenk put it, “basically where we were in the depths of the Great Recession.”

CUNA economists said they expect the economy to return to full employment, 4% to 4.5%, probably by the middle of next year.

“We do expect to see strong economic recovery this year, but the labor market recovery is going to have a long tail,” Schenk said. “The operating result at credit unions will mirror that long tail we see in the labor market recovery.”

“Because there continues to be a bunch of uncertainty, even though there’s a lot of pent-up demand, we think consumers are going to be pretty cautious,” he said.

For credit unions, that means savings rates will remain high and borrowing low.

Last year savings grew a record 20%; this year’s forecast calls for 15%. Loan portfolios grew 5.4%; this year’s forecast is for 5%.

CUNA’s estimate for March showed savings grew 23.8% and loans grew 4.9%.

The high rate of savings will mean a fast rise in asset growth, probably 12% this year. Schenk said that would be great if credit unions could lend out that money; instead they’ll be forced to sink it into short-term investments that earn almost zero interest.

Schenk said two broad areas of portfolios increased last year: First mortgages and business loans, including Paycheck Protection Program loans.

Last year, credit unions’ residential real estate originations grew 58% to $300.6 billion, while production of loans for automobiles and other non-real estate loans grew 5.9% to $351.4 billion.

This year, the Mortgage Bankers Association said it expects total first-mortgage originations for all lenders to fall 14.2% as refinances fall 32% and purchases rise 16%. It said it expects a further 30% drop in total originations in 2022.

As a result, Schenk said credit unions will have far fewer sales into the secondary market, reducing operating income. “That really drove earnings results in 2020,” he said.

Long-term interest rates are rising this year, which means that loans will be earning higher net interest margins. But with the mix of assets weighing too heavily toward low-yield investments, the overall net interest margins will drop, becoming a major cause of lower net income margins.

Those margins, of course, are measured as returns on average assets. For credit unions, the arithmetic is simple, but the math painful: As that asset denominator grows, net income has to rise at least as fast to show a gain.

And, for the reasons, Schenk outlined — lower mortgage originations and weaker net interest income — net income will fall behind asset growth.

One help for credit unions is the NCUA’s promise to be lenient on them when their net worth margins fall below the 7% “well capitalized” threshold when the reason for the drop is rising savings, rather than declining asset quality or other issues.

“The agency sees it as far better than turning depositors away just to maintain strong capital ratios,” he said.

“We’re here to serve members in tough times,” he said. “And these are tough times that are really being reduced by this unusual level of stimulus. That’s not the fault of credit union management or strategy; it’s exclusively the result of fiscal policy.”