Challenges Lie Ahead for Credit Unions

Credit unions have had one of their best runs so far this year, but economists said the road ahead is likely to be bumpy as mortgage originations fall, autos remain in short supply, wage pressures rise and net interest margins remain tight.

On top of that, the weird gyrations of loan loss provisions that sucked earnings out of 2020’s first half and inflated earnings in 2021’s first half will be returning to a normal that will tend to make year-ago comparisons less favorable.

And while economic growth will be strong this year, the U.S. Bureau of Economic Analysis took some air out the tires Oct. 28 when its preliminary estimate for gross domestic product growth from the second quarter to the third quarter came in at a seasonally adjusted annual rate of 2% – far less than many economists expected.

CUNA, for example, had forecast in September that GDP growth would be 4.5% for the third quarter and 6% for the year.

CUNA Chief Economist Mike Schenk said he now expects GDP growth for the year will be 5.5%, which he said is still a “very, very strong number.”

Much of the drop in GDP was because of supply chain issues that held back sales of automobiles, and to a lesser extent, new homes. Schenk said Fed reports indicate that manufacturers believe those supply issues will be clearing up in three to six months.

While inflation is causing pain for many now, Schenk said he believes it is transitory. Most of the big month-to-month gains occurred in the second quarter, and gains since then have been small. Year-to-year it is likely to end 2020 at 5.5%, which would be the second highest in the last 40 years. But Schenk said the comparisons will become better by mid-2022 and inflation is likely to fall back to 2.5% in 2022.

“The increases, we think, are in the rear-view mirror,” Schenk said.

Steven Rick, chief economist for CUNA Mutual Group, said consumers are still feeling flush with cash. The year-to-year increases in savings have diminished this year, but average savings per member remains high. Savings per member has risen from about $10,860 in June 2019, before the pandemic, to about $13,490 in June this year, Rick said.

“That’s a huge amount of liquidity or purchasing power ready to be spent,” Rick said.

At the end of 2020, savings were 20% higher than a year earlier, nearly triple the long-run average of 7%. Rick said he expects savings balances to grow 12% this year and 6% in 2022 as members increase their spending on leisure and hospitality.

He added he also expects lending to rise. Credit union loan balances grew 5.3% in 2020, and growth was 5.3% from August 2020 to August 2021. For 2022 and 2023, Rick said he expects loans will grow 9% per year as the economy resumes its normal growth, unemployment rates fall and infrastructure spending kicks in.

Meanwhile, payoff rates for credit cards and other high-cost, short-term debt remain high.

Pandemic effects that are lingering also include lower spending for certain services – face-to-face activities such as going to movie theaters, eating in restaurants and staying in hotels, Rick said.

The Fed’s most recent report showed credit card balances continuing their recovery in August, but still falling short of their pre-pandemic levels. Credit unions were 5.7% below February 2020’s balances, while banks were down 9%.

By next summer, Rick said he expects credit card balances will finally reach pre-pandemic levels at credit unions.

Another major area with pandemic-related economic effects is the auto market. Curt Long, chief economist for NAFCU, said the shortages of semiconductor chips has reduced car production, and in turn sales, and in turn lending.

“We’ve got another couple of quarters to go before we start to see some relief there,” Long said.

Long said he expects the suppressed demand will resurface when supplies resume, allowing credit unions to increase their lending.

“You will see some above-trend loan growth for credit unions once we get on the other side of this disruption,” Long said.

Normally U.S. dealers have about 750,000 new cars on their lots. In October they had about 150,000. “That’s a huge drop in the inventory of cars,” Rick said. “So sales are way down.”

Sales fell from 17 million new cars and light trucks in 2019 to 14.4 million in 2020. IHS Markit, a London-based analytics company, forecast sales will rise 4.6% to 15.1 million this year and 2.6% to 15.5 million in 2022.

CUNA Mutual Group’s Credit Union Trends Report showed new car loans stood at $142.8 billion on Aug. 31, down 0.6% from a year earlier and down 0.1% from a month earlier. Used car loans were $257 billion, up 7.1% from a year earlier and up 1.1% from July.

Rick predicted that credit union new car loan balances will continue to fall for the next nine months as loan repayments exceed originations.

In real estate, Schenk said purchase mortgages will remain healthy, but not enough to overcome a sharp drop in refinances as long-term rates rise.

Overall, CUNA forecast credit union first-mortgage originations for the full 12 months of 2021 will be $180 billion, down 20% from a record $252.2 billion in 2020. Next year, CUNA forecast first mortgages will fall 36% to $115 billion.

The Mortgage Bankers Association forecast that the rate for 30-year fixed rate mortgages will rise to 4% by the end of 2022. Rick said the rate forecast is in line with his expectations for 10-year Treasury bonds, which track closely with long-term mortgage rates.

“We expect Treasury notes to rise 1 to 1.5 percentage points over the next year or so as the Federal Reserve tapers down their quantitative easing program,” Rick said. “For credit unions, that’s going to mean a huge slowdown in the mortgage refi business, and big reduction in their gains on sales of mortgages.”

That’s not only because of the lower volume, but also lower margins. Credit unions are now making about 2.6% on the sale of mortgages to Fannie Mae and Freddie Mac. That’s down from a high of 3% in 2020, and it’s likely to fall next year to its historical average of about 1.5%.

CUNA Mutual Group’s Trends Report forecast that credit unions’ return on average assets will reach 0.95% for the full 12 months of 2021, the highest level since 2004.

Long said heavy loan loss provisions from early in the pandemic have been followed by income recoupment or lighter-than-normal provision expenses.

“That’s supporting ROA right now, but obviously that can’t continue indefinitely,” Long said.

Rick predicted credit unions will increase loan loss provisions to levels closer to the long-run averages next year as loan growth accelerates and stimulus checks disappear.

Long said one of credit unions’ biggest challenges over the next year will be responding to tight net interest margins.

Net interest before loan loss provisions had ranged from 0.70% to 0.79% of average assets from the first quarter of 2015 through the first quarter of 2019 for federally-insured credit unions. NCUA data showed it peaked at 0.80% in 2019’s second quarter and has steadily declined since. It fell below 0.70% in last year’s third quarter and stood at 0.63% in the second quarter of this year.

“It’s still plummeting,” Long said. “Something dramatic would have to happen for it to stop shrinking. It will bottom out once we get the data rolling in from Q4 of this year, but it’s going to stay at a very low level for a while.”

Another pressure on ROA is pay and benefits. The scarcity of labor has led many credit unions to raise wages for tellers and other workers.

“As employers, they’re probably thinking about it,” Long said.

From 1999 to 2019, NCUA data showed pay and benefits accounted for just under 50% of operational costs at federally-insured credit unions. That number rose to just over 52% last year and in the first half of 2021.