Average net income for credit unions in 2012 will be about 90 basis points (bp) of average assets—the first time since 2006 that return on assets (ROA) has been in the long-term “normal” range of 80 bp to 100 bp.
From 2007 to 2011, ROA averaged only 40 bp—less than half of what we had come to expect as normal. Most of the decline was caused by a sharp increase in provision for loan loss expense, although corporate stabilization expenses also took a toll.
With delinquency and loan charge-offs falling, and with high loan loss allowance levels built up during the recession, provision expenses will remain low. As a result, CUNA’s economists forecast ROA of 90 bp in 2013 as well.
Although ROA for 2012 is in the same ballpark as it was in 2006, there have been significant changes in its composition (“CU Earnings”). The compression of interest rates to their lowest levels in more than 60 years has lowered gross spread (net interest margin) below 3% for the first time in memory (2.92%), a decline of 25 bp since 2006.
Compensating for this has been a 24 bp increase in “other income” and a 23 bp drop in operating expenses. The boost in other income results largely from mortgage refinance activity. The decline in operating expenses actually understates improvements in credit union efficiency, as it includes about 8 bp in corporate stabilization assessments.
Some of these changes are temporary; others may persist. In particular, the mortgage refinance boom should be the last major event of this kind for quite some time. That’s because mortgage interest rates are unlikely to ever fall much below recent levels. When the refinancing ends, “gains on sale” resulting from mortgage originations will be sharply reduced as a source of income.
Fortunately, this should be accompanied by a recovery in net interest income. The very rise in interest rates that chokes off refinancing will raise yields on loans and investments.
Likewise, the temporary corporate stabilization assessments should end in two to four years, allowing even greater reductions in expense ratios. The improvement in credit union efficiency during the past few years will likely persist, although the need to keep up with constantly changing technology will create continued cost pressures.
An important factor not shown in the table is the difference in outcomes for smaller credit unions. They’ve experienced the same interest- margin compression that larger credit unions have but without growth in other income, because most small credit unions don’t originate first mortgages for sale.
The estimated 2012 average ROA for credit unions with less than $50 million in assets is only 25 basis points—a quarter of the overall average—and a third of these credit unions had negative earnings for the year.
A concern for credit unions of all sizes is what happens if interest rates stay very low for a long time, especially if mortgage refinancing slows before rates rise.
Because deposit rates can’t go much lower, and longer-term loans and investments will continue to roll over into lower interest rates, this would put even more downward pressure on net interest income and, hence, earnings.
This could push ROA below our 90 bp forecast. In this event, some credit unions might be tempted to hold longer-term loans or investments to shore up earnings.
It is exactly to avoid such situations that credit unions build capital ratios. Having sufficient capital to accept lower than desirable ROAs for several quarters is far preferable to the serious shocks that could result from exposing a long-term, fixed-rate balance sheet to a sustained rise in interest rates.
BILL HAMPELis CUNA’s chief economist and senior vice president of research and policy analysis. Contact him at 202-508- 6760.