Prepare for a slow, gradual climb back from the depths of the Great Recession.
Few credit unions have come through this recession unscathed. Some have been hit harder than others. For most, just surviving the Great Recession has been a major accomplishment.
But we’re not out of the woods yet. As the economy slowly climbs back from the depths, the recovery—like the severity of the recession—will affect some credit unions faster than others. Credit unions in the “sand states” still are dealing with record-high mortgage foreclosures and loan delinquencies. Credit unions closely tied to manufacturing industries have been particularly hard hit—record-high unemployment is devastating their communities, and many members’ jobs will never return.
Credit union earnings declined to a razor-thin 15 basis points (bp) last year. The National Credit Union Administration’s (NCUA) corporate stabilization plan will put even more pressure on earnings this year—and for years to come.
The deepest recession in decades clearly has tested the movement’s agility and credit unions’ strategic planning abilities. If nothing else, the recession has taught credit unions that they must respond faster to market changes and members’ needs.
As boards and management teams look to the future, they should consider these 10 trends from the Credit Union National Association’s (CUNA) 2010-2011 Credit Union Environmental Scan (E-Scan):
1. The “shape” of the recovery. Economists are divided as to the sustainability of the current economic recovery. Some say we’re on a gradual upward trend toward full recovery and others say we’re heading for the second dip of a double-dip recession as soon as government stimulus programs dry up.
There are numerous barriers on the road to economic recovery—rising foreclosures, falling consumer confidence, weak state budgets, falling home prices, slower-than-expected job creation, and rising interest rates.
CUNA economists expect a subdued recovery in 2010 and continued expansion in 2011, with a 3% growth rate for both years. Inflation is not an imminent threat in the near term, but remains a risk in three to five years.
A faster growing global economy after 2011 will push up commodity, energy, and crude material prices, leading to potentially higher inflation. So far in 2010, core crude materials prices, which are a good leading indicator of global economic growth, are up 35% from a year ago. As these higher prices are pushed through the production pipeline, producer price and consumer price indexes will start to accelerate.
2. Unemployment. The recession that began in December 2007 resulted in 8.4 million job losses. There are currently more than 6.1 million people who have been unemployed for more than six months, up from 1.4 million two years ago. This is the largest number of “long-term” unemployed since 1948.
The long-term unemployed largely are made up of older (45- to 64-years old), low-skilled, low-educated males. Many were employed in the manufacturing and construction sectors, which are still shedding jobs. This rise in long-term unemployment is a serious concern for credit unions’ credit quality.
The “underemployment” rate (unemployment rate plus those who’ve been forced to go from full time to part time) climbed to more than 17% in the second half of 2009—the highest level ever recorded.
The unemployment rate will gradually fall in 2011 as employers increase hiring faster than new entrants enter the labor force. Firms remain reluctant to hire during this time of economic uncertainty.
The credit-quality turnaround for credit unions that have a lot of members who are structurally unemployed is a long way off. If your credit union has a lot of young, well-educated, highly skilled workers, your loan delinquency and charge-off rates will peak and start to descend in 2010.
3. The shifting middle class. The Great Recession has dealt a serious blow to middle-class families with staggering losses to their jobs, health insurance, savings, pensions, and home values. The plight of the middle class presents credit unions with both challenges and opportunities.
When members’ household finances are threatened by forces beyond their control, credit unions are faced with declining creditworthiness, rising loan delinquencies and foreclosures, and growing personal bankruptcies.
But credit unions also have a unique and rare opportunity to capitalize on members’ trust and shore up members’ finances through financial counseling and education. Credit unions must update their priorities and policies to play a significant role in building and keeping financially strong member households in the wake of this recession.
4. Lending. At the end of 2009, the Federal Reserve reported a 4% annual drop in consumer credit outstanding—the largest decrease ever. Part of the decline was due to households paying down debt. The other part was due to financial institutions’ loan charge-offs.
Credit union members demonstrated little appetite for additional debt in 2009, which resulted in a meager 1% rise in credit union loan balances—the smallest gain since 1943. Credit union loan growth is expected to be 4% in 2010 and 6% in 2011, but still below its recent five-year average of 6.8%.
Another reason for such slow credit union loan growth was an increase in the sales of mortgage loans into the secondary market. The percentage of first mortgages sold increased from 28% in December 2008 to 55% in December 2009.
