By Ray Birch
MADISON, Wis.—There are any number of economic issues affecting or with the potential to affect credit unions, but one economist is particularly concerned about one data point—although he also sees some positive trendlines, too.
CUNA Mutual’s chief economist, Steve Rick, said what most worries him at least in the near term is that credit unions’ yield on asset ratio fell to 2.9% in the first quarter of 2022, the lowest in credit union history—and significantly below the 4.6% long-run average.
The ratio has fallen 112 basis points from the 4% set in 2019, right before the COVID-19 pandemic, Rick said.
“This 28% drop in interest earnings as a percent of assets is a serious concern for credit unions, since 72% of their total revenues come from interest revenues,” said Rick. “The other 28% of revenues come from fees, interchange income, gains on the sale of mortgages, etc.
“In the first quarter we still had those record-low interest rates, back in January and February, before the Federal Reserve began pulling the trigger on really raising rates,” said Rick, addressing the yield on asset ratio. “The fact is interest rates were extremely low and the interest we are earning on our loans and investments are also rock bottom. And new loans that we were booking at those low rates… the overall average yield on assets dropped to the lowest we've ever seen in credit unions.”
At the same time CUs are putting on super-low-rate loans, there is implications from “mix effect” to address, added Rick.
“At the same time, we have this interest rate effect, the second thing to pay attention to is just the mix of assets, which we call the mix effect,” explained Rick. “We had just a lot of investments in our portfolios, so when you have low-yielding investments taking up a good chunk of our assets, that also brought down the overall average yield on assets (or) the combination of the mix of our assets and the interest rates on our loans…”
An Increasing Concern
Why this becomes increasingly concerning, according to Risk, is that all of this is placing downward pressure on net interest margins.
Steve Rick
“With the yield on assets falling, our cost of funds has not been falling as fast, because our costs are already at rock bottom rates,” he said. “You can't get really much closer to zero. Basically, our cost of funds are very close to zero, and that means our net interest margin, or the spread, is also at a record low level. We need that margin, that net interest income, to cover operating expenses to keep the credit union running—to pay for office operations and salaries. When you have the tightest net interest margin in credit union history it makes it hard to generate earnings.”
The Good News
But what has been somewhat unexpected in the first four months of the year for credit unions has been the strong loan growth.
“Going through April, credit unions have experienced the fastest loan growth in credit union history,” said Rick. “Loan balances rose 5.2%, just in the first four months of this year…The good news is things are turning around and loan growth is accelerating, and that's going to help with the mix effect I mentioned. More of our assets are going into loans and taking money out of investments to fund those loans. Loan demand has been very impressive in the first half of this year.”
Rick pointed out that while first mortgage activity is now slowing, home equity loans are “booming,” as are used auto loans.
“Even new auto loans are coming back,” said Rick. “We are forecasting loan growth to be 11%, maybe even 12%, which would be really strong compared to normal loan growth, which is about 7% annually. With the Fed continuing to raise interest rates, that will slow loans. So, we are forecasting only 8% loan growth for next year.”
Yet those Fed interest rates also come with a silver lining—credit unions will be earning more on their investment portfolios, reminded Rick
“Everything is turning around for credit unions,” Rick said.`
The Potentially Difficult News
Yet there remains one potential headwind for all credit unions, and that is the potential for a recession.
“I forecast about a 50% probability will have a growth recession and a 20% probability we could see a soft landing,” said Rick, adding he believes the chances are less for a recession in which the economy will experience negative growth. “I see the chance greater for a growth recession, where the economy will keep growing, but at a very slow pace.”