CUNA: Recession Will Only Dent Credit Unions Next Year

CUNA said it expects a recession next year that will be mild enough to put only a small dent in credit union income.

CUNA Senior Economist Ligia Vado said in the group’s most recent Economic Update that the economic team’s recession prediction is based, in part, on the Fed’s rapid increase in the federal funds rate this year to tame inflation.

CUNA said it expects the federal funds rate to rise to 4.35% at year’s end and to 4.5% to 5% by the end of 2023. Meanwhile, it expects inflation to ease to 4% next year and 2.5% in 2024 — close to the Fed’s 2% target.

The recession forecast is also based on two usual indicators: Two consecutive quarters of decline in the gross domestic product (this year’s first and second quarters) and an inverted yield curve. The yield on 2-year Treasury notes exceeded the yield on 10-year notes by 30 to 40 basis points from July to October.

Over the past 50 years, yield curve inversions of that size have been followed by recessions within six to 12 months. The COVID-19 recession maintained the streak; although it was also a demonstration that correlation is not always causation.

In any case, based on the inversion timing, CUNA forecast that the recession will start in the first half of next year.

“This recession will be relatively mild,” she said. “The downturn will be nowhere as short and sharp” as the recession from February to April 2020 as the COVID-19 pandemic began, or as “deep and extended” as the Great Recession from 2007 to 2009.

“Members’ healthy financial condition is one of the most important reasons why if, indeed, there is a recession next year, its impacts on credit unions will be much less severe” than the Great Recession, Vado said.

Vado said credit unions should expect three main trends:

1. Lending will slow, while savings will grow. CUNA forecast loan balances in December will be 18% higher than a year earlier, “the strongest calendar-year growth in over 25 years,” she said. Next year loans will rise 7%, compared with a 10-year average of 8.2%. Savings which grew a record 20% in 2020, are expected to rise only about 3.5% in the 12 months ending Dec. 31 and 6% in 2023. The 10-year average for savings growth is 8.1%.

Vado said this year’s high loan growth is a product of both pent-up demand from the pandemic and inflation. Another factor is slowing pre-payments on mortgage loans originated at bargain interest rates. “And, so far, credit unions have been slow to increase consumer loan interest rates,” she said.

The weak savings growth is due in part to members spending down the excess savings they built during the worst of the COVID-19 shutdowns, Vado said. “More recently, members with larger balances are likely finding rates at internet banks, money market mutual funds and even Treasury bill more attractive,” she said.

2. Liquidity will tighten. CUNA forecast the loan-to-share ratio will rise from 79% on Sept. 30, to 81% by December 2022 and 82% by December 2023. “Many credit unions now are fully loaned up and facing significant liquidity challenges,” she said.

3. Earnings will fall. CUNA estimated annualized returns on average assets (ROA) will be 0.65% in both the third and fourth quarters. It had previously forecast 0.70% ROA for the third quarter and 0.60% for the fourth quarter. For 2024, it said it expects ROA will be 0.60%, down from 0.75% this year.

“Interest rate increases normally boost credit unions’ earnings, but the inversion of the yield curve may increase deposit costs more than loan yields,” especially for credit unions vulnerable to losing business to fintechs and other non-banks, Vado said.

Operating income will fall as slower household spending reduces interchange income and income from mortgage refinancing remains at a trickle as mortgage rates remain high.

Finally, operational expenses will rise due to inflation.

Net charge-off and delinquency rates will rise, but will remain well below historical averages, Vado said.

“These low readings are likely due to a low unemployment rate and the fact many members’ balance sheets improved substantially due to savings accumulation and reduced borrowing for big-ticket durables as a result of COVID,” she said.