The combination of low home prices, low mortgage interest rates, and continuing government home purchase incentives has increased originations of fixed-rate, long-term mortgages. During the past three years, credit union fixed-rate mortgages with terms greater than 15 years increased from 29% to 37% of total first mortgages outstanding.
Credit union loan delinquency will remain above 1.9% in 2010 but fall below 1.6% in 2011.
5. Housing market. The decimated housing market may get worse before it gets better. A record three million homes received foreclosure notices in 2009, and the pace continues. Monthly home foreclosures totaled more than 300,000 for the 12th straight month in February 2010. As the supply of homes on the market increases, home prices will continue to fall and hit bottom in 2011.
The biggest problem likely will be a flood of housing inventory hitting the market from rising foreclosures. With a mountain of specialized adjustable-rate mortgages (ARMs)—known as option ARMs and certain Alt-A mortgages—slated to reset during the next six to 12 months and with unemployment still hovering around 10%, the number of homeowners defaulting on their mortgages could surge. At least $64 billion in option ARMs will reset this year and another $68 billion in 2011, according to First American CoreLogic.
Through all this turbulence, credit unions have been picking up mortgage origination market share. Credit unions originated a record $94 billion in first mortgages in 2009, accounting for about 4.5% of total U.S. mortgage originations.
6. Pressure on earnings. The big question on the minds of many credit union executives today is whether or not the excess liquidity the Federal Reserve has pumped into the banking system will eventually lead to higher inflation. If inflation rises, the credit markets will respond with higher interest rates. This could present a significant risk for those credit unions holding large positions in long-term, fixed-rate mortgages.
A rising interest-rate environment could then lead to falling credit union earnings as rising funding costs outpace sluggish increases in asset yields. This scenario happened a generation ago and was a contributing factor to the demise of hundreds of savings and loans.
It’s unlikely we’ll see a significant upward move in inflation in the next few years. But with interest rates at historic low levels today, there’s only one direction they can head tomorrow. Credit unions should model the income-statement and balance-sheet effects of a three to four percentage-point increase in interest rates during the next two to four years.
Meantime, the current steep yield curve and strong deposit growth will be good news for credit union earnings. With the Federal Reserve maintaining a 0% to 0.25% target range for the federal-funds interest rate until the end of 2010, and longer-term interest rates possibly heading up, the yield curve could get even steeper during the second half of 2010 and even into 2011.
For credit unions with strong loan demand, the steep yield curve should increase net interest margins as they use low-rate, short-term deposits to fund longer-term, higher-rate loans. The higher net interest margins should help those credit unions cover loan charge-offs and NCUA assessments and earn their way out of the current financial mess.
Credit union earnings have passed their low point and will improve during the next two years. Lower loan-loss provisions, rising net-interest margins, and cost-containment efforts will boost earnings from 2009’s historic low of 15 bp. Credit union earnings are expected to recover to 40 bp in 2010 and 60 bp in 2011 (before corporate stabilization expenses). Credit unions should budget for NCUA assessments to consume 20 to 40 bp of assets for years to come.
7. Compliance burden. Credit unions have never shouldered a heavier compliance burden than they do right now. The recent banking crisis has triggered a regulatory backlash from Congress designed to increase the transparency of financial products and services and protect consumers from egregious practices. One of the biggest challenges in the first half of 2010 was complying with changes to Regulation Z’s open-end lending provisions.
A few others on the immediate horizon include dealing with August deadlines covering Regulation E’s overdraft rules for existing accounts, and several additional Credit Card Accountability, Responsibility, and Disclosure (CARD) Act provisions. And, eventually, the Fed will issue the final rules for both closed-end mortgage loans and home equity lines of credit.
Check cuna.organd Credit Union Magazine’s monthly Compliance Matters section (p. 60) for the latest updates.
8. Bank backlash. For the past year, banks have been subjecting consumers to some outrageous treatment—imposing high rates and fees, lowering credit card limits, taking taxpayer money for bailouts, paying large bonuses to top executives, and instituting unreasonably stringent underwriting standards.
As painful as these practices are for millions of consumers, most of them still haven’t reached a high enough pain threshold to make the switch from banks to credit unions.Like it or not, there’s a great deal of inertia in banking relationships—once the relationship is formed, it takes a tremendous amount of energy to motivate people to change.
