LAS VEGAS–Credit unions will almost certainly report robust financials at year-end 2016, but one analyst sees more headwinds than tailwinds ahead.
One of those headwinds: loan yield has been declining by an average of 25 basis points per year, and will likely continue to do so
Steven Houle, VP-Advisory Services with Catalyst Corporate, said that when he tallies up the economic challenges-- China’s economic transition, falling commodity prices, emerging market recessions, and the IMF’s statement it sees a lack of policy space to manage economies—and compares those with the positive trends—accommodative monetary policy, lower oil prices, and growth in advanced economies, the former wins.
Steven Houle, Catalyst Corporate
Speaking to the issue of Key Global Economic Issues during Catalyst’s Accelerating Success Conference here, Houle said the statement that best sums up the global economic picture right now is a statement made by the IMF in April: “Too slow for too long.”
Looking to U.S. real GDP in 2015, it increased at the same rate as 2014, said Houle, although fourth quarter growth was a meager 1.4% compared to 2% in the prior corner. “As of its March 2016 meeting, the Fed projects real GDP to be between 2.0% and 2.2% between 2016 and 2018,” said Houle. “Interestingly, there were a few differences in this year’s first quarter versus first quarters of last few years: one, no bad weather. But the more disturbing one is that there were no off-setting growth trends. We need to have a rebound in the second quarter, or we’re going to be in trouble.”
The unemployment rate, however, has remained a bright spot, observed Houle, with the Fed projecting it will slide to 4.7% by year-end 2016 from the current 5%. He called the current 59-week streak of initial jobless claims remaining below 300,000 “amazing.”
“The one key here is this: Consumers really aren’t spending their excess money. They are actually saving more,” said Houle. “I think some of the first quarter deposit growth is going to stick around a little longer.”
As for the big question of when will the Fed move again on rates, Houle said, “The Fed would like to be more convinced inflation will stick before raising rates again.”
As have other forecasters, Houle urged credit unions to prepare for a decline in new auto sales, and further cautioned the more important issue to watch is rising delinquencies. As CUToday.info has reported, new JD Power data show that in most recent quarter loans 72 months or longer accounted for more than 33 % of sales, and 31.3% of all car owners owe more than their cars are worth,
“A member who finances a $35,000 vehicle at 0% for 60 months is in a negative equity position for approximately 34 months,” said Houle. “A member who finances a $35,000 vehicle for 84 months is in a negative equity position for approximately 41 months.”
Other issues touched on by Houle:
The Yield Curve
“I think you are probably in a more rate challenging environment now than you were even two or three years ago, and will be into 2017, due to shape of the yield curve,” said Houle. “The Treasury curve has flattened since year-end and is shifting in a non-parallel fashion. The spread between the two-year and 10-year has tightened 19 BPs since the end of December 2015. I think a lot of pressures are going to remain on the yield curve.”
Credit Union ROA
Houle predicted credit union earnings will be lower in 2016 than previous years, and will average around 65BPs.
Assets & Net worth
Houle said credit union net worth growth has been approximately 7% for the past five years. The industry’s net worth ratio has also been increasing the last five years due to strong earnings and managed asset growth.
Loans
Houle noted loan growth has been increasing for five consecutive years. The industry’s loans-to-assets ratio was 66% at the end of 2015, the highest level since 2009. Year-end growth numbers continue to finish higher than mid-year projections and 2016 should be the same, around 10%.
“I think 2016 will be a strong year for lending, but I have concerns around earnings,” he said.
Loan Allocations
Houle, who is an advocate of credit unions making more real estate loans, said that real estate allocations are now approximately 50% of the total loan portfolio, followed by vehicle loans at 33%
Credit unions made $86 billion in fixed-rate, first mortgage loans during 2015, a whopping 46% increase over 2014.
At the same time, foreclosed real estate loans were down 20% in 2015 compared to 2014.
Share Growth
Share growth continues to be in non-term accounts, Houle said. Term certificates increased for the first time in seven years in 2015, but “unfortunately only count for 19% of total shares and deposits. In 2009, this figure was 30%.”
What are credit unions doing to mitigate that? Using lower-cost alternatives to replace the run-off in term certificates, including going the non-member deposit route with $6.6 billion in deposits, said Houle.
Liquidity
With tighter liquidity profiles, Houle said credit unions are actively selling loans and investments. Loan participations outstanding are currently $24 billion, a 95% increase since 2011.
Earnings
The increasing loans-to-assets ratio has helped maintain the industry’s asset yield as more assets have been reallocated from lower-yielding investments to higher-yielding loans,” said Houle, who asked a rhetorical question, “Has cost of funds hit a floor at 50 BPs?”
“The only saving grace has been that a low provision expense has helped increase the industry’s net margin,” said Houle. “This is the biggest concern to credit unions. Loan yield has been declining by an average of 25 basis points per year, and will continue to do so.
Houle forecast that the credit union net margin average in 2016 is probably going to be lower than 291. Net operating expense has increased since 2011 as non-interest expense has increased, he noted.
The Forecast
“The industry’s earnings profile is strong, but will continue to face downward pressure with a flat yield curve,” said Houle. “II think the days of 1% ROA are long gone. Strong earnings and modest asset growth should push the industry’s net worth ratio to 11% in 2016. Loan growth should be 10% in 2016 as strong demand for vehicle and real estate loans continue. This will push the industry’s loan-to-asset ratio close to 67% by year-end 2016.”
To optimize loans, Houle offered this Loan Optimization Question Checklist:
- What types of loans are your members seeking?
- What’s your current loan mix?
- How are your current loans performing?
- What are your current limits?
- What’s your appetite for risk (IRR/Losses)
- Are staffing and expertise available?
- What’s your current capital level?