Credit unions need a long-term, consistent approach to marketing to overcome that inertia. All marketing materials and campaigns should have a consistent message and brand. When bank customers finally reach their pain threshold, many of them will remember your marketing message and turn to your credit union.
9. Corporate restructuring. The comment period for NCUA’s proposed changes to its corporate credit union regulation ended in March 2010. The agency will spend the balance of 2010 interpreting and considering these comments. Credit unions can expect an interim rule to be issued later this year, but the complexity of the issues could make this a long, involved process.
The corporate restructuring proposal looks at: new capital requirements, prompt corrective action provisions for corporates, investment authority, credit risk management and concentrations of credit risk, asset/liability management policies, liquidity management, corporate credit union service organizations, and corporate governance issues.
For planning purposes, credit unions should anticipate corporate stabilization costs to reduce their earnings 20 bp to 40 bp for years to come.
10. Newly credit-impaired members. One of the lingering legacies of the Great Recession will be a new category of borrower called the “newly credit impaired” (CU Mag 4/10). About two million consumers have dropped from a higher credit score band into the lowest score band between the second quarter of 2008 and the second quarter of 2009.
Strategic planning discussion should center on lending policies and procedures, for example: What will your credit union do with loan applicants who have foreclosures listed on their credit files? Were they caught in one of the worst real estate markets in recent history? Did they own a home in one of the “sand states,” where housing values dropped drastically? Did they default because they had to move for job reasons and couldn’t sell their old homes? Did they strategically default on their homes, but paid all of their other bills? Did they use a stated-income loan to purchase a home they couldn’t afford?
“There’s precious little data—other than a credit score—currently available to help predict which of these borrowers will repay their loans,” says Bill Vogeney, chief lending office and senior vice president at Ent Federal Credit Union in Colorado Springs, Colo. “I don’t think a credit score is going to be a very valuable tool in measuring risk for the newly credit impaired. Instead, credit unions will have to become more comfortable making what I call ‘story loans’.”
Story loans are based on members’ stories of what caused their past problems, says Vogeney. In these cases, credit decisions are based more on members’ character—current job, attitude, and the circumstances surrounding their past credit—than their current credit scores. The bottom line: The story has to be reasonable and make sense.
If a member claims his credit problems were caused by a job loss in 2009, make sure you don’t see a history of serious credit problems before 2009. If a member claims a divorce caused him to default, make sure his past accounts were joint obligations and were approved using two incomes.
A few years ago, the economy was doing very well, and a lot of lenders were going after credit-impaired borrowers. But times have changed. In 2010 and beyond, fewer lenders will pursue credit-impaired borrowers, but more borrowers now need loans. Credit unions will have to become more skilled at lending to members who don’t have excellent credit. Improve processes such as income verification, collateral valuation and inspection, and collections to safely capture this segment of the market.
HITTING A MOVING TARGET
The challenge credit unions face as they conduct their strategic planning sessions is like hitting a moving target. Market forces are changing so quickly, your goals need to be constantly adjusted and realigned. That’s why it’s essential to keep your competitive and strategic intelligence fresh, regularly conduct member and nonmember research, keep your boards and management teams up-to-date on the latest trends, and design your products to meet members’ current and future needs.
To make sure credit union strategic planning teams have the latest data and analysis, CUNA’s Credit Union Environmental Scan is adding a monthly newsletter and a companion Web site. What was once CUNA’s CU360 newsletter and Web site is becoming the Credit Union E-Scan newsletter and Web site. You can find more information at escan.cuna.org/planning.
The eight-page monthly newsletter delivers to subscribers the same type of information the annual E-Scan delivers—national trends and advice designed to arm strategic planning teams with the most current information and insightful analysis possible. And the E-Scan Web site will be there whenever you need it with the same critical information your planning team needs to set goals.
As the importance of planning grows, so does the family of E-Scan products. The newsletter and Web site now join the annual report, DVD, PowerPoint presentation, and planning guide to equip your team with everything it needs for productive and insightful strategic planning sessions.
• CUNA, strategic planning resources:
1. 2010-2011 Credit Union Environmental Scan: buy.cuna.org. Available as a report (enter 29436 in the product finder), DVD (29437), PowerPoint (29438P), or strategic planning guide (29439K).
2. Credit Union E-Scan newsletter and Web site: escan.cuna.org/planning.
3. Board training options: training.cuna.org, select “board & volunteer.”